Economy and Market

Jan 17, 2011. US Employment picture improved in Non-farm payroll and the four-week average of the initial jobless claim. Core retail sale in December was flat, and the ability of the consumers to increase spending should tie with the employment situation. Job lost in public services and job added in Healthcare, retail, leisure, business services, and durable goods manufacturing. The expectation for the fourth quarter GDP was 2.7%, and the first quarter ’12 should be softer. During the earning season coming up, Financials and Energy sectors will be closely watched for profitability. JP Morgan and Citi bank were a disappointment.

In Eurozone, retail sales and industrial production for November were very soft but business climate and investor confidence improved in December. The sovereign bond auction in Italy and Spain had great demand and brought down the yield. In Germany, there were mixed results, such as decent retail sales and trade balances but weak factory orders and industrial production. The recent data showed that GDP and unemployment rate were decent but PMI services were a touch lower. Italy and France held up better than countries like Spain. Inflation came down in UK, and house price seemed on a slow path to recovery. Japan machine tool order increased in steel and industrial machinery and with trading partners such as China. Lending and monetary base also increased slightly, but retail sales and domestic orders were weak.

In emerging countries, China had less soft data than expected, such as in GDP, money supply, and industrial production. Retail sale was also stronger, helped by an early lunar new year, and have grew at much faster pace than export. Producer price came down as well. In Brazil, lower commodities price cooled the economy, as shown in equipment and clothing manufacturing. In India, the industrial production and car sale showed the strength of consumers, such as in basic goods and consumer non-durables. Food and primary articles prices softened. Russia net export increased, mainly with commonwealth countries.

Regarding to asset classes expectations, there are different views out there. One view is that many developed countries including US are still in deleveraging, and the process typically takes many years. Equity return typically is not very good or better than bond return. The opposing view is that equity is much cheaper than it was many years ago, and it could bounce given that we just had large negative return in Q3 of 2011. Besides, what if Fed comes out with QE3 in the spring? Should not we be front running it? Whatever your view might be, putting too many eggs in one basket may not be a good idea.

Jan 3, 2011. US saw continued strength in manufacturing and lower prices. The initial jobless claim was on a trajectory to lower claims. Retail sales and consumer confidence were decent given the deleveraging process and very little income growth.

Manufacturing and services in Eurozone improved as a whole and in various countries like Germany, France, Italy, and UK. However, business and consumer confidence improved in Germany but not in other countries. In Japan, third Quarter annualized GDP of 5.6% was one of the highest among the developed countries, helped by the rebuilding after the earthquake in the first quarter. Purchasing manager survey (PMI) also became expansionary. However, retail sales and business outlook were lower.

In China, manufacturing and services improved. Retail sales continued to be strong whereas producer and consumer prices both came down. Fixed asset investment softened a bit but the foreign direct investment became negative. In India, inflation came down especially in food and primary articles. Brazil inflation also came down, whereas PMI strengthened slightly. Russia retail sales and production were strong, and inflation pressure was upward.

December 6, 2011. In US, the third Quarter real GDP was at 2% annual growth rate from the prior quarter. Consumer outlook bounced from the low in Oct. The 50 cents drop of average gasoline prices from the high in May provided additional comfort to consumer spending. The weakness outside US actually lowed the energy prices and helped the economy given the abnormally gasoline prices last year. Survey showed that the Black Friday sales were stronger than in the prior two years. The Christmas gift spending survey conducted by Gallup showed the intention was back to the level of ’06 in dollar term and on a brisk upward trajectory since ‘09. Payroll growth was better than expected, helped by the retail hiring for the holiday sales. Unemployment rate dropped from 9.2% to 8.6%, even though part of the drop was due to some people were no longer looking for a job. The fiscal deficit constraint including the expected spending cut would put a constraint on the economic activities next year, but the Federal Reserve could do more quantitative easing if things get much worse than expected. In the market, the fear of double dip recession subdued, and asset prices reflected the expectation of a modest recovery next year.

In China, manufacturing and services softened in Nov relative to the prior months. In response, the central bank eased the monetary base by loosening the reserve requirement of banks. Inflation was expected to soften as a result of weaker manufacturing activities. A recession in Europe could easily set back one percentage GDP by weakening Chinese export if there is not sufficient monetary or fiscal actions to offset that. India manufacturing and services PMI saw slight increase in Nov from the recent low in Sept and Oct. Food inflation also softened even though fuel related inflation was still high. Brazil manufacturing was also improving from the Sept low, and the central bank cut the target rate from 10.5% to 10% last month. Russia industrial production and car sales in Oct were decent, even though the political corruption came into light in the recent election scandal. With central banks supporting the EM economies and the strong consumers spending, the economy could continue expanding at a rate close to the historic average.

