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Lookout Report: The U.S. March Employment Report Was Not Weak, Just Disappointing
Lookout Report: The U.S. March Employment Report Was Not Weak, Just Disappointing
The U.S. March Employment Report Was Not Weak, Just Disappointing
Michael Thompson Managing Director Global Markets Intelligence (1) 212-438-3480 michael_thompson@spcapitaliq.com Robert Keiser Vice President Global Markets Intelligence (1) 212-438-3540 robert_keiser@spcapitaliq.com
Financial media outlets have indentified the "weak" 120,000 increase in March U.S. nonfarm payrolls and the uptick in European sovereign fiscal stress as the main reasons for the 4% decline in the S&P 500 Index since the April 2 intraday high of 1,422.38. With both Italian and Spanish sovereign credit default swap (CDS) spreads again trading higher than 400 basis points (bps), the Global Markets Intelligence (GMI) research team agrees that European sovereign fiscal stress is once again tempering investor appetite for risk assets. However, we are skeptical of the media's perception of the March employment report. Although the report was average and disappointing, the increase in payrolls was not as weak or worrisome as the media suggests, in our opinion. The 120,000 increase in March payrolls is nearly spot-on the long-term linear regression for monthly changes in job creation, based on data since 1939 (see chart 1).
Chart 1
The Lookout Report is a compendium of current data and perspectives from across S&P Capital IQ and S&P Indices covering corporate earnings, market and credit risks, capital markets activity, index investing, and proprietary data and analytics. Published bi-weekly by the Global Markets Intelligence research group, the Lookout Report offers a detailed cross-market and cross-asset view of investment conditions, risks, and opportunities.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Investors' collective risk-off reaction to the disappointing jobs report (expectation of a 215,000 increase), combined with rising European sovereign credit risk, is fully justified, in our opinion. While we were hopeful that March payrolls would be closer to market expectations, the long-term regression result is hardly surprising within the context of the ongoing historically subpar U.S. economic recovery. For the moment, the latest increase in payrolls is much healthier than the below 100,000 rate that prevailed last year between May and August, when investors were seriously concerned that the U.S. economy was tipping toward recession. We believe that the rate of U.S. job creation is the most important economic indicator for investors to consider this year (see "Lookout Report: Three Key Economic Topics To Follow Closely In 2012: Jobs, Housing, And Sovereign Risk," published Jan. 20, 2012, on the Global Credit Portal). However, nonfarm payroll data, unfortunately by its nature, contains a great deal of month-to-month statistical variance (essentially "noise") that presents challenges when interpreting the significance of any single report. We are now very interested to see if subsequent payroll reports will be higher or lower than the long-term central tendency of approximately 120,000. As investors begin to digest the flood of first-quarter earnings reports, which will divert attention away from last Friday's employment report, it is important to evaluate reported corporate earnings within the context of the existing modest--but perhaps very sustainable--economic recovery. Balanced with other key economic indicators like the ISM PMI reports and weekly initial jobless claims, GMI Research believes it is premature to conclude that the U.S. labor market is fundamentally weak. We are now focused on gauging the extent that S&P 500 corporations will either meet or exceed modest first-quarter earnings growth expectations of just 1% as a guide as to whether corporations will be able to achieve the steadily improving earnings growth foreshadowed by the S&P Capital IQ consensus over the balance of 2012.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Leveraged Commentary And Data: Leveraged Loan Technical Conditions Improve In March As The Inflow Surplus Grows
Loan market technical conditions strengthened further in March as inflows again outran supply. Together, CLO issuance and inflows to loan mutual funds totaled $2.6 billion, while the amount of S&P/LSTA Index loans outstanding contracted by $6.2 billion.
