Eurozone's Consumers, NE Asian Trade, China Industrial Momentum - Three Shocks & Surprises From Last Week

Three threads to pick up from the shocks and surprises of last week: 

• Eurozone Consumer Confidence Warns of Sharply Slowing 4Q Retail Sales
• NE Asian Trade - The Fall in Japan's Exports Says More About Falling Market Share than Falling Global Demand
• China Industrial Momentum Recovery - Reacting to Eased Money Conditions and Modest Uptick in Domestic Demand

1.Eurozone Confidence & the Consumer 
The EU Commission’s November Eurozone consumer confidence survey fell to its lowest level since May 09 in its preliminary reading. Although no details come with the preliminary reading, separate independent consumer confidence surveys today from Germany and Italy find both slipping worse than expected, with Italy making another record low. 
Over the past five years, the EU’s confidence survey has been a good indicator of the health of Eurozone retail demand, and an early indicator too, because it appears two months in advance of retail spending data. Thus, the latest Eurozone retail sales volume data we have is for September (when it fell 0.2% mom and fell 1% yoy). 

If this continues, then we must brace ourselves for intensifying retail weakness during 4Q. In yoy terms, retail sales fell 1.1% yoy in 3Q, but if the mom patterns were maintained through 4Q,  the yoy fall would be trimmed to just 0.2% yoy during the quarter. But if the consumer confidence indicator is any guide, we should be looking at a fall of around 2% yoy. If so, we should expect retail sales to fall by around 1% mom throughout 4Q. This is incompatible with consensus GDP forecasts, which purportedly expect a steady state decline throughout 3Q and 4Q.  

2. NE Asian Trade  Japan’s exports fell by 6.5% yoy in October, hobbled by a 9.9% mom fall in exports to the EU. The export weakness landed Japan with a Y549bn trade deficit –worse than the range of expectations and once again underlining the erosion of Japan’s private sector saving surplus. But Japan’s export weakness is more to do with its competitive weakness than with the state of world demand. Taking NE Asian together (China, Japan, S Korea, Taiwan), October exports rose 3.8% yoy in October, with the 6m momentum trendline inflecting up (though it is still modestly negative). In dollar terms, China’s exports rose 11.5% yoy, Korea’s rose 1.2%, Taiwan’s fell 1.9%, but Japan’s fell 9.2% yoy.

There is, simply, no comparison with 2008/09.  

Rather, what is happening is that Japan is losing market share at an accelerating rate: in the 12m to October Japan’s market share of NE Asian exports fell by 1.2pps to 22.1% whilst China’s rose 2.3pps to 54.9%  (Taiwan and S Korea lost 0.6pps and 0.5pps respectively). Why is it happening? US Customs data tells us since Jan 2008 the price of imports from Japan have risen 9.4%, whilst during the same period China’s have risen only 4%. If Japan’s productivity has not similarly outperformed China’s during the same period, competitiveness will have been lost. As it evidently has. There’s no reason to expect the downward pressure on the yen to abate soon.

3. China Industrial Momentum Although exports play a key role in soaking up the surplus production China’s financial repression/super-heavy investment growth model inevitably produces, this is not an export-driven or export-oriented economy. Rather, the pattern is that changes in demand shadow changes in monetary conditions, and that, generally, industrial momentum follows along in due course.

That’s what seems to be happening in the latest data. As the chart above shows (and as we have been pointing up in our reports) China has allowed a gentle degree of re-liquefication of the economy over the last few months, quietly using instruments such as bankers acceptances rather than straightforward bank lending.  Domestic demand (retail sales, investment, vehicle sales, property sales) have responded in appropriately low-key fashion. And finally, this week’s data suggested that the industrial sector is responding too: the MNI Business Sentiment index for November scored its most positive reading since June; the HSBC Manufacturing PMI flash for November gave its first (marginally) 50+ result since October 2011, and the Conference Board’s October Leading Economic Index rose strongly enough to break an already-rising trend.  There seems no reason to expect them to be wrong.

US Industrial Weakness - The End of the Beginning

Conclusion: The US's industrial data has been exceptionally volatile over recent months: October's shocking 0.9% mom fall in manufacturing output is countered today by the strongest Markit manufacturing PMI since June.  But beyond the noise, there is genuinely good news: US industry and its buyers are seeking, and finding, an equilibrium which was seriously threatened earlier this year. The volatility may well continue, but the worst scenarios of industrial recession are in retreat - most probably, the worst we can now say is that this is the end of the beginning. 

