Report From Europe: Disappointing Payroll Numbers

by: The Mole

A very muted reaction from equity markets to what were undoubtedly disappointing payroll numbers on Friday with the Dow closing down just 21 on Friday after a positive week that fall could have been considerably more. Asia much the same with the Nikkei off 69 and the Hang Seng down just 1.

Regarding those US Payrolls numbers Friday, the massive layoffs by state and local governments took most of the headlines but within the numbers there are more reasons for concern. Temporary employment fell considerably and layoffs in residential construction and real estate would suggest the double dip in the housing market is well under way. Overall it is very hard to see the consumer coming back soon and consumption growth is unlikely to offset the fading fiscal stimulus in the second half of the year. The house of the giant vampire squid, Goldman Sachs have cut their forecasts for growth in both the US and Japan citing stimulus boosts waning. In 2011 they forecast growth for Japan at 1.4% compared to 1.7% originally and for the US they revise down to 1.9% from 2.5% originally.

Today’s Market Moving Stories

  • Bank stress tests have shown that as much as 20% of loans by China’s commercial banks to state owned enterprises (SOEs) could go bad, Market Watch reported, citing a report in Japan’s Nikkei newspaper. Nikkei quoted an unnamed China Banking Regulatory Commission (CBRC) official as saying 20% of all outstanding loans to SOEs failed to meet lending requirements, though they could not yet be considered non-performing. Earlier, the CBRC said that non-performing loans had risen to US$67.2bn by the end of June. Official figures may understate the problem: Ratings agency Fitch has warned that Chinese credit data is distorted by informal exposure. “securitization of bank loans, which results “in pervasive understatement of credit growth and credit.
  • President Barack Obama’s top energy adviser said Sunday that BP will pay a “large financial penalty” for the Gulf of Mexico oil disaster but refused to say if criminal negligence charges will be pursued. With the ruptured Macondo well all but dead on the ocean floor as engineers shut the well for good, BP is shifting toward recovery operations, including cleaning hundreds of miles of shoreline and restoring the economic health of the region. Carol Browner, director of the White House Office of Energy and Climate Change Policy, stressed that the British energy giant was on the hook for billions of dollars in penalties for the largest unintentional oil spill in petroleum industry history. “BP will be held absolutely accountable,” Browner told NBC’s “Meet the Press” program. “There will be a large financial penalty.”
  • The WSJ reports that European equities may have rebounded as sovereign fears eased. But most major indexes remain down for the year. And with many companies increasing dividends, European stocks offer juicy yields now higher than those on government bonds for only the third time in 30 years. On the past two occasions, in early 2003 and 2009, that heralded an equity rally. But although equity markets are below long term price to book ratios, analysts are cautious about forecasting big gains, noting an uncertain growth outlook. That is good news for income investors. This year, European equities will yield 4.1%, UBS says, almost twice U.S. That is above the 3.3% yield on AA rated corporate bonds and the weighted average 3.6% on 10 year bonds from 11 euro zone countries. True, dividends can be cut. They have been by some 40% since 2008, versus cuts of less than 30% in the past three recessions. Cancelling BP’s dividend in June took 12% off forecasts for U.K. companies’ second quarter payments, notes Capita Registrars, and corporate earnings could disappoint: UBS forecasts of 24% European earnings growth in 2010 and 10% in 2011 compare with a 7% longrun average. But corporate cash balances are near all time highs. Even though companies are slowly returning to the acquisition trail, payouts look sustainable. Dividend cover at 1.6 times free cash-flow is in line with a 10 year average. Although dividend payments from banks, typically around a quarter of Europe’s highest yielding stocks, are still disappointing, the telecom, utilities and energy sectors all are yielding a respectable 5% to 6%, J.P Morgan says. Investors should take note.
  • The FT reports that the Federal Reserve is set to downgrade its assessment of US economic prospects when it meets on Tuesday to discuss ways to reboot the flagging recovery. Faced with weak economic data and rising fears of a double dip recession, the Federal Open Market Committee is likely to ensure its policy is not constraining growth and to use its statement to signal greater concern about the economy. It is, however, unlikely to agree big new steps to boost growth. Smaller measures to help the economy could initially take the form of a decision to reinvest proceeds from maturing mortgage backed securities held by the US central bank, thereby preventing the Fed’s balance sheet from shrinking naturally. Investors will also examine closely any changes to the pledge made by the FOMC in June to “employ its policy tools as necessary to promote economic recovery and price stability”, which could be hardened if policymakers choose to signal the potential for more aggressive move to boost the economy in the future, but even if that happens, most economists believe that it would take several more months of poor data for the Fed to actually begin a new round of asset purchases on the scale of those carried out during the recession. In congressional testimony last month, Ben Bernanke noted “unusual uncertainty” in the economic outlook and in a speech last week the Fed chairman warned of a “considerable way to go” before the US achieves a full recovery. Although Fed policymakers still believe the basic trajectory of the economy remains one of moderate expansion, there may be more attention given to heightened dangers of a sharp slowdown.
  • The highly influential and respected Ifo research institute in Munich expects the German economy to cool from the third quarter after the strong economic data recently, German daily Handelsblatt reports over the weekend. It cites Kai Carstensen, the director of Ifo’s business surveys as saying that the strong dynamics should lose some steam in the second half of the year.

