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U.S. Corporate Third Quarter Profits Looking Good…So Far

U.S. Corporate Third Quarter Profits Looking Good…So Far

U.S. Corporate Third Quarter Profits Looking Good…So Far

About 150 out of the 500 companies in the S&P 500 Index have reported third quarter earnings. The results should stoke market optimism. Some 70 percent have reported higher sales and earnings estimates, and of those, about two thirds posted profit margins ahead of expectations. It is still early in the reporting season, but so far the numbers look good and have decisively beaten gloomy expectations. As we know from decades of market research, corporate profit growth leads stock prices.

 

Commodity Prices Under Pressure — Here’s Why

For months, commodity prices have been sloshing around at levels well below their earlier 2011 peaks. One overriding reason: reduced availability of leverage to buy commodities. Banks in the U.S. and Europe have pulled back and decreased lending for hedging and speculation.

In the U.S., the so-called Volcker Rule within the Dodd-Frank Wall Street Reform and Consumer Protection Act calls for banks to reduce the dollar amount of swaps on their balance sheet. Swaps are the financial contracts widely-used by banks that extend credit to clients for the purpose of buying commodities like gold, silver, and copper, as well as other assets.

In Europe, the current banking crisis is also hobbling commodity lending. French banks, long the dominant financing agencies in the huge business of commodity trading, are reducing lending. Traditionally, the largest players in the world commodity markets have been the publicity-shy Swiss trading houses, with French banks such as Societe Generale, Credit Agricole, BNP Paribas, and others providing much of the cash to lubricate the financing.  Now, however, French banks need to conserve capital to cover their perilous holdings of toxic European sovereign debt. Among other authorities, the International Monetary Fund has called upon the banks to raise substantial capital and strengthen balance sheets. Rather than sell stock to raise capital at current low market valuations, French banks are gradually pulling back from commodity trade finance.  As they do, they are calling in part of their loan book. The reduction of loans outstanding causes borrowers to sell part of their commodity positions in order to raise capital to repay leveraged loans.

Click here to read a Financial Times in-depth article on this scenario that has impacted commodity markets.

Here’s our take on this situation: These events have frightened some investors. Not us, however. Fear creates opportunities. For us this is a time of ample opportunities and we are acting accordingly. The demand from major trading houses will eventually be filled by banks around the globe and a return of available capital will draw big buyers back into the commodity action.

 

Halloween in China?  What’s Behind Those Scary Headlines

Halloween isn’t celebrated in China, but to read the horror-soaked accounts of many pundits these days, you would think that demons and monsters are running amok and ravaging the Chinese economy.

Worldwide news and investment bank research are filled with tales of corporate corruption, collapsing property markets, severe nationwide banking crises, and an extraordinary number of bankruptcies. Some accounts are wildly inaccurate and the headlines they inspire even more distorted. Such reports contrast starkly with what we know to be happening in China’s economy in the past few months and what we expect will happen in the year ahead. The facts simply do not support the rampant pessimism and panic.

Over a decade ago we started following the reports of about a dozen economists covering China for major global banks.  After monitoring their analyses for several years, we identified three of them who were exceptionally accurate.  The “aces,” so to speak.  Although we continue to follow all dozen or so, we pay most attention to the three standouts.  Currently, they are in agreement that the situation in China today is not at all bad. Like them, we believe that China will experience a soft landing as the economy slows due to economic problems in Europe and elsewhere, but any kind of a hard landing or collapse does not appear to be in the cards.

One of our esteemed analysts put things into clear perspective.  Jonathan Anderson, chief emerging market economist, and formerly chief China economist, for UBS, had this to say: “It wasn’t just China of course — the entire MSCI-EM [emerging markets] index lost 25 percent of its value in dollar terms between end June and end September but Hong Kong-listed Chinese banks and property companies were down anywhere from 40- 65 percent over the same period.”

Obviously, the emerging markets, and the Chinese market, discounted a serious problem; that China would have a hard landing and big economic dislocation due to a collapse of demand from Europe which would lead to a collapse in demand from other sectors of the world.