Markit's US manufacturing PMI has too brief a history to be taken as definitive, but November's read of 52.4 implies the strongest expansion since June, and the details suggest that the strength is broad-based: output, new orders and employment all accelerated, whilst inventories of finished goods shrank work backlogs stagnated. Meanwhile, there are signs of supply-side stickiness, suppliers' delivery times lenthening the steepest since May and input prices jumping the most since March.

Whilst there will probably be more volatility to come, the uptick captured by the PMI shouldn't be ignored - there are good reasons to think that at the worst, this is the end of the beginning of this year's wave of US industrial weakness.

Understanding the dynamics of this year's weakness is the key to understanding why we are probably now exiting that phase. So consider the recent evidence: the industrial shocks fell thick and fast last week: industrial production fell 0.4% mom in October, with manufacturing down 0.9%, which dragged down capacity utilization rates to their lowest since November 2011. The news was exacerbated by a shockingly weak Philly Fed survey, a weakness in part reflecting the impact of Hurricane Sandy on production and orders. However, although those grabbed the headlines (and depressed sentiment), the news was not solely bad.

To understand why, consider the chart above, which tracks growth in output against growth in manufacturing and trade sales. Throughout much of the last year, the trend in sales has been declining relative to output. By June, we had finally reached the point where output was growing faster than sales – surely a herald of a production slowdown needed to restore equilibrium. This deteriorating supply/demand imbalance has led to recurring bouts of industrial weakness, of which September’s 0.4% mom decline was the latest manifestation.

But now look at the chart again: sales are now picking up both absolutely (manufacturing and trade sales rose 1.4% mom in September) and relative to production.

The picture is completed by taking into account movements in total inventories and exports. In September, both of these gave strong readings: total inventories rose 0.7% mom, and exports jumped 4.2% mom. When we compare the underlying 6m momentums of Output minus sales, plus inventories, and exports (see the chart below), we can see that neither the sharp excess of production over sales and inventories that was threatening by mid-year, nor the collapse of exports which also seemed likely, has come about. Back in June, the data threatened a repeat of 2001 and 2008-09. Despite, or perhaps because of, the volatility of industrial and trade data over the last few months, that threat has receded. 

Conclusion? Manufacturers and buyers are seeking, and beginning to find, an equilibrium. This doesn’t mean that US industrial weakness will quickly pass, or that volatility will end soon: but October’s output fall is more likely the end of the beginning than the beginning of the end – a suggestion buoyed by the unexpected strength of November's Markit PMI.

Germany & France GDP, US Industrial Shocks, China's Financing Surprise

The weight of shocks and surprises last week fell squarely on shocks - in data terms it was the  most miserable week since early June.  However, here are three aspects of the data which are worth bearing in mind: 

1. Germany and France GDP: Fundamentally Divergent Patterns Masked by Identical 3Q GDP Growth
2. US Industrial Weakness - The End of the Beginning? 
3. China's Aggregate Financing Surprise - Look Beyond Bank Lending

1. Germany and France GDP   The preliminary estimates of 3Q GDP showed both France and Germany growing +0.2% qoq. This was as expected for Germany, but a pleasant surprise for France (even if it may be revised away later), which suggests a comforting stability within the core of the Eurozone. Unfortunately, the likelihood that France and Germany will continue to grow at a similar pace in coming years is an illusion. The problem is not so much to do with the financial problems of the Eurozone per se, but rather that the two countries grow in different ways. Whilst for the first decade of the Eurozone this was masked by historic coincidence, it is unlikely to be so in the next decade.

Between 2000 and 2007, German growth averaged 1.7% a year, whilst France average 2.1% in real terms, suggesting a compatibility that tilted slightly in France’s favour.  However, Germany was pursuing a growth model based on  relatively low growth in capital stock but high and rising rates of return on that capital, whilst France’s growth was secured by high growth in capital stock but a far lower, and falling, rate of return.

Estimating growth of capital stock by depreciating all investment over a ten year period, between 2005 to now growth of Germany’s capital stock averaged 1.1% pa, whilst France’s was leaping along at 4.5% pa. The chart above shows that as a result, whilst Germany’s return on capital was likely rising throughout most of this period, France’s was (and is) falling. 

That behaviour isn't surviving the financial crisis: in 2008 at the beginning of the crisis, France’s capital stock was growing at 6.9% yoy, whilst Germany’s lagged at 2.1%. In the year to 3Q, I estimate France’s growth of capital stock had slowed to 3%, whilst Germany’s had risen slightly, to 2.4%. These numbers are the very cornerstone of future growth: and they strongly suggest that the years when France’s economy keeps pace with Germany’s are over.

