It’s Easy to Argue against Opinion – Much Harder against Data – Ask Tom


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It may be Tom Cruise’s opinion that his wife wanted to remain married, but it’s hard to argue against the divorce filing.  Somewhat definitive.  Not dissimilarly, we are bombarded by opinions on the markets’ movements, with the bulls making arguments based on fewer and fewer hard facts.  In the last week we have seen negative surprises from both the ISM numbers and the jobs numbers in the US, while the European pantomime continues.   Japan machinery orders fell almost 15% in May in data released overnight.

It is increasingly disappointing to see the new French President focus on things that have no hope of stimulating the economy, such as lowering the retirement age, punishing the denial that the 1915-16 killing of Armenians was genocide (important perhaps, but it will not create jobs), capping CEO pay and increasing high level income taxes (these last two will cause an exodus of the type of people who could help repair the economy).   These moves help to confirm our view that Europe has to get much worse before it will get the focus required to fix its economy. Europe cannot work if politicians are focused on local issues rather than the broader problems and those that have the more Euro centric view will soon tire of those that do not.

In the US we are at that point in the election cycle where we can expect nothing but finger pointing and no definitive policy that might address the economic malaise until after the election, which puts us in the New Year.

In the meantime, consumer spending falls, everywhere.

As we wrote last week, the scariest part of the ISM numbers for us was the customer inventory build.  In an environment of collapsing raw material pricing – basic plastics, aluminum, steel and crude oil prices are down around 20% from their recent highs (plastics prices down 22% in the last three months) – no one in the chain intentionally builds inventory.   If customer inventories are up, it is mostly because their sales fell faster than they could reduce purchases.  There may a pricing lag from the higher raw material pricing earlier in the year, but we do not think it is material.  Our view is that this number is a very clear indicator of weakening consumer spending.   The risk is that overall manufacturing falls further as the inventory gain is corrected over the next couple of months.  The rapid decline in New Orders in June is a combination of customers trying to cope with lower demand themselves as well as trying to contain inventory.   The Japan machinery number for May shows the same phenomenon.

As indicated in our Monthly report last Monday, we still face a rosy forecast from analysts.  While earnings estimates have come down for 2012, the move has been marginal.  In the Chemical sector, Q3 earnings estimates are as much as 50% higher than earnings in Q3 2011, despite a weaker Euro.  The highest growth estimates are in two of the sub-sectors most exposed to Europe – Specialty and Diversified Chemicals.

More cautious guidance (in Q2 earnings calls) for the balance of 2012 is inevitable in our opinion and should come as no surprise given the warning signs.  Yet we continue to see sectors where, in our view, it is not adequately reflected in valuation:

  • Electrical Equipment
  • Coatings
  • Specialty Chemicals
  • Paper

Instead, we would advise clients to look for safer havens, such as Metals (where a slowdown is priced in) or Packaging (beneficiaries of falling raw material prices).

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