Europe manufacturing continued to drop in Nov, offset by the improvement in services. However, political headline drove down the investor sentiment to levels much lower than the economic numbers would suggest. At one point, people were concerned about whether a few weaker countries like Greece would leave Eurozone or the Euro bloc. The credit ratings of the 17 European countries were in doubt due to the political discord and the inability to take the needed actions. The summit next week gave investors some comfort that Germany and France will lead the countries into more fiscal integration and responsibility. European central bank (ECB) was expected to act meaningfully if there is an agreement on fiscal integration. At the minimal, ECB can lower the rate further if the European economy including Germany was weak in the future months. If some political clarity toward fiscal integration is achieved in the next couple of months, the asset prices in Europe would benefit. This would in turn encourage business and consumer activities to avoid further depress.

Nov 1, 2011: The economy in Europe seemed the weakest globally. Eurozone manufacturing manager survey (PMI) continue weakening, and the speed of decline in the past six months matched that near the end of ’08. As a whole, both manufacturing and services weakened, and unemployment rate went up in Oct. Germany and UK saw weakening in manufacturing but strengthening in services. France had services contracted. Italy services PMI weakened greatly and consumer confidence eroded to the same level as in ’08 recession. UK retail sales in volume and excluding fuel increased only 0.6% year over year. UK economy was weak with real GDP growth of 0.5% year over year vs. 2.6% a year ago, and Bank of England raised asset purchase target from 200B to 275B.

US earning season is mostly in line even though the company guidance was soft. Institute for supply management (ISM) survey showed continued weakness in manufacturing: new orders especially export orders were weak and order backlog was also weak. Inventory was low including that at retailers, and retailers expect better than 10-year average holiday sales growth. In addition, retailers expect to add hiring. US capital goods nondefense ex aircraft order was higher than expected. Capacity utilization rate was still tamed at 77.4%. After the seasonal adjustment, retail sales excluding auto and gas increased 0.5% vs. the prior month, at the long term average level. Food and energy prices year over year increase was a concern for the producer but not a concern for the consumer as much. Based on the four week average, new layoff each week was 403k. It is heading lower but still higher than the low of 389k in March before the Japan earthquake. The number of people who could not find full-time jobs due to economic reason edged higher to 16.5% since the end of March, and we have not seen improvement.

Emerging market saw some cooling but domestic retail continued to be robust. China manufacturing new orders especially export orders were weaker than before. New loan growth slowed, that is much needed to cool the property market. Domestic retail sales continued to be strong at 11.6% in real term year over year, after netting consumer price (CPI) increase of 6.1%. Petroleum, Jewelry, furniture, and clothing led the charge. India manufacturing slowed just slightly, and the India central bank increase of the repo rate by 25bp to tame the high inflation. Brazil PMI up slightly from the low in the prior reading, and its central bank cut rate by 50bp due to the growth concern. Russia retail sales growth was 9.2% vs. wage growth of 6.2% year over year in real term. PMI also gradually recovered since July.

Back to Europe, there was a great degree of political uncertainty about how to solve Greece government debt problem without jeopardizing the financial system. Countries, such as Spain and UK, are still working through the deleveraging process in the real estate market. In less than a month, we saw the failure of two financial institutions: Dexia in Belgium failed due to market funding difficulty, and MF global failed due to the heightened risk of $6b bet on European Sovereign debt. Domino effect is not expected but small banks with exposure to Europe could still fail if Greece government debt is technically defaulted. European leader’s grand plan provided hope and allowed the stock market increase greatly in the week following it. However, the lack of detail and implementation uncertainty helped brought down stock market sharply in the past two days. During the recovery, the deleveraging economies were greatly supported by the government funding, possibly through printed money. However, the deleveraging process can be painfully longer than we might hope for before we see healthy GDP growth quarter over quarter. In this environment with high macro risk, individual investment opportunities could still exist but need to have caution.

