How could we get to lower profit margins, wage inflation, higher commodity prices?

Indeed!

"The bullish case for equities now seems to hinge on the new paradigm thinking that profitability will stay historically high while the Fed keeps bond yields low well into a recovery."

"Maybe this shouldn’t be surprising, given the weight central bankers have put on wealth effects to lift their domestic economies, and, once again, the Federal Reserve has thrown itself behind the bull case. A paper earlier this month by Fernando Duarte and Carlo Rosa of the New York Fed, “Are Stocks Cheap? A Review of the Evidence,” came out with a pretty unequivocal “yes.” Yes, they are cheap.
The Fed researchers look at 29 economic models that estimate the equity risk premium–the expected excess return equities deliver over safe bonds. The average risk premium at the end of December was 5.4%, about as high as it’s ever been since the early 1960s. The only two previous periods when the risk premium was this high were back at the end of 1974 and just before the market hit its post-crisis low in 2009."

Reversion to the Mean is a nasty thing:



Now why would profit margins fall to more normal i.e. (6% long term average)?

Unemployment is high and commodity prices are low and productivity is at all-time highs, the main inputs towards profitability are all favorable towards continuing high profits!

Maybe not:


Fewer people are working, they have left the labor force, retired, live with parents, on the street or have gone into an underground economy:


Yet positions are harder to fill.


Companies have squeezed workers to become more productive and have lean labor forces but they are not prepared for any kind of recovery. Who will they hire? The long-term unemployed? the retired? The homeless?


"We see evidence of this happening system-wide in the data showing lower hourly wages and a reduced number of hours in the work week. And those trends seem to be stabilizing. We are seeing the creation of a two-tier market, an upper tier for those with skills in demand and a lower one for those whose skills just do not command a premium in today's marketplace.

Rosie makes the argument that there is a shortage of skilled labor and that the price for those workers is going to rise, surprising the Federal Reserve, which still looks at historical data from a world that no longer exists. And he says this segment of the labor market is going to be large enough to create wage-push inflation."

"The crucial change that has taken place over the past decade or so is that wages in low-cost countries have soared. According to the International Labour Organisation, real wages in Asia between 2000 and 2008 rose by 7.1-7.8% a year. Pay for senior management in several emerging markets, such as China, Turkey and Brazil, now either matches or exceeds pay in America and Europe, according to a recent study by the Hay Group, a consulting firm. Pay in advanced economies, on the other hand, rose by just 0.5% to 0.9% a year between 2000 and 2008, says the McKinsey Global Institute. In manufacturing, the financial crisis actually reduced pay: real wages in American manufacturing have declined by 2.2% since 2005.

By contrast, pay and benefits for the average Chinese factory worker rose by 10% a year between 2000 and 2005 and speeded up to 19% a year between 2005 and 2010, according to BCG. The Chinese government has set a target for annual increases in the minimum wage of 13% until 2015. Strikes are becoming more frequent, and when they happen, says one executive, the government often tells the plant manager to meet workers’ demands immediately. Following labour unrest, wages at some factories have gone up steeply. Honda, a Japanese carmaker, gave its Chinese workers a 47% pay rise after strikes in 2010. Foxconn Technology Group, a subsidiary of Hon Hai Precision Industries, a Taiwanese firm that does a lot of manufacturing for Apple and other big technology firms, doubled pay at its factory complex in Shenzhen after a series of suicides. Its labour troubles are still continuing."

Japan has shouldered the weight of a global beggar-thy-neighbor currency battle and trade rebalancing since 2009 with a stronger currency and resulting trade deficit:

Until recently when Abe said, enough and quickly undid years of a strengthening Yen:

US econ stats update

latam developments

May 16 (Reuters) - Mexico state oil monopoly Pemex said on Thursday it has found "clear indications" of light crude at its ultra-deepwater Maximino well.
The 9,515-foot well makes the third such find in the Perdido Fold Belt, located in Mexican territorial waters in the Gulf of Mexico.

Pemex says there are up to 29 billion barrels of crude equivalent in the Gulf, more than half of Mexico's potential resources.

The company has said it is interested in contracting private companies to help it tap the deepwater riches, but current legal restrictions prohibit it from engaging in joint ventures or signing production-sharing contracts.

Mexico, the world's No. 7 oil producer, has seen output drop to around 2.5 million barrels per day from a peak of 3.4 million bpd in 2004. If it cannot find and exploit new discoveries to replace declining output at its largest, aging fields, the country risks becoming a net importer of crude within a decade.

