Capital Spending

As go profits, so goes business spending. The recent stall in S&P 500 forward earnings isn’t a good omen for new factory orders, which have already stalled so far this year. Profitable companies expand their capacity by spending more on plant and equipment. Unprofitable companies scramble to cut their costs by reducing their capital outlays. In the real GDP accounts, the pace of capital spending has been slowing. It rose 5.3% (saar) during Q2 following a gain of 7.5% during Q1. Last year, such spending increased 8.6%.

The recent stall in orders is widespread. Orders for Machinery look especially toppy, led by recent weakness in Construction Machinery, Farm Machinery, and Mining, Oilfield & Gas Machinery. The slowdown in the growth rates of major emerging economies is depressing demand for construction machinery. The severe drought in the US is bad for farm incomes and outlays on farm equipment. The glut of natural gas is depressing the demand for rigs.

Today's Morning Briefing: ECB’s New Mandate. (1) The mandate question. (2) Draghi is focusing on spreads. (3) Hurry up, and drag your feet. (4) At WIT's end? (5) Less than zero IOER? (6) S&P 500 earnings expectations down across-the-board. (7) Energy and Materials estimates especially weak. (8) SMidCaps outpacing LargeCaps forward earnings. (9) Not-so-durable goods orders. (More for subscribers.)

WIT (“Whatever It Takes”)

Mario Draghi likes his job and wants to keep it. He is the President of the ECB, which was created to manage the euro within the European Monetary Union implemented on January 1, 1999. Therefore, it wasn’t all that surprising to hear him say last week that “the ECB is ready to do whatever it takes to preserve the euro” since he wants to keep his job. Nevertheless, the S&P 500 rose 3.6% on Thursday and Friday after Draghi's assurances, while the MSCI Europe stock price index jumped 3.9%. The Spanish 10-year government bond yield plunged from a record high of 7.63% on Tuesday to 6.50% this morning. The euro also surged.

The hoopla was triggered by Draghi’s presentation on Thursday, July 26 at the Global Investment Conference in London. Given the importance of what he said and its impact on the markets, it was very odd that the speech wasn’t based on a prepared text. The ECB’s website billed it as the “Verbatim of the remarks by Mario Draghi.” According to the official transcript, Draghi said, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” A video shows that he actually repeated “within our mandate” twice. Draghi seems to be saying that his mandate is to save the euro no matter what.

The markets were happily surprised because Draghi’s remarks suggested that the ECB’s Governing Council--which includes six members of the Executive Board and the governors of the 17 euro zone central banks--may vote on Thursday to restart the central bank’s program of buying government bonds of debt-challenged euro zone members like Spain and Italy. Not so happy might be the other members of the Governing Council, who apparently were also surprised by Draghi’s off-the-cuff statement.

Financial markets will be nervously awaiting the results of Thursday’s meeting to see if the ECB’s Governing Council will buy Draghi’s “more Europe” by agreeing to purchase more Spanish and Italian bonds.

Financial markets will also be nervously awaiting the conclusion of the next FOMC meeting on Wednesday. A week ago, John Williams, president of the Federal Reserve Bank of San Francisco, said he favored QE3, with the Fed buying mortgage-backed securities, in an interview reported in the FT. He is a voting member of the FOMC. In his interview, he warned of significant downside risks to the US economy from the fiscal cliff, the euro zone crisis, and the global slowdown. He proposed that the next round of QE be open-ended without specifying how much the Fed would purchase and when the program would end.

Then last Wednesday, Jon Hilsenrath reported in the WSJ that Fed officials “are moving closer to taking new steps to spur activity and hiring.” Mr. Bernanke is frustrated that the economy is “stuck in the mud” and has yet to achieve “escape velocity.” QE3 is on the table, and the Fed is “exploring other novel measures,” such as to provide cheap credit directly to banks that make new business or consumer loans.

On Friday, we learned that real GDP rose only 1.5% (saar) during Q2, down from 2.0% during Q1 and 4.1% during Q4. Real final sales rose just 1.2% (saar) during the second quarter, the slowest since Q1-2011. On a year-over-year basis, real GDP is up 2.2%, with consumer spending up 1.9%, while real wages and salaries are up only 1.6%. We now have four July regional Fed business surveys, for New York, Philadelphia, Richmond, and Kansas City. The average of the composite business indexes remained negative for a second month in a row at -4.4, led by a negative reading for orders.

This could be an interesting week if both the Fed and ECB implement another round of WIT ("whatever it takes").

Today's Morning Briefing: Whatever It Takes. (1) ECB wants to stay in business. (2) Mario’s WIT, i.e., “Whatever It Takes” (3) The Bundesbank is not amused. (4) Cheerleaders in Paris and Berlin. (5) Bottomless pit in Spain. (6) Schäuble says nein. (7) The euro is a bumblebee. (8) Will the ECB buy “more Europe?” (9) Will the Fed buy more bonds? (10) WIT makes stocks smile. (11) Do earnings matter? (12) America’s two economies. (13) Britain gives itself gold medal for entitlements. (14) “The Intouchables” (+++). (More for subscribers.)

China

Recently, lots of doubts have been raised about the accuracy of official economic measures released by China’s government. I don’t doubt that the quality of much of the data is questionable. We regularly update our China chart book and try to assess the big picture as best we can using all the available data as a whole.