Market Derived Signal Commentary: Spain's Rising Credit Risk Affects U.S. Financials Companies' CDS
The risk premium on Spain continued to rise over the past week after the sovereign's disappointing bond sale, and Italy and U.S. financials companies also felt the heat on fears of credit contagion from the eurozone. On April 4, Spain sold 2.6 billion of bonds, less than the 3.5 billion the country planned, as investors demanded a significant premium to hold the debt.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 2
The beat rate has also helped to prop up the still lackluster expectation for S&P 500 growth, now expected to come in at 1.59%, much higher than the lows of 0.5% in mid-March. While this is still very low compared with the 8.8% 10-year average, it's important to consider the difficult year-over-year comparison. In the year-ago period, earnings for the S&P 500 Index grew by nearly 20%, on top of 56% growth in first-quarter 2010 (see chart 3). We believe there is additional room for improvement in the first-quarter growth rate, presuming the early reported results are indicative of things to come.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 3
The peak of earnings season begins next week, when 85 companies are scheduled to report. Peak earnings season will last from April 16 to May 4, when approximately 80% of S&P 500 companies will report first-quarter earnings.
Europe
Analysts continued to lower estimates for anticipated 2012 S&P Europe 350 earnings but they also increased estimates for 2013 earnings per share, according to data aggregated by S&P Capital IQ. In the two weeks ended April 5, consensus 2012 expectations declined 0.1% to 98.92, while 2013 expectations rose by 0.03% to 110.65. Analysts remain generally pessimistic about this year, but 2012 earnings forecasts have started to stabilize since the end of February (see chart 4).
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 4
Last Friday's disappointing U.S. labor report and rising European sovereign credit default swap spreads have led to a decline in European investor confidence, which was already fragile due to declining 2012 earnings growth expectations. Analysts likely remain concerned that simmering European fiscal stress will continue to hinder European consumer activity and economic growth. Although short-term economic and fiscal uncertainty continue to weigh on 2012 earnings growth forecasts, analysts continue to indicate they expect improved corporate performance in 2013. Overall, analysts have tended to raise 2013 earnings estimates since the beginning of March (see chart 5). The International Monetary Fund (IMF) still expects eurozone GDP to contract 0.5% in 2012 and return to growth of 0.8% in 2013. The IMF will publish its next update of the World Economic Outlook on April 17, according to the group.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 5
Sector leaders for calendar-year 2012 earnings include the financials (20.46% expected growth) and industrials (9.59% expected growth) sectors. Earnings laggards for calendar-year 2012 include the information technology (decline of 16.14% expected) and materials (decline of 1.63% expected) sectors. First-quarter U.S. earnings season is now underway, but a few European companies will also be reporting their first-quarter results in the weeks to come. Contact Information: Christine Short, Senior ManagerGlobal Markets Intelligence, Christine_Short@spcapitaliq.com Victoria Chernykh, DirectorGlobal Markets Intelligence, Victoria Chernykh@spcapitaliq.com
The U.S. March Employment Report Was Not Weak, Just Disappointing
common stocks, we estimate another $174.9 billion in savings for a total of $358.4 billion over the 10-year period (see table 1).
Table 1
So the question for companies is whether to pay investors $21 billion or more in January 2013, allowing individuals to keep 56.6% after 43.4% in federal taxes, or pay them on Dec. 31, 2012, when they can keep 85%. The 28.4% net difference is extremely significant to investors, while the early cash disbursement from the companies should only slightly affect their year-end ratios and liquidity. In our opinion, a company better have a really good reason for permitting investors to only net $0.57 in January instead of $0.85 in December. However, we think the change in the dividend tax rate will force corporations to reexamine their policy on returning value to shareholders policy, and this could lead to a pullback in dividend increases and an increase in share buybacks. From an individual investor's perspective, the risk-return ratio shifts significantly since they would now retain less than $0.57 on the dollar compared with the current $0.85. Should the current legislation remain unchanged, we expect fifth-quarter dividend payments, either in whole or as a percentage of the full amount; two months of dividends paid in 2012 to reflect the holding period, for example. This year is already expected to post a record year for dividends, and that was before Apple Inc.'s $9.9 billion planned payout. With more and more investors searching for income, and as dividend income remains a significant component of retiree income, higher taxes will inevitably change the landscape. While both practitioners and academics will certainly argue the extent of the effect of the tax increase, individuals will be able to measure it much more quickly--by comparing how much they have left in their pocket in fourth-quarter 2012 and first-quarter 2013. Contact Information: Howard Silverblatt, Senior Index AnalystS&P Indices, Howard_Silverblatt@standardandpoors.com
Leveraged Commentary And Data: Leveraged Loan Technical Conditions Improve In March As The Inflow Surplus Grows
Loan market technical conditions strengthened further in March as inflows again outran supply. Together, CLO issuance and inflows to loan mutual funds totaled $2.6 billion, while the amount of S&P/LSTA Index loans outstanding contracted by $6.2 billion (see chart 6).