President Enrique Pena Nieto has said he will seek a sweeping energy reform aimed at boosting production by loosening restrictions on private capital in the country's oil industry. The reform proposal is expected by September.

By ROBERT KOZAK in Lima and DARCY CROWE in Bogota

Presidents of some of the most economically dynamic countries in Latin America are looking to promote a new trade group as an alternative to other regional blocs that have become more protectionist in recent years.

At a meeting this week of the Pacific Alliance, which includes Mexico, Chile, Colombia and Peru, leaders planned to work on decreasing trade barriers for goods and services, linking their stock markets and finding common ground on issues such as currency fluctuations. Their main goal is to increase trade with fast-growing Asian nations.

The leaders also will likely try to send the message that their countries are a safe place to invest in a bid to differentiate themselves from Mercosur, the South American trade bloc that includes Brazil and Argentina.

Venezuela joined Mercosur in 2012 after expropriating numerous foreign-owned firms in sectors such as food production, which relies heavily on imports. The country is now facing shortages of basic goods amid high inflation.

Mercosur frequently engages in trade squabbles and has adopted some protectionist measures in recent years. The member countries of the Pacific Alliance, meanwhile, have a strong track record of welcoming foreign investment.

"Anything that irons out the differences, that clears away overlapping rules and regulations, and makes investors more comfortable with their economic trajectory will help boost investments," said Barbara Kotschwar, a research fellow with the Peterson Institute for International Economics.

Analysts say the Pacific Alliance grew out of the failure of the earlier Free Trade Area of the Americas, which attempted to link the economies of North, Central and South America.

"It is the first time in Latin America that nations in the area have taken a leadership position on trade. It stems from a position that they took that said, 'We can do this and we need to do this,' " said Eric Farnsworth, vice president of the Council of the Americas and the Americas Society.

Enrique Peña Nieto of Mexico, Juan Manuel Santos of Colombia, Sebastián Piñera of Chile and Ollanta Humala of Peru will meet in Cali, near Colombia's Pacific coast, on Wednesday and Thursday.

Nine nations will participate as observers: Canada, Spain, Australia, New Zealand, Uruguay, Japan, Guatemala, Costa Rica and Panama.

"Its central purpose is really to enhance a common position regarding trade with Asia," said Michael Shifter, president of The Inter-American Dialogue, a Washington-based think tank.

Trade analysts say the Pacific Alliance could end up growing along the lines of the Trans-Pacific Partnership, a trade-liberalization group that started out with four countries in Asia and Latin America and now includes 12, including the U.S. and Japan. Costa Rica and Panama are candidates to join.

The alliance, which was founded in June 2012, aims to carry out an integration to allow free circulation of goods, services, capital and people. Some of the member countries have already lifted requirements for travel visas among them.

"They have been trying to avoid political rhetoric and are trying to make real advances," Mr. Shifter said.

Pacific Alliance members represent a large portion of the economy in Latin America and have posted solid economic indicators even as some of their neighbors grapple with high inflation and a significant slowdown in growth.

Data from the summit organizers shows that Mexico, Peru, Colombia and Chile account for about 35% of Latin America's combined gross domestic product. The average economic growth for the four nations was 5% in 2012 while inflation stood at 3.2%.

The four countries represent 33% of the total trade in the region and take in about a quarter of all the foreign direct investment coming into Latin America, the figures show.

"These countries share most of the same economic principles," Mr. Shifter said.

Private businesses have also taken steps toward broader integration within the member countries of the Pacific Alliance. An example is a common trading platform that has linked the bourses of Chile, Colombia and Peru. Mexico is expected to become a part of the trading system, known as MILA, in 2014.

Write to Robert Kozak at robert.kozak@dowjones.com and Darcy Crowe atdarcy.crowe@dowjones.com

A version of this article appeared May 22, 2013, on page A12 in the U.S. edition of The Wall Street Journal, with the headline: Latin America Seeks Asian Trade.

A chronicle of the changes in investment attitudes, investment flows, and valuation changes across asset classes - May 2013:


#1

America’s very wealthy have a new investment goal: asset appreciation. That’s a significant change in investor sentiment since last year, when extreme caution ruled the day.

U.S. Trust, the private banking arm of Bank Of America (BAC), is in the process of releasing its comprehensive 2013 study of 711 folks with more than $3 million in investable assets.