2. US Industry Shocks  The industrial shocks fell thick and fast this week: industrial production fell 0.4% mom in October, with manufacturing down 0.9%, which dragged down capacity utilization rates to their lowest since November 2011. The news was exacerbated by a shockingly weak Philly Fed survey, a weakness in part reflecting the impact of Hurricane Sandy on production and orders. However, although those grabbed the headlines (and depressed sentiment), the news was not solely bad.

To understand why, consider the chart above, which tracks growth in output against growth in manufacturing and trade sales. Throughout much of the last year, the trend in sales has been declining relative to output. By June, we had finally reached the point where output was growing faster than sales – surely a herald of a production slowdown needed to restore equilibrium. This deteriorating supply/demand imbalance has led to recurring bouts of industrial weakness, of which September’s 0.4% mom decline was the latest manifestation.

But now look at the chart again: sales are now picking up both absolutely (manufacturing and trade sales rose 1.4% mom in September) and relative to production. In addition, total inventories rose 0.7% mom, and exports jumped 4.2% mom. In short, manufacturers and buyers are seeking, and beginning to find, an equilibrium. This doesn’t mean that US industrial weakness will quickly pass: but October’s output fall is more likely the end of the beginning than the beginning of the end.    

3. China Aggregate Financing Surprise The one genuinely positive surprise last week came from China and passed virtually unnoticed. The surprise was the strength of the Rmb1.29tr in new aggregate financing extended in October, which was 63.1% higher than in October 2011. However, the data was largely ignored, in favour of the  ‘disappointing’ Rmb 505bn in new bank loans made during the same month. Now bank lending is a subset of China’s monthly ‘aggregate financing’ which also includes bankers acceptances, trust loans, bond issues and fx loans.

Historically bank lending has accounted for the lion’s share of China’s visible financing, but is being steadily eclipsed by other financing methods. This eclipse is partly driven by the perennial efforts of cash-rich banks (loan/deposit ratio of 69%) to escape the corset of PBOC’s lending disciplines. But currently, in addition, the large-scale issuance of bankers acceptances helps to reliquefy cramped industrial cashflows without necessarily re-igniting property markets. In coming years, meanwhile, the envisioned phased liberalization of financial markets and institutions is likely to keep driving down bank lending as a proportion of total financing.

All of which raises the question: what is happening to overall financing levels. We know that growth of banks’ loan books slowed to 15.9% yoy in October and has been slowing 

Different Trains: Germany and France GDP

The preliminary estimates of 3Q GDP showed both France and Germany growing +0.2% qoq. This was as expected for Germany, but a pleasant surprise for France (though one that risks being revised away at a later date). It paints a comforting picture of enduring convergence between the Eurozone's two largest economies. 

Unfortunately, the likelihood that France and Germany will continue to grow at a similar pace in coming years is an illusion. The problem is not so much to do with the financial problems of the Eurozone per se, but rather that the two countries grow in different ways. Whilst for the first decade of the Eurozone this was masked by historic coincidence, it is unlikely to be so in the next decade. France must expect a long retreat in its GDP relative to Germany.

And this would be new. Between 2000 and 2007, German growth averaged 1.7% a year, whilst France average 2.1% in real terms, suggesting a compatibility that tilted slightly in France’s favour. In real terms, since 2000, France's GDP has grown by 30%, Germany's by 25%. In nominal terms, however, the difference has been tilted sharply to France: it has growth 68% since 2000, whilst Germany has grown only 36%. The advantage of the single currency, then, would seem to have been primarily France's.

This state of affairs, however, is now unravelling, because Germany was pursuing a growth model based on relatively low growth in capital stock but high and rising rates of return on that capital, whilst France’s growth was secured by high growth in capital stock but a far lower, and falling, rate of return.

We can see this by estimating growth of capital stock by depreciating all investment over a ten year period, and then expressing GDP as an income from that stock of capital. Of course, this is an imperfect measure, but it is at least likely to indicate broad differences between growth models, as well as changes in direction of ROC.

First, between 2005 to now growth of Germany’s capital stock averaged 1.1% pa, whilst France’s was leaping along at 4.5% pa. As the chart below shows, the mismatch in growth of capital stock has diminished over time, and particularly during the last couple of years.

However, the corollary is that whilst Germany's economy was winning rising asset turns, and rising ROC from its capital stock,in France the extra investment was producing sharply diminishing asset turns. Again, the most noticeable divorce in trends took place before the onset of the financial crisis. However, Germany's legacy is that it now seemingly enjoys sharply higher ROC than France.