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 6
The $8.8 billion inflow surplus in March was the most in 13 months, up from $5 billion in February. All of this excess capital kept the bulls running. The average price of the S&P/LSTA Leveraged Loan 100, for instance, rose another 0.24 points in March to 93.69, from 93.45 at the end of February (see chart 7). Before March, the average was last that high in August 2011.
The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 7
The new-issue market also brightened during the month. The average yield for new-issue paper fell further, to a nine-month low of 6.1%, from 6.3% in February. Drilling down, 'BB' yields stabilized after touching all-time lows in February (see chart 8). 'B' yields, meanwhile, fell further, to 6.15% on average, from 6.55% in February.
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 8
The warmth of the primary market allowed opportunistic executions to blossom (see table 2).
Table 2
Selected Statistics
(Bil. $) 1/31/2011 2/28/2011 3/31/2011 4/30/2011 5/31/2011 6/30/2011 7/31/2011 8/31/2011 9/30/2011 10/31/2011 11/30/2011 12/31/2011 1/31/2012 2/29/2012 3/31/2012
Source: S&P Capital IQ LCD.
Repricings 13.66 30.11 12.03 6.06 4.50 0.68 0.23 0.00 0.00 0.00 1.41 1.25 2.10 4.67 1.50
Dividends 2.77 7.25 3.04 4.36 5.20 2.47 0.91 0.00 0.09 0.10 0.37 0.55 0.78 6.11 6.92
A-to-E 3.58 1.06 5.67 17.90 3.81 2.00 0.00 0.00 0.00 0.00 0.00 1.44 1.60 12.69 12.51
Cov-lite 6.60 14.26 3.86 8.28 9.31 5.53 2.70 0.00 2.61 0.37 2.50 0.95 1.43 5.25 3.77
Propelled by refinancings and dividend loans, new-issue institutional volume surged to a 13-month high of $30.4 billion,
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The U.S. March Employment Report Was Not Weak, Just Disappointing
from $22 billion in February (see chart 9). It was not the supply bonanza for which cash-rich managers hoped, however. On the one hand, M&A-driven institutional activity was again weak, at $17 billion.
Chart 9
On the other hand, repayments, propelled by $3.3 billion of high-yield takeouts and $1.9 billion of pro rata takeouts, pushed to an 11-month high of $20.3 billion in March (see chart 10).