A robust 88% of those surveyed claimed they now felt “financially secure,” with 48% actually insisting they feel more financially secure today than they did five years ago. Six in 10 of these investors say that growth is now a “higher priority” than asset preservation, a significant reversal in objectives from just a year ago, when 58% said preserving assets was their overriding goal. The study supports a recent Barrons.com story on how the market keeps climbing as the wall of worry tumbles.

But life wouldn’t be interesting without a bit of dissonance: 63% also said reducing risk and achieving a lower rate of return was more important than pursuing higher returns by increasing risk. That’s wishful thinking. There are few investments where lowering your risk tolerance will result in higher asset appreciation. As Leon Cooperman of Omega Overseas Partners points out in our Penta magazine cover, the hunt for higher returns means, “Everyone is in the process of moving up the risk curve.”

#2

Signals that the Federal Reserve remains far from winding down its bond purchases, combined with a bullish outlook from Goldman Sachs, GS +1.20%helped push stocks toward another winning Tuesday.

The Dow Jones Industrial Average gained 68 points, or 0.4%, to 15404 in late-afternoon trading, putting the blue-chip measure on pace for another record high—and an unprecedented 19th consecutive Tuesday of gains. The Standard & Poor's 500-stock index, meanwhile, added five points, or 0.3%, to 1671, while the Nasdaq Composite climbed 10 points, or 0.3%, to 3507.

Gold falls, leveraged funds get margin calls and triggers Apple sell off?

Spurious correlation? or something else, imagine telling someone, "Hey I have a great idea, let's short Gold and Apple, the world is in a deep recession, those securities are the worst."

 



 All kidding aside, I am wondering if some large players are getting creamed on lower gold prices and are selling Apple stock to meet margin calls. The definition of forced selling and maybe what you could call panic selling. If the price of a metal gets high enough it is just as easily in a bubble as housing was (or Tulips). Strange world.

For example:

Appaloosa Management LP, the hedge-fund manager run by billionaire David Tepper, cut its stake in Apple Inc. by 41% last quarter as the computer maker slumped while stock markets rallied.

Appaloosa held 540,000 shares of the Cupertino, California- based technology company at the end of March, valued at US$239-million, down from 912,661 shares at the end of last year, according to a regulatory filing today. Apple extended losses after the filing, declining the most in three weeks.
Tepper, who had been investing in the stock since the end of 2010, pared his stake as Apple declined 17% in the first three months of the year, even as U.S. stocks added 10%. Tepper said in an interview with CNBC yesterday that he sold Apple shares because the maker of the iPhone and iPad devices hasn’t been “evolutionary” or “revolutionary” recently."

Of course Tepper is telling everyone the truth about why they sold Apple (sarcasm). If they'd lost money on a bad bet on Gold you think he'd go on CNBC and say, "Hey we got into some deep #$@! We're levered up the arse and had some margin calls and well we had to sell the the largest and most liquid asset we had to raise cash and not move the market."

Wage Inflation in the US?

I've thought about the same topic David writes about below. Good to see I'm not absolutely mad and that this may actually happen.

David Rosenberg: A Bond Bull Turns Bearish

How do we get to full employment and improved national education from the launching point of David Rosenberg's very recent call (at the conference and elsewhere) that we will soon see inflation and the onset of a bond bear market? I must say that he surprised a few of us with his conversion from bond bull to bond bear. But the reason why he converted surprised us even more. I am not going to be able to do justice to his impeccably reasoned, highly detailed presentation in this short space, but let me hit some highlights.
Specifically, Rosie thinks that the Fed is going to be surprised by wage-push inflation. How could we see inflation in wages in such a soft labor market? That was the first question in my mind, and the following charts give me some reasons for my question.
The present unemployment rate is still higher than at any time in the last 60 years, except after recessions. The Great Recession ended four years ago, and unemployment is still stubbornly high. Indeed, this is the slowest "jobs recovery" we have ever experienced. The current level of unemployment has never been seen four years after the end of a recession.

And those who lose their jobs are staying unemployed longer. The fact is that the mean duration of unemployment is still almost double what it has ever been. Average length of unemployment is 37 weeks. When the recession ended, it stood at 23 weeks. This is structural, not frictional, unemployment. Ninety million American adults now subsist outside the official labor force –It could be there's an underground economy that we need to capture. The pool of available labor for the business sector is shrinking 2% per year.