We are constantly on the lookout for more data to add to our chart book. I recently asked one of my colleagues to work on China’s official tax revenues. He found the latest official release in Chinese and used Google’s translation utility to read it. He ran a chart showing tax revenues in yuan during H1-2012. A second chart shows the y/y growth in revenues during H1-2012 versus during H1-2011.

The data were released by the Ministry of Finance on Tuesday of this week and outlined in a story appearing in the English version of xinhuanet.com. The data confirm a significant slowdown in Chinese economic growth during the first half of this year:

(1) Tax revenues rose only 9.8% y/y during H1-2012, down from 29.6% over the same period a year ago. Growth rates were down across all 11 major revenue sources.

(2) Personal income taxes actually declined 8.0%. A year ago, they rose 35.4%. Corporate income taxes rose 17.3%, but that was down from 38.3% a year ago.

(3) Revenues from property transactions took a hit. The ones from “Land Value Increment” rose 14.7% vs. 91.1% a year ago. “Deed” revenues fell 9.9% after rising 27.5% a year ago.

Today's Morning Briefing: The Best & the Brightest. (1) Weill, Greenspan, and Blankfein have seen the light. (2) Bair is flabbergasted. (3) The Great Barofsky. (4) Other Peoples’ Money. (5) Capitalism’s weakest link. (6) Geithner’s turn to come clean. (7) Nowotny’s golden opportunity? (8) Don’t bank on bank stocks. (9) Europe has very good Health Care for investors. (10) China’s tax revenues confirm slowdown. (More for subscribers.)

Europe

Eurostat reported on Monday that government debt in the euro area rose 4.5% y/y to a record €8.3 trillion during Q1-2012. Economic activity did not increase as fast as government debt, which rose to 88.2% of the euro area’s GDP from 86.2% a year ago. Greece’s ratio was one of the few that fell (from 152.4% to 132.4%), but remained the highest in the area. Rising were Italy (from 119.5 to 123.3), Spain (64.7 to 72.1), and France (84.3 to 89.2). Europeans seem to be struggling to resolve their debt crisis by trying to lower their borrowing cost so they can borrow more!

Yesterday, Markit reported that the Flash Eurozone PMI Composite Index remained unchanged at 46.4 during July. The services PMI edged higher (from 47.1 to 47.6) while the manufacturing PMI edged lower (from 45.1 to 44.1). The manufacturing output PMI fell to a 38-month low of 43.6 with Germany’s output down for a third month in a row. This morning we learn that Germany’s Ifo business climate index dropped to 103.3 in July from 105.2 in June. The sub-index measuring the current business situation fell to 111.6 in July from 113.9 in June, while the outlook sub-index dropped to 95.6 from 97.2.

Late on Monday, Moody’s issued a “negative” outlook for Germany, the Netherlands, and Luxembourg. The triple-A credit ratings of the three are vulnerable to downgrades because of the risk of more euro zone bailouts. The Germans must be having quiet debates among themselves about whether they might be better off exiting the euro zone themselves rather than continuing to play the role of widely dissed authoritarian paymaster demanding austerity in exchange for bailout funds.

Today's Morning Briefing: Wobbly World. (1) Unsettling news out of China, the US, and Europe. (2) Home sweet home. (3) China’s PMI is up, but still down. (4) Three bad US regional surveys. (5) Europe hooked on debt. (6) Germany can’t run, can’t hide from European woes. (7) Moody’s says outlook is negative for Europe’s Triple-A’s. (8) Hilsenrath says Fed is toying with novelties. (9) Closer to zero. (10) King of the World. (11) Geopolitical tensions. (12) Healthier in the US. (More for subscribers.)

S&P 500 Earnings

Every Tuesday, I scrub the weekly consensus expected earnings data for the S&P 500. I get the stats from the folks at Thomson Reuters I/B/E/S, who missed a few spots during the week of July 12. They reported an uptick in the quarterly consensus earnings expectations for Q2, Q3, and Q4. Now their numbers show that Q2 has been flat for the past two weeks through July 19 at a new low for the series around $25 per share, which would be an increase of just 4.5% y/y. The latest numbers also show that Q3 and Q4 estimates have been lowered every week since the start of Q2. In other words, the upticks two weeks ago are gone.

As a result, the 2012 and 2013 estimates are at new lows of $104.11 and $116.41, respectively. These numbers imply earnings growth rates of 6% this year and 12% next year. They may still be too optimistic since revenue growth is likely to be closer to 5% during 2012 and 2013, while profit margins are likely to remain flat over this period.

S&P 500 forward earnings, which is the time-weighted average of the current and coming year estimates, has flattened out over the past seven weeks at a record high around $110. That happens to be my forecast for next year’s earnings, and is a relatively bullish outlook. Forward earnings tends to be a very good year-ahead leading indicator of actual earnings when the economy is growing. It will be way off the mark if the US economy falls off a fiscal cliff into a recession next year. Nevertheless, it tends to be highly correlated with the Index of Leading Economic Indicators, which fell 0.3% during June, but remains on an uptrend.

Today's Morning Briefing: Food for Thought. (1) Droughts and depressions. (2) QE and the price of corn. (3) Consensus earnings expectations may have further to fall. (4) Yet forward earnings are still at record highs. (5) No recession in analysts’ earnings forecasts. (6) NERI tumbles. (7) A bubble in dividend yielders? (8) Riding the rails. (More for subscribers.)