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 10
The combination of rising repayments and lackluster new-money deal flow caused the aforementioned decline in the supply of loans outstanding and, thus, magnified the modest increase in fresh capital investors put to work in the asset class in March. Inflows to loan mutual funds, for instance, perked up to $513 million in March, according to EPFR, in the first positive reading since July 2011. More encouraging still, inflows shifted into a higher gear during the final two weeks of the month--not coincidentally after 10-year Treasury yields began trending higher on better economic news--jumping to $318 million, from $164 million earlier in the month. In the CLO market, meanwhile, issuance was robust again, at $2.1 billion versus $2.3 billion in February. In fact, it was the first time CLO issuance has topped $2 billion for two months in a row since October and November 2007. And with 'AAA' spreads sinking to L+130-145 on the most recent deals, from L+146-155 earlier in the year, the volume of deals ramping up has also increased, adding another shot of capital to the market. In addition to these visible sources, managers say that allocations to the asset class from pension funds and other institutional investors continued in the $1 billion to $2 billion range in March (of course, that is a best guess, not an empirical figure). Looking ahead, participants are hopeful that with the risk trade on again for the moment and 10-year Treasury yields trending higher, the loan market will continue to take in capital from all corners--retail, institutional, and structured finance. Certainly, mutual fund flows got off to a strong start, with EPFR reporting $180 million of inflows between April 2 and April 5. So did the CLO market, where during that same four-day period, two managers--Goldentree Asset Management and Silvermine Capital Management--printed new vehicles totaling $989 million. Notably, Goldentree and
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Silvermine join Octagon and Invesco as 2012 CLO issuers that had not printed a new deal since the 2008 credit crisis. Participants say this activity is a clear indication that the universe of managers that can raise new CLOs is finally starting to expand after the wrenching contraction of 2008 to 2010, as the investor base for CLO liabilities and equity has expanded. On the supply side of the ledger, arrangers report an encouraging increase in screening activity for new merger and acquisition (M&A)-driven deals, and the calendar of loans that back LBOs and acquisitions expanded to a six-month high of $11.7 billion on March 28, from $5.5 billion at the end of February (see chart 11).
Chart 11
Even here, however, there is less than meets the eye. After all, the $3.15 billion of institutional tranches backing Lawson Software's acquisition of Infor Global Solutions--the largest loan on the M&A calendar--will replace two institutional loans that originally totaled $3.4 billion. With this in mind, arrangers say that any meaningful revival in leveraged finance M&A activity is unlikely to appear until the third quarter. Until then, participants generally believe the market's positive bias will continue until the technical winds shift or an outside shock intrudes. Even so, a 2011-style spring fling seems unlikely. In fact, the spike of new-issue volume during March already has cleared some of the froth from the market (see chart 12).
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 12
March's volume blitz allowed accounts to be more selective. As a result, flex activity went from overwhelmingly favoring issuers to a more mixed picture. Among the March flexes, 31% went higher and 69% lower, versus 14% and 86%, respectively, earlier in the year. Moreover, break-price premiums narrowed, suggesting that new-issue pricing has reached a resistance point (though not an inflection point; see table 3).
Table 3
Selected Statistics
3/31/2011 4/30/2011 5/31/2011 6/30/2011 7/31/2011 8/31/2011 9/30/2011 10/31/2011 11/30/2011 12/31/2011 1/31/2012 2/29/2012 3/31/2012
Source: S&P Capital IQ LCD.
'BB' clearing yield (%) 3.97 4.11 4.76 4.39 4.67 5.07 6.26 5.38 4.96 4.48 4.31 4.48 4.73
'B' clearing yield (%) 6.23 5.86 5.70 6.54 7.12 6.84 8.68 8.34 7.22 7.01 7.33 6.55 6.24
Break price premium over new-issue OID (bps) 56 87 78 52 92 48 128 165 123 92 165 89 80
Contact Information: Steven Miller, Managing DirectorLeveraged Commentary And Data, Steven_Miller@spcapitaliq.com
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The U.S. March Employment Report Was Not Weak, Just Disappointing
North American Risk-Reward Profiles By Sector--Average R2P Score And Components Changes
Consumer discretionary Consumer staples Energy Financials Health care Industrials Information technology Materials Telecommunication services Utilities Scores (%) (11) (10) (10) 0 (15) (11) (8) (9) (5) (15) OAS (bps) (2) (4) (3) (1) 1 (6) 0 (1) (2) (9) PD (%) 27 (4) 25 (17) 0 (9) (39) 11 26 25 Bond price vol. (%) (2) 3 5 2 5 0 (2) 1 (7) 6
Change as of April 11, 2012, from March 30, 2012. OAS--Option-adjusted spread. PD--Probability of default.