Oct 4, 2011: Manufacturing results had mixed signals globally. US saw some stabilizing signs in ISM manufacturing index and initial jobless claims. The easing of auto supply constraint from the Japan earthquake could have contributed to the small increase of the production. The new order component was still weak. Eurozone as a whole saw both manufacturing and services contracting. In Germany, business sentiment was weaker. France and UK purchasing manager index (PMI) improved but Japan PMI weakened. PMI in the emerging economies also had mixed results. China Manufacturing PMI held at the low level of last month. Russia PMI increased slightly, but India and Brazil PMI declined.
In the US, Fed chairman Ben Bernanke initiated an operational twist instead of another round of quantitate easing (QE). This operational twist would allow Fed to keep the treasury holding amount constant and to switch from short dated treasury to long dated treasury till June 2012. Effectively, it will extend the treasury maturity or duration for two years. Technically speaking, it should act similarly as QE2 in reducing the interest rate exposure but not lowering the USD. However, the equity market took the potential impact as a disappointment. Last week, German parliament approved expanding EU bailout fund to 440B Euro to buy government bond when needed. The other EU member countries approved or are expected to approve this fund. The market still doubts the capital adequacy of a large number of European Banks, who are not the direct beneficiary of the bailout fund. Headline risk would remain for Greece since IMF and EU have to review the progress of the austerity package, and it seemed that Greece missed the current year target already.
Chinese government is still managing soft landing, and we do not expect the policies to loosen in the near term. As EU officials recognized the magnitude of the problem and discuss solutions for Europe, investor community increased concerns over credit and local government financing in China. Since a month or two ago, the market debated about whether we were heading to a recession. With China issues in the spotlight, the question now seems how bad a slow down we will get. For US persons invest internationally, currency movement would add return in an up market but further depress return in a down market. In the past two months, dollar strengthened due to the market fear. Emerging market currencies sled over 10% and other developed currencies sled over 5% versus the US dollar. Again, long term investors should not shun away in down market since there should be more bargains than in an up market.

Sept 11, 2011: Institute for Supply Management (ISM) manufacturing in the US was 50.6, lower than in last month and close to the contraction level of 50. New order was still weak in Aug at 49.6, but higher than the low in July of 49.2. The ISM Services was better at 53.3, higher than in July. Non-farm payroll did not grow in August, with private growth of 17k completely offset by the shrinkage in the public sector. The initial jobless claim was still over 400k per week. Personal income growth was lower than personal consumption growth. Purchasing manager survey (PMI) for manufacturing in Eurozone was 49.7, in contraction level. The level was 50.9 in Germany, 49.1 in France, 47 in Italy, and 45.3 in Spain. PMI for service in Eurozone was 51.5, better than for manufacturing. Inflation was not a concern for consumers in the developed economy. However, producer price year over year increase was much higher than consumer price increase, so manufactures could not pass all the price increase to consumers.
In emerging markets, China PMI was slightly higher than in last month. Fixed asset investment, industrial production and retail sales were still strong. Car sales, trade, and inflation were strong in India, and similar situation was in Russia. Brazil had PMI manufacturing fall further to 46, and the central bank cut target rate by 0.5% to 12%. It is fair to say that emerging economies were moderating, and the central banks in these economies will likely keep rate on hold or even cut rate when further weakness develops.
In the US, Fed Chairman Bernanke mentioned last month that he could not do it alone in recovering the economy. People have increased doubt on the quantitative easing (QE) programs. The low interest rate and weak US dollar from these programs helped the economy, but additional QE may not provide a large enough shock to the economy. President Obama’s job proposal of $447bn stimulus package did have infrastructure and education components, which can pay dividend. The high estimate of this stimulus is to add 1% GDP in 2012. Nevertheless, the passage of this bill depends on the agreement from the republicans and the planned fiscal reduction to proceed successfully. The economic weakness in Europe was worse, especially in countries like Greece. European central bank (ECB) president kept rate unchanged, citing economic situation was a bigger concern than inflation. As many European countries go through austerity measure to cut government spending and debt, economic weakness is unavoidable in these countries. The question is whether the progress will be orderly without political or market upheavals. If you have an investment horizon over ten years, this risk could mean opportunities.

Aug 20, 2011: The US economy recovered very slowly. Initial jobless claim was still elevated at over 400k per week. Even though retail sales domestically seemed holding well, new orders in the regional manufacturing survey were weak. Germany GDP in the second quarter was also weaker than expected, and export activities seemed weaker globally. With the slowing down in emerging market and Europe, US is unlikely to achieve over 1% of real annual GDP growth rate without experiencing some negative shocks.
There was an inherit challenge for some emerging market countries, such as China. The fixed exchange rate pegged to dollar and the low interest rate in the US depressed the interest rate in these emerging economies. On the other hand, these emerging economies had high inflation and growth, requiring a higher interest rate than in the U.S. The net result of this challenge is overheated economies. In addition, credit over GDP ratio in China increase significantly since 2009, raising the red flag of asset quality problem in the banks. As these emerging economies slowed down to normal level, there will be impact to developed economies in Europe and US.
On the other hand, European politician underestimated the solvency problem of a number of periphery countries. They provided liquidity and tried to boost the market by curving short sale and buying sovereign bonds, including Italy and Spanish bond. Being part of the Eurozone for the insolvent periphery countries was part of the problem. For example, Greece could not depreciate the currency and were not allowed to default on the debt. In addition, with the high energy and food cost, the rate set by European central bank was not low enough for these insolvent countries. Germany had a stronger economy and ran a surplus against other Eurozone economies. However, it was unwilling to take a major role in bailing out the periphery economies. If Germany waits longer, it will likely need to write a larger check to avoid a deeper trouble in Eurozone.
The stock market quickly turned sharply negative this month, and the risk is to the downside. Federal Reserve Chairman seems unlikely to start another quantitative easing program quickly, given that the core inflation is higher at 1.8% annual rate. Putting aside the high US fiscal deficit, more spending outside of infrastructure, research, and education may not have high immediate payoff to improve the economy.