We take issue with this view. We are bullish on some emerging markets and part of the reason is that China is growing and will continue to grow at a respectable rate.

Here are additional reasons why China is headed for a soft landing:

  •  Economic data for the month of September indicates a solid — more than 9 percent pace — in GDP growth. There has been no slowdown in Chinese retail spending. Meanwhile, inflation is slowly declining. New bank loans (a statistic often referred to by scaremongers if it rises too fast) and bank deposits were in line or modestly declining.
  • Housing is a key indicator of the economic climate, so let’s check the supply and demand situation. We know that a hard landing or soft landing scenario will be decided by what happens to property and construction, and we also know that there is a large supply of housing in some markets within China.  Again, Jonathan Anderson provides us with more insight.

“Nationwide new housing sales actually rose nicely in September on a seasonally-adjusted basis,” he says.  “So did domestic steel consumption.  So did auto sales.  Nationwide, prices for newly-constructed houses are still up visibly year over year, and essentially flat for the last quarter. In short, nothing that points to demand-side stress at the macro level. Indeed, if anything, very much the opposite.  And this nearly a year after the onset of serious macro tightening (interest rates have been rising for a year in China), and after nearly three months of market panic.”

In our opinion, Mr. Anderson has it right. China’s real estate and housing markets are not in meltdown. Banks are not in danger. Real estate loans in China are fully collateralized and the government has $3 trillion available to recapitalize poorly managed banks. Our most pessimistic estimate is that bad debts may amount to $300 billion after collateral is seized.  That’s quite manageable. The government might have to spend up to 1/10th of its cash hoard to recapitalize banks. The government also has plenty of incentive to punish bad bankers.

 

EEM (1 Year Chart) 

Courtesy of Bloomberg

 

GOLD  (1 Year Chart)

Courtesy of Bloomberg

 

OIL (1 Year Chart)

Courtesy of Bloomberg

 


S&P (1 Year Chart)

Courtesy of Bloomberg

 

Wheat (1 Year Chart)

Courtesy of Bloomberg

 

Tracking the Real Rising Cost of Living 

In September, the Guild Basic Needs Index TM (GBNI) was affected by the decline in the prices of foods, energy, and housing. We anticipate that October will show a substantial rise in the GBNI reflecting the continuing cost of basic needs that are well in excess of the U.S. consumer price index for the last year and since the turn of the century.

The GBNI and U.S. Consumer Price Index (CPI) data for the periods ending September 30, 2011 are:

1 Month GBNI -5.65% CPI 0.14%
1 Year GBNI 6.60% CPI 3.90%
Since Inception January 1, 2000 GBNI 78.50% CPI 34.80%

The Guild Basic Needs IndexTM

Guild Investment Management has long believed that the existing indices used to measure cost of living changes in the United States are inadequate and misleading.

For instance, the widely quoted inflation index, the Consumer Price Index, is currently based on data collected from spending surveys given by the U.S. Bureau of Labor Statistics from approximately 14,000 urban families.  In addition to basic needs, the CPI includes other expenditures, such as insurance and taxes.  However, it also includes discretionary spending items such as personal care services and entertainment purchases such as the latest flat screen televisions and consumer electronics.

Another point about the CPI is that the Bureau of Labor Statistics periodically alters its content, making adjustments to the weighting of the components, and smoothing seasonal patterns.  Such tinkering with data, as we have mentioned over the years, usually results in an understatement of the inflation rate and creates an unreliable, misleading cost of living index.

We believe a simpler index is necessary for tracking the price changes of basic needs.  No such index exists.  So, we have created one: the Guild Basic Needs IndexTM.  The GBNI will not reflect spending patterns of one segment of the population.  Rather, it will measure the changing prices of essential living expenditures.  Another key differentiator between the GBNI and the government’s measures is that the components of the GBNI do not change. They are not adjusted, statistically smoothed or manipulated.