Until the outbreak of the financial crisis, this difference in economic models was not recognized in any significant bond yield differential: France could finance its high-investment/low return growth model on the same terms as Germany's low-investment/high return growth model. But those days are over: currently 10yr German government bonds yield 1.42% whilst France's yield 2.15%. If France continues to pursue its traditional high investment/low returns model, whilst Germany persists in the opposite model, there is no reason to expect bond yields to converge again. 

Indeed, the gap in relative investment behaviours is already narrowing fast: in 2008 at the beginning of the crisis, France’s capital stock was growing at 6.9% yoy, whilst Germany’s lagged at 2.1%. In the year to 3Q, I estimate France’s growth of capital stock had slowed to 3%, whilst Germany’s had risen slightly, to 2.4%. But there has been little change in either country's return on that capital as expressed in nominal GDP.

These numbers are the very cornerstone of future growth: unless they change again, they guarantee that the years when France’s nominal GDP outpaced Germany's are over. Indeed, the long retreat has already begun: when the Euro was introduced in 1999, France's nominal GDP was 67.5% that of Germany: that proportion rose almost uninterrupted to a peak of 79.6% in 3Q2009. Three years later it had fallen back to 76.8%, and there is no reason to think its retreat will not be as steady as its rise.  

Asian Trade Prices; Germany's Industrial Economy; Japan's Private Sector Savings Surplus

The shocks and surprises of last week mainly concerned the downturn in the world's industrial economy, and particularly the impact of the downturn in the capital goods sector on Germany and Japan.  The three strands that stood out for me were: 

1. US Import Prices, and the story they tell of intra-Asian competitive pressures
2.  Germany's Industrial Sector Data - Output, Orders and Exports All Crumbled in September, turning key cyclical indicators sharply negative
3. Japan's Current Account Disappointment was a further chapter in the long-running story of Japan's savings surplus running out. 

1. US Import Prices and Asian Trade

US ex-petroleum import rose 0.3% mom in October, with industrial supplies up 1.2% mom and consumer goods and F&B both up 0.2%. However, the real surprise came in the breakdown of import prices by country and region: prices of imports from China fell 0.3%, but rose 0.3% mom from both Japan and NE Asia, and 0.6% from the EU and Latin America. Such a divergence in pricing trends won’t last long. As the chart shows, the divergence between prices from Japan and China has gradually widened to its most extreme since at least 2004, and this has coincided with sharp falls in Japanese exports (down 10.3% yoy in yen terms in September), and a spike in inventory/shipment ratios (see last week’s Espresso). 

The result is that we must expect Japanese export prices to  fall in the coming months. But so too will prices from Asean, where historically trade prices have converged with China’s. The Singapore dollar has weakened slightly against the Rmb from its mid-September peak, but the fall in China’s trade prices to the rest of the world suggests there’s more to come. Meanwhile, their differing pricing structures suggest that S Korea and Taiwan have evolved an industrial structure which is competing directly neither with China/Asean nor Japan. 

2. Germany Industrial Economy The week brought a spate of bad news about the state of Germany’s industrial economy in September: manufacturing/mining fell 2.3% mom, factory orders fell 3.3% mom and exports fell 2.5% mom.  This is testament mainly to the capital goods basis of its industrial base: output of capital goods fell 3.5% mom, and orders for capital goods fell 2.4% mom (orders from the Eurozone fell 9.3% mom). The relationship between new orders and output is, of course, a reasonable early cyclical indicator – a sort of book-to-bill ratio.  And the pattern of this ratio is strikingly similar to the spike in Japan's inventory/shipment ratio which we noticed last week. The ratio has been deteriorating since July last year, and September’s data took it to the the lowest level since mid-2009. 

3. Japan Current Account and Private Sector Savings Surplus 
September’s current account surplus sank to Y503.6bn, which was a shock to consensus, albeit the consensus was more difficult to explain than the result: the trade and services deficits were both in line with trends, as was the Y1.309tr income surplus which now buttresses the current account. 

The relevant shock is not therefore the current account surplus itself so much as what it tells us about the rapid and accelerating erosion of Japan’s private sector savings surplus – ie, the flows of cash which underpin Japan’s economy. During 3Q, rapidly has fallen sharply over the last two months. The combination of September’s build-up in domestic government debt and the current account position tells us that Japan’s private sector had a Y6.54tr savings deficit during the month. During 3Q Japan’s private sector ran a savings deficit of Y3.86 tr, equivalent to 3.4% of GDP, and compared with a surplus of Y4.11tr in the same period last year.  For the 12m to September, Japan’s private sector savings surplus had dwindled to just 1.6% of GDP, down from 8.9% in the same period last year.  