Jul 30, 2011: The market nervously waits for a bipartisan compromise on US debt ceiling this weekend. Both parties agree that budget cut and debt ceiling increase are necessary but differ on the cut level of $1tn vs. $2tn and when the budget should be balanced. Some expected that business confidence will be affected if the politic dilemma drags on, and the economy will be affected if government shuts down. The recovery, however weak it was, has been a salute to the fairly loose monetary and fiscal policies a year or two ago. If we have to tighten on the fiscal side, it will be a drag to the recovery in the coming year.
This week, the political situation dampened the equity market even though the US earning season has been strong with over 60% of large cap companies reported. Large and Mid cap discretionary and tech companies have seen positive surprises, possibly due to the low expectation before. Energy companies have seen strong sales but not earnings due to the low refinery spread and the high cost of new projects to increase production. Large banks did not beat on sales but the lower than expected loan loss helped earnings. As a whole, large cap had healthy margin, helped by the low wage increase, low interest cost, high international exposure, and weak dollar. We did see a few companies announced layoff to shore up the earning for the coming quarters. The next quarter is expected to improve further as the energy cost decreases slightly and the auto industry increases production to recoup from an earlier shock from Japan.
On the macro front in US, the 3 week average of initial jobless claims in July was still over 400k, little changed. The 2nd quarter real GDP growth was at 1.3% annual pace, coupling with the revised 1st quarter number of 0.4% was concerning. Incoming ISM number is expected to be soft given the regional PMIs released. Eurozone combined PMI was also weaker in July, barely not in contraction territory. On the other hand, manufacturing in China showed a warning sign of potential contraction due to the soft landing policy. A silver lining was that CPI continued decreasing across the globe. With so much uncertainty ahead, paying off debt and having some cash at hand would be prudent for investors.

Jul 11, 2011: The recent US economics showed higher than expected ISM manufacturing results for June even though vehicle sale was still soft, likely due to supply chain issue from Japan quake. However, ISM non-manufacturing was softer than expected. Initial jobless claim was still elevated at over 400k, and the change in nonfarm payroll was very disappointing in both private and government. Unemployment ticked higher from 9.1% to 9.2%. Even though as expected, average hourly wage increased only 1.9% vs. a year ago, hurting consumer purchasing power with the total CPI including food and energy increased over 3% vs. a year ago. The US debt ceiling talks are still on going and it would not be surprising to see an agreement only comes in at the last minute as politicians want to show as fighting a good fight. Quarterly earnings season officially kicks off today, and it is expected that the bank earning will be disappointing due to the lower trading profit, low interest rate spread, and headwind from regulation or lawsuits. As the earning season progress, other sectors will see some bright spot, and we are hopeful that the company guidance will signal continuing improvement for the second half of the year.
Internationally, as China increased 1-year lending rate by 25bp as expected, the consumer and producer prices still came in higher than expected in June. The non-manufacturing and service PMIs still came in as similar to or better than last month. However, import and exports came in softer, possibly from the global activity. A softening is unavoidable given the many unsold residences in various cities and the heavy reliance of local government infrastructure financing on the selling of land. EU has changed the stance that leaders would reject the French plan and accept Greece default on some of its bonds, possibly due to the reaction of rating agencies consider the French plan a selective default. The talk may not bear any fruit till the end of the summer, and at the meantime, Italy government spread has widen significantly.

Jul 1, 2011: Market took a breeze after some good news about Greek sovereign debt. First, Greece’s parliament approved the government’s austerity plans; Second, there is a French proposal suggesting investors (60% is outside of central banks, and mostly French and German banks) to roll over most of the debt maturing before 2014. If 80% of investors participate as expected, this proposal will let Greece come up with $25B less than the original expectation of $61B, without triggering a technical default. Some concern remains about whether 80% of investors will participate and what the market impact will be if one of three rating agencies considers this a default. In addition, market volatility remains every three months as EU and IMF will have to review the Greece execution of the austerity measure before release more bail out money. Even though there is lots of political drama. However, for now, the market is taking a rebound, along with the U.S. strength due to a run up before the holiday.