Summary

We are bullish on the U.S. market, emerging markets, some currencies (see below), gold, oil, and wheat. We aren’t buying into the endless fear and scare scenario, and don’t believe that the European banking system will melt down.  Fear-based reporting may make riveting headlines and draw readers’ attention, but the facts, as we see them, tell a different story and do not support the panic that is sown so routinely in the media.

The events of the past few days have proved our case that more QE will be coming.  In Europe, they will not let their banking system fail and will provide the necessary liquidity to backstop their banks.  They can either nationalize banks or recapitalize the banking system with new capital from several countries.  The bottom line is that liquidity will be added and central banks’ balance sheets will expand.  QE has become a way of life for the developed economies. Growing use of QE is bullish in the short to intermediate term for stocks in the U.S. and emerging markets, and it is bullish for gold, oil, wheat, and the currencies we have recommended.

 

Recommendations

Date

Date

Appreciation/Depreciation

Investment

Recommended

Closed

in U.S. Dollars

Commodity Market Recommendations
Gold

6/25/2002

Open

+391.4%

Oil

10/24/2011

Open

+3.2%

Wheat

10/24/2011

Open

-2.0%

Corn

4/20/2011

8/3/201

-6.3%

Oil

2/11/2009

8/3/2011

+157.1%

Corn

12/31/2008

3/3/2011

+81.0%

Soybeans

12/31/2008

3/3/2011

+44.1%

Wheat

12/31/2008

3/3/2011 

+35.0%

Currency
Recommendations
Long
Canadian Dollar

10/24/2011

Open

+0.2%

Long
Singapore Dollar

10/24/2011

Open

+0.3%

Long
Canadian Dollar

9/13/2010

9/21/2011

+2.2%

Long
Chinese Yuan

9/13/2010

9/21/2011

+5.8%

Long
Swiss Franc

9/13/2010

9/21/2011

+12.1%

Long
Brazilian Real

9/13/2010

9/1/2011

+6.4%

Long
Singapore Dollar

9/13/2010

8/3/2011

+10.9%

Long
Australian Dollar

9/13/2010

6/29/2011

+14.1%

Long
Thai Baht

9/13/2010

6/22/2011

+6.5%

Short
Japanese Yen

4/6/2011

7/27/2011

-9.7%

Short
Japanese Yen

9/14/2010

10/20/2010

-3.3%

Equity Market
Recommendations
iShares MSCI Emerging Market Index

10/24/2011

Open

+3.7%

U.S.

10/24/2011

Open

+0.3%

U.S.

9/14/2011

9/21/2011

-2.3%

India

4/6/2011

9/21/2011

-21.6%

Malaysia

6/29/2011

8/3/2011

+0.1%

U.S.

6/29/2011

8/3/2011

-4.6%

Japan

2/15/2011

8/3/2011

-9.5%

Australia

2/15/2011

6/22/2011

-0.9%

Canada

3/24/2011

6/22/2011

-7.1%

Colombia

9/13/2010

6/22/2011

+2.6%

Malaysia

4/6/2011

6/22/2011

+0.8%

Canada

12/16/2010

3/11/2011

+7.9%

U.S.

9/9/2010

3/11/2011

+18.1%

South Korea

1/6/2011

3/3/2011

-2.9%

Colombia

9/13/2010

2/2/2011

+3.9%

China

9/13/2010

1/27/2011

+5.0%

India

9/13/2010

1/6/2011

+7.9%

Chile

9/13/2010

12/16/2010

+8.9%

Indonesia

9/13/2010

12/16/2010

+9.5%

Malaysia

9/13/2010

12/16/2010

+1.3%

Peru

9/13/2010

12/16/2010

+32.2%

Singapore

9/13/2010

12/16/2010

+4.8%

Thailand

9/13/2010

12/16/2010

+11.9%

Bond Market
Recommendations
 30 YR Long Term
U.S. Treasury Bond

8/27/2010

10/20/2010

0.0%