Tuesday, 6 March 2012

Shocks and Surprises, Week Ending March 4th

Over the last few months, the US, Europe and China have provided a steady series of view-adjusting shocks and surprises, whilst Japan's sustained moderate misery has surprised no-one. Until last week, when first Japan reported a 4,1% MoM jump in retail sales in January, then followed up the next day with a surprise 2.0% MoM rise in industrial output.

But these two were then eclipsed by a surprise 7.6% YoY rise in capital spending reported for 4Q in the Ministry of Finance's enormous quarterly survey of balance sheets and p&ls. This was far removed form the 6.5% YoY fall expected. The details showed manufacturing investment rose 5.7%, whilst non-manufacturing rose 8.6%. There were big jumps in capex in construction (88.7%), wholesale/retail (24.6%), real estate (35.7%), but also in machinery (83.1%), business machinery (25.3%), and chemicals (10.5%).

It's tempting to get rather excited by this: after all, by virtually every measure 2011 was a rotten year for Japan, with currency strength compounding the misery already perpetrated by earthquake, tsunami, nuclear accident and political uncertainty. The same quarterly data shows sales fell 3.7% YoY, operating profits fell 8.6%, operating margins fell from 3.26% in 2010 to 3.09% in 2011, ROA fell to 3.01% from 3.32%, and ROE fell to 8.2% from 9%.

So why is capital spending up 7.6% YoY? There are two possible levels of explanation, of varying cheeriness. Let's take the cheery explanation first. One can argue that increased capex is simply the dividend now being paid for decades of corporate balance sheet restructuring. This chart takes two interpretations of leverage: financial leverage (total assets/shareholders equity), and net debt/equity ratio. And yes, they have both finally stabilized, a mere 22 years after they the bubble imploded.
That in itself is potentially a game-changer. But there's more – after deleveraging comes a cash build-up. And here it is:

So, after completing deleveraging and building up a cash horde, the logical next step is to start spending/investing once again. And so, we have the third chart. . . 
But at this point, the observant will see that the headline 7.6% YoY growth in capital spending is rather more impressive than the actual amount, compared with past spending plans. And in fact, such spending hardly breaks out of the investment slump we've seen since 2008. There is an awful lot of sustained investment spending to be done before we can describe a new era of Japanese industrial investment is underway.

At which point, we look at a fourth chart, which expresses current spending on plant and equipment with depreciation allowances. And the key point here is that even the 7.6% YoY rise in spending during 4Q still leaves total investment only very marginally higher than the depreciation on existing capital stock. In short, this surprise isn't (yet) telling us Japan is expanding its capital stock – it is still merely treading water.
Eurozone: In Denial
Elsewhere, for the most part, the data-run from the Eurozone continues to suggest that economists are strangely reluctant to acknowledge the unfolding recession. German retail sales fell 1.6% MoM, with pretty much everything falling – furniture was down 3% MoM, infotech donw 2.2%, autos down 1.7% and even clothes/shoes were down 0.9%. Similarly, French household consumption fell 0.4%, buoyed only by a 2% rise in spending on energy and a 1.4% rise in food spending. Elsewhere, French spending on durable goods fell 4.3%, and autos fell 7.6%. Why should this be surprising? Despite economists' unanimous expectation that the unemployment ratio would remain unchanged at 10.4%, it jumped to 10.7%. There are some absolute horror stories in that data – most notably Spain's ratio rising to 23.3%. Dreadful though it is, that is expected. But Germany's ratio is also now rising, to 5.8% from previous 5.7% (that's the EU count – Germany's own count puts its unemployment ratio at 6.8%). This month, only Austria bucked the trend of rising unemployment.

But there was one surprise – Eurozone M3 growth rose 2.5% YoY in January, recouping most of the ground lost in December's 1.6% YoY shock. The key statistics in all the monetary and banking data for January, in my opinion, was the 0.3% MoM rise (not seasonally adjusted) in bank lending to the private sector – this followed consecutive falls of 0.8% MoM in December, 0.1% in November, and 0.3% in October. In other words, January saw a modest and very probably temporary brake on the pace of household deleveraging. On the other side of the banking system's balance sheets, total deposits rose 0.6% MoM (nsa), up from 0.2% in December, allowing the YoY to rise to 2.7% in January from 2.1% in December. That's the good news. The less good news is that the rise in deposits was almost entirely the work of governments: government deposits jumped 23.1% MoM, whilst everyone else's stagnated at 0.1% MoM. Yes, there are strong seasonal patterns at work in December and January differentiating government private sector deposits – but they are not normally this strong. January's partial recovery in Eurozone monetary data will not be long-sustained.

US – Softer January, Harder February
From the US came an unexpected raft of worse-than-expected data – made all the worse because the shocks came from hard data, rather than surveys of intentions or dispositions. First durable goods orders fell 4% MoM in January, with capital goods orders, ex-defence and air down 4.5% MoM. Orders for machinery collapsed by 10.4% MoM, primary metals fell 6.7%. Shipments of capital goods did better – they rose 0.4% MoM, and both unfilled orders rose (up 0.5% MoM) and so did inventories (up 0.7%).

This was followed later in the week by unexpected weakness in personal income growth (up 0.3% MoM – wages up 0.4% MoM, but transfer payments fell 0.2% whilst social insurance costs rose 1% and taxes rose 1.6%). Personal spending also disappointed, rising only 0.2% - and within this demand for goods rose 0.6% but services stagnated entirely.

Finally, the roll-call of bad news was completed by an unanticipated fall of 0.1% MoM in construction spending, mainly reflecting a 3.9% MoM fall in hotel-building.

All of which was more grim news than we've seen from the US for a number of months now. However, there was solace in that all those negative indicators reflected reports of activity in January. Meanwhile, hard data was arriving from February which painted a far stronger picture. ISCM Chain Store sales jumped 6.7% YoY, even though sales of luxury goods were flat. And total vehicle sales topped an annualized 15mn for the first time since early 2008. The Conference Board consumer confidence index also jumped to its best reading since February last year , as readings both on current circumstances, and future expectations jumped.

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