Larry Shover

“Plenty of Headlines – No Real News”

“Plenty of Headlines – No Real News” – 10/07/2014
October 11, 2014
by Larry Shover
Macro Update

Equity Strategy : October Chart book: Many red flags, but I still believe that dips should be bought: I acknowledge a number of worrying signals: the selloff in high yield bonds, falling commodity prices, flattening yield curve, and a narrowing participation in the market, among others.

{C}· All of these could keep volatility elevated in the short term, but I think the underlying equity backdrop remains constructive and advise using the dips to add.

{C}· I do not believe US activity is about to take a step lower, as the recovery is far from being “credit-less”, “jobless” and “housing-less”.

{C}· USD strength should not be seen as a bearish signal as it’s largely a result of robust US growth, and the credit selloff is technical in nature.

{C}· Additionally, Q3 results are likely to be a positive event in the US, despite stronger USD, given the very undemanding hurdle rate, and equities offer the best relative valuations compared to other asset classes.

Credit update – a break-down of ownership trends. Central banks and commercial banks have been soaking up sovereign bonds (G4 central and commercial banks own ~52% of the tradable global bond universe). As a result of this diminished sovereign supply, non-bank investors are very overweight corporate bonds. On my calculations, non-bank investors are overweight credit by 17% currently, compared to zero (neutral) weighting in 2009.

Rates update. An update on Fed normalization, the regulatory environment, and the evolution of short-term interest rates. Even as the Fed plots its exit, the legacy of extraordinary accommodation combined with regulatory and economic considerations fuels questions about if it can and how it will raise rates. Some rates will be harder to raise than others.

US Fixed Income Update. Although the September employment report was solid, with the unemployment rate falling below 6%, the strengthening dollar and declining inflation expectations are sources of concern and make the Fed calculus trickier. With no major events on the calendar over the near term, I turn neutral on duration but continue to look for yields to rise over the longer term.

FX update. Although the USD is overshooting most short-term valuation models, I lower year-end targets for several currencies.

· This acknowledges the dollar’s upward bias as long as US 2-yr rates tick higher and non-US growth remains weak.

· New targets for Q4 2014 (previous forecast in parentheses) include EUR/USD 1.25 (1.30), AUD/USD 0.87 (0.90), USD/MXN 13.20 (12.90). Unchanged year-end targets include: USD/JPY 109.

· My main short-term reservation is that FX moves have been running well ahead of shifts in interest rates, as the USD appears to be front-loading the approaching Fed tightening cycle.

Fed – the inflation vs. jobs debate will heat up in the coming week.

Inflation trends suggest the maintenance of ZIRP. The broad Fed policy assumptions remain unchanged at the moment (balance sheet expansion over by the end of Oct w/the first hike prob. at the June 19 meeting) but inflation developments (or more specifically disinflation trends) may disrupt the present thinking.

· The Fed already downgraded their inflation language in the last statement and market-based indicators are falling to multi-year lows. 10yr TIPS spreads are sitting below 2% and 5yr spreads are close to 1.7%.

· How much of this is due to plunging commodity prices/dollar strength and PIMCO-related disruptions remains to be seen but the Fed may be hesitant to evolve its rhetoric in a more hawkish direction until there is more clarity on the inflation front (people had been assuming the removal of “considerable time” from the 10/29 statement but that phrase could wind up staying at this point).

· Fri’s wage numbers were tepid and it won’t be until later in Oct when the next inflation releases cross the tape (the Sept CPI is on 10/22).

Fed – jobs suggest a move away from ZIRP. While disinflation pressures appear to be building, the jobs data is signaling a Fed that should begin shifting away from ZIRP. The unemployment rate now has a “5” handle (it hit 5.9% Fri) and other components of the jobs market are improving.


The “risk” checklist – so far, so good. The list of things that need to happen for stocks to begin behaving better:

{C}1. Draghi will have to define his addressable market as including both retained securities and those held by investors – he did that last Thurs.

{C}2. the Fri jobs needs to be within the “range of acceptability” (net adds ~170-235K, UR 6.1-6.3%, and wages 2-2.2%) – that mostly happened Fri (the sluggish wage # offset the “5” UR handle).

{C}3. HK needs to open this Fri and trade decently – that happened Friday although it will have to continue in the coming days.

{C}4. The Fed minutes (Wed 10/8) can’t read any more hawkish than the “dots” already suggested.

{C}5. Some of the fixed income flow information (i.e. out of PIMCO and into others) needs to start stabilizing.

{C}6. The first few earnings reports need to be OK, inc. YUM 10/7, AA 10/8, PEP 10/9, INFY 10/10, C/JNJ/JPM/WFC/INTC 10/14, BAC/AXP 10/15, IBM 10/16, andBK/GE/HON 10/17.


Global Data Watch: The global economy is being buffeted by two sizable market movements: USD strength and commodity price declines. In part, these moves reflect relative shifts in demand and policy.

· Demand is shifting toward the US and away from commodity-intensive consumers at the same time that there is a relative shift in G4 monetary policy.

· I view the Fed implications of the September employment report as mildly hawkish, with the committee likely to place more weight on the falling unemployment rate than on the stagnant wage figures.

· I view the latest signals from the ECB and BoJ as increasing the likelihood that further easing measures will be forthcoming. A rising dollar and falling commodity prices, of course, signal growing downside risk to global growth, a point underscored by the recent decline in risky asset prices.

· Independent of the drivers, there are likely to be important macroeconomic repercussions. The most obvious is a move toward lower global inflation.

· I’m already building in a significant fall in inflation in the coming months, and the recent drop-off in oil prices is not fully incorporated in the forecasts. Viewed on a high-frequency basis, the 3-month annualized inflation rate should fall to its lowest level since the Great Recession


Expectations have dropped for Yum! Brands’third quarter results in the month leading up to the company’s earnings announcement slated for Tuesday, October 7, 2014. The consensus analyst estimate has dropped from $1.00 a share to the current estimate of earnings of 87 cents a share.

The consensus estimate has dipped over the past three months from $1.08. For the fiscal year, analysts are expecting earnings of $3.38 per share. Analysts are projecting revenue this quarter to stay static at $3.46 billion. A year after being $3.47 billion, analysts expect revenue to fall less than a percent year-over-year to $3.46 billion for the quarter. For the year, revenue is projected to come in at $13.67 billion.

Over the last four quarters, revenue has fallen an average of 1% year-over-year. The biggest drop came in the most recent quarter, when revenue fell 8% from the year-earlier quarter.

The company has been profitable for the last eight quarters, and for the last four, profit has risen year-over-year by an average of 16%. The quarter with the biggest boost was the most recent quarter, which saw a more than twofold surge.

Yum Brands develops, operates, franchises and licenses a system of restaurants. Domino’s Pizza, Inc., also in the restaurants industry, will report earnings on Tuesday, October 14, 2014. Analysts are expecting earnings of $0.61 per share for Domino’s Pizza, up 20% from last year’s earnings of $0.51 per share. Other companies in the restaurants industry with upcoming earnings release dates include: Chipotle, McDonald’s and Carrols Restaurant Group.