Worse yet, the unemployment rate is still stubbornly high in spite of an unprecedented rise in the number of people who are no longer counted as being in the labor force. These are people who are no longer looking for jobs.We are back to workforce participation levels not seen since the 1970s. A good 5% of US citizens who are able to work are no longer are looking for work. Part of this trend is due to alternatives to employment becoming easier to pursue. Millions have been added to the disability rolls – some 4 million since the beginning of this century and almost 2 million since the beginning of the Great Recession (and still rising at an alarming rate!). Others have gone back to school, borrowing money in the form of student loans, which have topped over $1 trillion and are the only form of consumer credit that has been on the increase.
As a quick aside, we are also seeing skyrocketing rates of late payments as student loans overwhelm the ability of borrowers to pay. This is a true crisis brewing, as student loans are the only type of debt that cannot be discharged in bankruptcy. Student loans can make you an indentured servant for a very long time.
Some would-be workers find that in some states they can collect more on government assistance than they can earn by working lower-wage jobs, and thus they have no economic incentive to look for jobs that would actually lower their income. As I wrote in a recent letter, this is why we are seeing a large rise in non-reported incomes and jobs. And finally, there are those who are just discouraged. Jobs seemingly do not exist for their skill sets and in places where they can access them.
With so many people not participating in the labor market, isn't it reasonable to assume that if jobs again ever become available, these people will rejoin the official workforce? And wouldn't that create a shadow supply of workers that would keep wages suppressed for a long time?

Wage Inflation?
Maybe yes and maybe no. Rosie makes the case that there are numerous jobs available and that the numbers are rising, and there is data that supports his argument. I will reproduce here a few of his charts (out of the 59 he showed!). Job openings are on the rise and are back to levels last seen in the middle of the previous decade.
And what about all the businesses that have jobs on offer but can't find people to fill them? The following chart is from Rosie's and my mutual friend William Dunkelberg, chief economist for the National Federation of Independent Businesses. While job openings are not at all-time highs, the trend is encouraging.


The next chart shows the ratio of job openings to new hires. It is at a six-year high. As Rosie stated (inexact quotes, from my notes):

Looking for labor? Labor demand is not weak – JOLTS survey shows job openings up 10%, employers can't find qualified applicants. Firings plunge, layoffs 10% lower than in 2007. Number of job quitters rises – people leaving jobs to go to new ones, the 'take this job and shove it index.' 7.5% unemployment is actually the new 4.4%.

What are companies doing? More overtime, longer work week. Combination of rising wages, productivity growth heading lower. We've taken a lot of inventory out of the labor market. Keep your eye on unit labor costs. Correlation with inflation – unit labor costs are on the rise.

Employees are increasingly willing to leave a job and go to another one, yet productivity has recently begun to fall.
Yet young people are having increasing difficulty landing jobs. People aged 20-24 are still unemployed at levels not seen unless a recession is involved (see chart below). And research keeps coming in that more than 50% of college graduates are stuck in jobs for which a degree is not needed.

Even though the headline unemployment rate is falling, a large part of that drop is due to the precipitous plunge in the participation rate, as well as a rise in low-paying jobs. Curiously, it now seems a disproportionately high level of temporary jobs is no longer a precursor to economic recovery but is a new structural fixture.
Part of the responsibility for that increase in temporary employment can readily be laid at the feet of the Affordable Healthcare Act (Obamacare). Employers do not have to pay health insurance for temporary employees; that burden falls on the employee.
Healthcare for lower-wage employees can be a huge percentage of overall labor costs. While you may argue that employers should cover workers at all levels, the data coming in says that is not happening – thus the rise in temporary workers. Even an established employer like UPS is hiring new temporary employees in low-skill jobs at low wages without health insurance for their first year and cutting back on employees with major seniority (who cost more than double what new employees do), not giving them enough hours to survive and forcing them into the temporary market to meet their basic living needs.
We see evidence of this happening system-wide in the data showing lower hourly wages and a reduced number of hours in the work week. And those trends seem to be stabilizing. We are seeing the creation of a two-tier market, an upper tier for those with skills in demand and a lower one for those whose skills just do not command a premium in today's marketplace.
Rosie makes the argument that there is a shortage of skilled labor and that the price for those workers is going to rise, surprising the Federal Reserve, which still looks at historical data from a world that no longer exists. And he says this segment of the labor market is going to be large enough to create wage-push inflation.
It is an interesting argument, and contradicting David Rosenberg is generally not a good idea, although he did not convince Lacy Hunt or Gary Shilling, at least not at the conference. But at any turn there is always someone who has to lead the way. His arguments are something we must pay attention to.
In the panel discussion later in the day, I agreed that there are two labor markets, but the divide is between workers with skills that are in demand and workers whose jobs require no special experience or education.