Throughout the entire lifetime of modern Japan, the assumption that a flow of ‘surplus’ private sector savings will underpin virtually any fiscal excess has been well-founded. That assumption is no longer justified: Japan's fiscal position is now financed by the central bank's quantitative easing, not Japanese private savings flows. 

US Savings, Japan Inventory/Shipment Ratio, Spanish Retail Sales -Three To Watch

Three shocks and surprises from last week's data which are worth thinking about: 

1. US Savings Ratio - After rising very sharply in 2Q, the household savings ratio is now falling fast - but how much lower will it go?
2. Japan Inventory/Shipment Ratio - Despite weak industrial production data, the inventory situation worsened again in September.  Prices will fall.
3. Spain Retail Sales - The collapse in September's sales was a 4.6 SD event


1. US Savings Ratio Personal income grew 0.4% mom in September, but personal spending rose at 0.8% - double the pace. The combination cut the personal savings ratio to 3.3%, nearly the lowest since end-2007 – a concrete manifestation of the recovery in consumer confidence found by surveys in the last two months. 

This is both good news and bad news. It is good news because the unexpected rise in household savings had compromised domestic demand growth since late-2011. As the savings ratio rose from a low of 3.2% in November 2011 to 4.4% in June 2012, so growth of personal consumption expenditure slowed from 2.8% (12ma 3Q11) to 2.0% (12m to 2Q12).  With wage growth slowing from 2.7% yoy at the beginning of the year to just 1.3% yoy in September’s data, the rise in savings ratio also cut into sales growth (5.9% in 1H2012 vs 7.6% in 2H2011).  The cut in savings ratio during 3Q will go some way towards cushioning retail sales from the impact of torpid income growth. 

The less good news is that it seems unlikely that the savings ratio has much further to fall: during pre-crisis 2000-2007 the savings ratio averaged 2.8%, with a standard deviation of 0.8pps. In the absence of a recovery in income growth, if the savings ratio now stabilizes, it will drain support from consumption demand.

2. Japan Inventory/Shipment Ratio  September’s industrial data was dreadful: production fell 4.1% mom, shipments fell 4.4%, inventory fell only 0.9% and consequently the inventory/shipment ratio rose 4.2% mom. This took the inventory/shipment ratio to its highest level since mid-2009, and 30% higher than the 2003-2007 average. 

The spike in this ratio rapidly results in two things. First, it heralds a further slowdown in production from the affected industries. Second, it also signals a fall in export prices, achieved with or without the aid of a currency fall – a deflationary twist which will be felt by all Japan’s trading competitors.  

So which sectors face the toughest situation? The transport sector is by far the worst affected, with a relatively mild upward trend throughout the year culminating in a spike during the last two months. It is tempting to attribute this spike to the deterioration in diplomatic and popular relations with China. Otherwise, the weaknesses are in consumer durables, in general machinery and electrical machinery, in precision instruments, and pulp & paper. But the sectors where the ratio has not built up include most of the usual commodity suspects: there is little sign of inventory build in iron & steel, in non-ferrous metals, in petroleum/coke products, or in ex-pharma chemicals. The inventory/shipment ratio for electronic parts and devices, meanwhile, is actually falling, suggesting tightening demand. The ratio for the information/communications equipment sector remains high, but has fallen sharply over the last two months.

3. Spain Retail Sales In volume terms, sales fell 12.6% yoy in September, and the 9.5% mom contraction was no less than 4.6 standard deviations below seasonal trends. This fall did more than reverse August’s  unexpected relative strength. During the first nine months of the year, Spain’s sales were 21.8% lower than during the same period in 2007, but on a 6m momentum basis, they are now weakening at the same pace as in early 2008 at the onset of the crisis. 

The main problem, of course, is employment, which shrank by 4.6% yoy in 3Q12, and in the latest 12 months was 13.6% (or 2.74mn) below the same period in 2007.   With October’s manufacturing PMI falling to 43.5 – its lowest in three months – and with firms cutting purchasing, inventories and jobs, there is no reason to expect any early jobs relief.   In addition to jobs, consumer credit is also being crushed, with consumer lending down 40.4% from its mid-2008 peak, and still falling by 11.7% yoy. Although this is no worsening against trend, the trend itself is running at a 20% fall over the coming year.