Irish financials

The Financial Regulator has confirmed that the year end deadline for AIB to raise €7.4bn is not to be extended. However, if disposals are confirmed, the Regulator will be “reasonable” when accounting for delays due to regulatory approval for deals. The comments, reported in the Tribune, come after Managing Director of AIB, Colm Doherty, said he hoped the regulator would be “rational” if the bank were to experience delays in the asset disposal process. Doherty said that AIB may have to raise over €3bn after asset disposals, to meet the Regulator’s capital targets.

A radical reorganisation of the Ulster Bank loan book will see almost €6.3bn of property loans on the Irish portfolio swapped into its non core unit, according to reports. €6bn of residential home loans will move into back into core Ulster Bank, leaving €22bn of loans in the non core operations, and stemming potential future losses in the Irish operations. RBS has already invested €2.6bn in new capital into Ulster Bank since the banking crisis began according to the Sunday Times. Ulster reported last week that 4.8% of its mortgage book was in arrears, with a further 3% in forbearance. Separately, Bank of Scotland Ireland reported last week that 90% of its €6bn property development loan book was impaired, while 46% of its €7.3bn investment property loan book was impaired. Lloyds (NYSE:LYG) has injected €4.5bn in capital, since the crisis hit the €32bn Irish loan book, of which 44% is now impaired.

The decision on Anglo Irish Bank “good bank/ bad bank” concept and its strategic future is expected from the EU in September. According to the Tribune, the failure to get approval for Anglo Irish Bank new structure may impact on the calculation of Irish national debt by Eurostat, if the bank is not seen as a going concern.

JC Flowers are reported to be preparing to lodge a bid for EBS, ahead of tomorrow’s deadline according to press reports over the weekend. The private equity group will join Irish Life & Permanent (OTCPK:ILPMF) and Carlyle Group (OTC:CARYK) as potential acquirers according to the Sunday Independent.

Company / Equity News

  • Royal Bank of Scotland (NYSE:RBS) and Lloyds have been told by the Bank of England that they could be penalized by the European Union if the special funding program begun in the financial crisis were to be extended, the Times reported without saying where it got the information. An extension would break EU rules, in the bank’s opinion, because it would mainly assist the two state-controlled banks and not the entire banking sector, the Times said. Many financial industry observers have said the central bank will have to lengthen the program, called the Special Liquidity Scheme, because banks continue to find it difficult to fund themselves, and they disagree with the Bank of England’s argument that it would incur EU problems, the newspaper said.
  • The sudden departure of Hewlett- Packard (NYSE:HPQ) CEO Mark Hurd leaves the company in search of a successor who can integrate more than $20bn in acquisitions and maintain sales growth. Hurd resigned after an investigation found he had a personal relationship with a contractor who received numerous inappropriate payments from the company. His exit will force a fresh CEO to follow through on a half-finished expansion into new businesses ranging from smartphones to networking gear.
  • Bloomberg reports that GDF Suez (GDFZY.PK) and International Power (OTC:IPRPY) are close to agreeing on a transaction that would have France’s second largest utility take control of the British company with interests in more than 45 power stations, according to two people familiar with the matter. GDF Suez will pay International Power shareholders a special dividend of about £1.3bn as part of the deal, and GDF will control about two thirds of the enlarged company, said one of the people, who declined to be identified as the talks are private. While the companies are trying to reach a deal before both report earnings on Aug. 10, there’s a chance an agreement won’t be reached.
  • In related news an alliance comprising a parliamentary group, southern states of Germany and the German economics ministry favour extending the life span of German nuclear power plants by 14 years on average, German magazine Der Spiegel reports over the weekend, without citing sources. German Environment Minister Norbert Roettgen, however, wants shorter extensions, the report adds. Joachim Pfeiffer, lawmaker and economic spokesman for the ruling conservative parties’ parliamentary group in the lower house, tells Der Spiegel “Roettgen should acknowledge that the majority in the party and parliamentary group regard longer life spans as absolutely necessary to ensure power supply.” Pfeiffer added that the parliamentary group won’t approve a planned tax on nuclear fuel rods unless as broader agreement is reached. According to the magazine, the German government is in talks with the four nuclear power plant operators, E.ON AG (OTCPK:EONGY), RWE AG, EnBW Energie Baden-Wuerttemberg and Vattenfall about alternatives to a nuclear fuel rod tax. The four companies want to avoid an additional tax in return for life span extensions for the plants.

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