the warning signs of an asset bubble - bonds, stocks & the search for yield redux

May 16, 2013 - Investors are searching for yield and returns, this happened in 2007 and we've all been warned about inflation but what happened in 2007 was that a bubble formed in housing and if you remember, inflation was stable as far as the government measures it through CPI core and CPI including food & energy. When housing was in a bubble, people denied, it failed to deflate, it seemed like the party would never end. Today, in the absence of demand and revenue generating enterprises and cheap money it makes sense to lever up and invest in the largest most liquid markets on earth treasuries, bonds, then high yield bonds, then finally dividend yielding stocks.

The financial markets in the US are an asset bubble in 2013. Real GDP for the US and Europe are forecast to remain low and downright negative respectively in 2013 and possibly 2014. While China struggles to rebalance in a lower demand world towards a consumer led economy or at least more consumer based. The rise in asset prices do not reflect current fundamentals or even 1 or 2 years out. Commodity prices have declined in pace with slower global demand, a downright recession. On top of this there was probably a bit of oversupply and now it is a lot of oversupply, thus commodity prices are forecast to continue to remain flat, despite all the money printing.


Valuation: Impossible to Properly MeasureWhile market sentiment and valuation are separate constructs, they are both affected by the Fed's monetary policy. Continuing to use traditional Wall Street axioms on valuation without considering the current environment is inane. It is impossible to see clearly by looking at theS&P(INDEXSP:.INX) through the lens of Price to Earnings without factoring in the Fed buying of $85 billiona month in debt. We are not saying that stocks are expensive or cheap. Rather, we are saying that traditional valuation analysis has been rendered impossible by the Fed.

Furthermore, we believe the ferocious buying back of shares by companies from issuing cheap debt is thetruelow valuation story. However, it is a story that is anchored on a historically unprecedented and unsustainable catalyst of Fed bond market manipulation.

These are negative short term fundamentals on a global and macro scale. This is an asset bubble built to combat deflation. This was Bernanke's specialty and PHD thesis. If the asset bubble pops the underlying deflationary current will join the bursting current from the deflating asset bubble.  This asset bubble is in financial assets as opposed to the last bubble that was in housing. Asset inflation encourages those with stocks/bonds/ financial interests to spend more as their apparent wealth increases. It's the same story as the credit crisis except instead of housing, financial assets are at the center of this story this time around. In 2007 subprime borrowers took equity out of homes and spent. As long as house prices rose this party went on.As fund managers run out of BONDs to invest in at reasonable prices they're rushing into high yielding dividend stocks at low trailing P/FCF and imo (were) good value stocks = MSFT LXK AAPL.

Debt: Connection with Equity Markets and Divergence from IssuanceIt is also important to look at the market structure issues within the debt markets. Corporate issuance had its busiest January ever with $412.3 billion vs. the all-time high January issuance of $407.2 billion in January of 2009. The obvious difference is the massive narrowing of spreads from historically wide levels in 2009 to all-time lows today. We believe the Fed's QE programs have turned equity markets into expressions of "bond yield complacency" and therefore the two markets are inextricably linked. This link manifests itself in the capital market phenomenon of Profit and Loss (PnL). For any market participant, whether institutional like a pension or hedge fund, or an individual, it's the loss of principal that causes aggressive net selling.

The real risk here is the global margin call that can occur from simply too much long leverage chasing artificially low yields. The bloat in the system on the long side in bonds is now associated with long bloat on the equity side. Margin calls and selling in junk bonds and down bond funds will bleed over into equity funds and vice versa. The Fed would have zero control over a global PnL margin call on bond principal scenario.

Read more: http://www.nasdaq.com/article/us-stocks-overleveraged-markets-at-risk-of-global-margin-call-cm238313#ixzz2SXP7un6C

http://etfdailynews.com/2013/04/17/the-great-duration-rotation-continues-but-for-how-long/


UPDATE - 5/29/13 approximately 13 days later:

This chart



now looks more like:

and the culprit?

The Chart below is concerning because it looks as if hedge funds also joined the fun in 2013 and have been trying to play catch-up with the S&P 500, couple this with record high profit margins, high valuations, and a flood of money into dividend yield stocks, you have a crowded trade. Who else is coming?