Table 5
The U.S. March Employment Report Was Not Weak, Just Disappointing
Table 5
European Risk-Reward Profiles By Sector--Average R2P Score And Components Changes (cont.)
Energy Financials Health care Industrials Information technology Materials Telecommunication services Utilities (10) (1) (15) 1 10 0 (7) 6 (11) 2 (3) (4) 4 (3) 12 (2) 14 (25) (1) (22) (16) 2 (11) (23) 8 6 9 7 19 1 9 2
Change as of April 11, 2012, from March 30, 2012. OAS--Option-adjusted spread. PD--Probability of default.
Market Derived Signal Commentary: Spain's Rising Credit Risk Affects U.S. Financials Companies' CDS
The risk premium on Spain continued to rise over the past week after the sovereign's disappointing bond sale, and Italy and U.S. financials companies also felt the heat on fears of credit contagion from the eurozone. On April 4, Spain sold 2.6 billion of bonds, less than the 3.5 billion the country planned, as investors demanded a significant premium to hold the debt (see "Credit Market Commentary: Market Derived Signal: Spains CDS Widens As Investors Demand Premium For Government Debt," published April 5, 2012, on the Global Credit Portal). On April 12, Italy issued 2.88 billion of three-year bonds, lower than a target of 3 billion, at a yield of 3.89%, up from 2.76% at a sale on March 14, and Italy's deputy finance minister said the Treasury did not sell the maximum because of the "unfavorable yield," Bloomberg reported on April 12. The five-year CDS spread on Spain rose to 459 basis points (bps) on April 11 from 434 bps a week ago, and the cost to purchase protection against an Italian default increased 7.8% to 417 bps, according to CMA DataVision. But one of the most significant moves in CDS spreads over the past week occurred for U.S. financials companies, whose average CDS spread widened 15.4% to 195 bps, as measured by the S&P/ISDA CDS U.S. Financials Select 10 Index (see chart 13). Financials companies took a tumble in the equity market as well, losing 4% in the past week.
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 13
Bank of America Corp., Citigroup Inc., The Goldman Sachs Group Inc., JPMorgan Chase & Co., and Morgan Stanley are among the constituents of the Financials Index. All have exposure to Spanish and Italian debt to varying degrees, according to a New York Times report published Jan. 29, 2012. Each has gained some protection against a default in the at-risk sovereigns through the credit default swap market (see chart 14). However, sovereign exposure is but one problem facing the big banks, and the CDS spreads appear to reflect a variety of concerns. S&P Capital IQ equity research has a neutral outlook on the three largest U.S. banks (JPMorgan Chase, Citigroup, and Bank of America) based on "concerns about the exposure these banks have to the troubled Eurozone, the legacy costs of mortgages underwritten and securitized during the peak of the housing market, increasing regulatory costs and limitations, and the costs of implementing Basel III."
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 14
First-quarter earnings reports, which companies began to release on April 10, could be a positive catalyst for bank spreads, in our opinion. The financials sector is expected to report a year-over-year decline in first-quarter earnings of 0.45% to $4.08 per share, according to data aggregated by S&P Capital IQ, but there is always the potential for upside surprises. In the fourth quarter, 47.5% of 80 financials companies beat the consensus estimate, lifting the reported fourth-quarter earnings per share figure to $3.63 per share from the estimate of $3.46 at the beginning of 2012. The GMI team will continue to monitor financials companies' CDS for significant changes in credit risk sentiment. Contact Information: Lisa Sanders, DirectorGlobal Markets Intelligence, Lisa_Sanders@spcapitaliq.com
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The U.S. March Employment Report Was Not Weak, Just Disappointing
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The U.S. March Employment Report Was Not Weak, Just Disappointing
Chart 15
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