Economic and Market Themes: 2014-10-27 US, Europe and China

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I have a lot of threads to cover today. So let’s get right into it.

New home sales. I want to start in the US first because the macro data backdrop is good. The first piece of data here is actually a bit soft and says that residential investment will not be a key lift to GDP numbers coming out at the end of the week and expected to show 3.0% annualized growth in Q3.

The headline new home sales number was almost unchanged at a 467,000 12-month pace for September, up from the 4666,000 pace in August. The data underneath were soft though. August was revised down from 504,000 and both June and July were revised down as well. These numbers are very weak in any context if one looks at the last 40 years of monthly data.

New Home Sales

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Source: Floating Path

Refis. But mortgage rates are coming down and that will add to consumer income. According to Zillow, “mortgage rates have fallen by 23 basis points in two weeks, from 4.12 percent on October 5th to 3.79 percent on October 17th. The number of refinance requests on Zillow more than doubled from a week earlier on Wednesday, October 15th as rates fell below 4 percent.”

Note the following from the Wall Street Journal, however:

The gap between the more expensive median price of newly built homes and that of resales has exceeded $70,000 for most of the economic recovery, the widest spread since the Commerce Department and the National Association of Realtors started tracking the figures in 1968. In September, it stood at roughly $49,000.

This may account for why new home sales are so sluggish.

Oil. The drop in oil prices will add to consumer disposable income as well though. According to the latest Lundberg survey, gasoline prices are at a 4-year low in the U.S.. The average price of gasoline dropped 18 cents to $3.08 in the past 2 weeks.

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Corporate balance sheets. Moreover, the FT is running with a story about corporations in the U.S. spending more. I am a bit sceptical that it will translate into more consumer disposable income but the data do seem to indicate that corporates are letting their balance sheet cash piles draw down as the need for excess cash declines due to a reduced concern about economic fragility. Investment will need to pick up for this to meaningful. Let’s see what the Q3 GDP data say.

Venezuela. Back to the oil theme, the drop in prices will have political consequences, which are as yet unknown. In Venezuela, PdVSA has decided not to cell its CITGO refining and marketing arm “Amid severe dollar shortages and economic woes that have roiled this oil-rich country and sparked fears of a default on external debt”. Venezuela is getting killed by the decline in oil prices and the consequences could be severe, with contagion happening in EM.

Emerging Markets. Speaking of EM, think of the decline in oil prices as a proxy in investors’ minds for low global consumer demand growth. This is why the equity markets sell off and government bonds rally every time oil sells off. Since EM is leveraged to commodities and oil, investors have been selling EM equities. The FT says investors “removed $9bn from stocks and shares across Africa, Latin America, eastern Europe and Asia in October.” The lower oil prices go, the more EM will suffer. Goldman has cut its medium-term price target on Brent crude to $80 a barrel.

Russia. The ruble hit another all-time low today. And the news is not just oil-related it is also due to exit polls showing that pro-Western factions scored big victories in the Ukrainian elections on Sunday and that is going to further isolate Russia from the West and their allies.

Chinese consumers. China is the big dog here though. And the main theme in China is rebalancing, which means shifting away from export and infrastructure-led growth to consumer led growth. In my view, this is what is responsible for the decline in oil prices and global market turmoil. The problem is that the shift is creating a downdraft in global growth. Witness these comments about Chinese consumer demand from the Telegraph.

Unilever, the world’s third largest consumer goods company, said they were surprised by the “unusually rapid” slowdown in Chinese consumer demand.

The company said that sales growth had slumped to about 2pc during the nine months ended September, down from about 8pc growth last year. The slowdown in Chinese sales growth to about 2pc is also an average – there are pockets where trading is far worse. The company added that sales to the big hypermarkets in the country are less than 2pc or even negative in some cases.

Nestle, the worlds largest food company, recently reported falling sales for the first nine months of the year and also warned of “challenging” Chinese trading conditions. The fear of China going backwards is now becoming a reality, as the Chinese consumer is not picking up from where capital investment left off.

The problem here is housing. Not only are we seeing a fall off in infrastructure and export-led sectors but housing is becoming a drag on consumer demand. The latest survey shows 69 of 70 major Chinese cities with price declines. And amid rampant overbuilding and speculation, this is going to have a negative impact on the household wealth effect, household liquidity and consumer demand.

Stress tests. The big news out of Europe are the stress tests. I am not thrilled with the exercise. And the final verdict was underwhelming fro a credibility perspective, with 25 euro banks failing and 8 or 9 still needing a top up. I am going to say very little on this today until I have had a chance to review the data in greater detail. I would point out this great chart from an Alen Mattich and Phillipa Leighton-Jones article on the stress tests. It is the chart of the day, showing the ECB balance sheet from 2008.

ECB balance sheet This speaks volumes about the problems in Europe’s credit markets.

European earnings. On the earnings front, its not just Danone and Unilever reporting weakness. It is across the board. On Friday, Ford released earnings that showed a $439 million loss in Europe, hurt by both the EU and Russia. BASF said it sees 10-12 billion Euros in 2015 EBITDA, down from an earlier forecast of 14 billion because it sees no positive momentum through 2015 for Europe. Think of this as a proxy for what’s happening in Germany as well as in Europe.

Germany. The German IFO survey showed the weakness as well, with German business sentiment at a 22-month low. The level of sentiment is actually pretty good. It is the directionality and the correlation to GDP that is worrying.

IFO survey

My view here is that Germany is weaker than we realize. My bullish Spain – bearish Germany call is playing out as predicted. And that is actually bullish for Bunds more than it is for Spanish government bonds because it means low inflation, continued monetary easing and zero rates as far as the eye can see.

Supposedly, German households are actually more stressed than we think. I can’t confirm the tenor of these reports. However, I do know that wage suppression in Germany has retarded consumer demand growth, that when combined with an aging demographic profile and budgetary restraint, makes Germany a weak link in terms of adding a positive economic impulse to Euroland as it tries to prevent a debt deflation.

Right now Europe and China are the biggest problems globally. The US sis surprisingly strong and the data do not point to imminent stalling.

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