***JAPAN WATCH

U.S. Consumer Prices Rose Slightly in July Data shows an extension of this year’s inflation deceleration

The consumer-price index increased 0.1% in July from the prior month, the Labor Department said Friday. Excluding the often-volatile categories of food and energy, so-called core prices also rose 0.1%. From a year earlier, overall consumer prices climbed 1.7%, as did core prices, below the Fed’s 2% goal for inflation. (…)

Despite some upsides, overall prices have grown at a seasonally adjusted annual rate of 0.9%, while core prices have risen just 1.3% through the first seven months of this year. (…)

A separate Labor Department report showed average weekly earnings for private-sector workers, adjusted for inflation, increased 0.2% in July from the prior month. From a year earlier, inflation-adjusted weekly earnings were up 1.1%.

Inflation reading has become a pretty inexact science, scary when you know that monetary policy depends on it.

The Cleveland Fed has this table showing various ways to measure inflation trends:

• Headline inflation (CPI) is ZERO in the last 6 months, ZERO in the last 3.
• Core CPI is stuck at +0.1% MoM, that is a 1.2% annualized rate. But if you go 3 decimals, the monthly changes average +0.45% over 6 months which is +0.54% annualized.
• The 16% trimmed-mean CPI, which excludes the outliers, is rising at a 1.2-1.4% annualized rate.
• The median CPI keeps rising 2.0% annualized.
• Core goods prices keep deflating, now for 6 consecutive months.
• Core services prices are also slowing rapidly from +3.1% YoY on February to +2.4% in July.

In all, it will be challenging for the FOMC members to see anything to fight in recent inflation numbers. Recent PMI surveys confirm that pricing trends remained soft at the end of July:

• “Average prices charged by US manufacturing firms increased at a modest pace”.
• “Average prices charged by service sector firms also increased at a weaker pace than the previous survey period.”
• The PPI for final demand, finished goods was ZERO in the past 2 months, –0.7% in the past 3 and –0.1% in the past 6 months.

Clearly, there is little pricing power, wherever you look, hence weak demand, almost across the board.

Tough on the top line growth. Requires continued focused on costs.

• Wage Growth Tracker Little Changed in July

The Atlanta Fed’s Wage Growth Tracker for continuously employed workers was 3.3 percent in July, up slightly from 3.2 percent in June, and close to the average for the last 12 months of 3.5 percent.

Despite very slow inflation trends, analysts are not cutting revenue estimates except in consumer sectors, telecom and energy related sectors. Industrials, IT, Financials and Health Care are all very positive (chart from Ed Yardeni).

Dollar Weakness Could Be the Boost U.S. Economy Needs The slow-growing U.S. economy could use a tailwind and it’s getting one in the form of a weaker dollar.

The WSJ Dollar Index, which measures the dollar against the currencies of major trading partners, is down about 8% since the beginning of the year, including a more than 2% drop over the past month. Its decline has been especially pronounced against the euro, 15%, and the Mexican peso, 28%. (…)

In June, exports were up 7% from a year earlier. That’s a sharp reversal compared with the 9% drop from 2014 to 2016, when the dollar was climbing rapidly. (…)

A weaker currency also increases the value of profits that multinationals earn overseas in other currencies—such as euros, pesos or yen—boosting the bottom line for investors when those foreign currencies are converted back into dollars. Moreover, at a time when Federal Reserve officials find domestic inflation too low, it puts upward pressure on consumer prices. (…)

• Draghi faces dilemma as strong euro sparks concern

The stronger euro is not impacting foreign sales yet as Markit’s August Manufacturing PMI revealed:

Companies benefitted from solid gains in new business from both domestic and foreign clients. Although rates of expansion in output (six-month low), new orders (five-month low) and new export business (four-month low) all eased during the latest survey month, they nonetheless remained among the best registered since the first half of 2011.

China Data Shows a Slowdown as Beijing’s Debt Crackdown Takes Hold Beijing’s effort to curb property speculation and debt shows in latest economic data

(…) Value-added industrial output, a rough proxy for economic growth, rose by 6.4% in July from a year earlier, compared with a 7.6% increase in June, the National Bureau of Statistics said. July’s figure was the slowest pace in five months.

Fixed-asset investment, which includes expenditure on roads, new apartments and factories, grew 8.3% in the first seven months of 2017 from a year earlier, slowing from a pace of 8.6% over the January-June period.

Retail sales, meanwhile, increased 10.4% in July from a year earlier, slowing from an 11.0% gain in June.

Property investment, which slowed to 7.9% expansion in the January-July period from 8.5% in the first six months, was one of the major forces that weighed on growth in July, economists said. (…)

Japan Posts 4.0% GDP Growth in April-June Quarter Japan’s economy grew more quickly than expected in the April-June quarter, with strong household spending driving the sixth straight quarter of growth under Prime Minister Shinzo Abe.

(…) Unlike recent quarters, when foreign demand for items such as smartphone components and semiconductor equipment drove Japan’s economy, strong private spending was the key factor in the April-June period. Household spending grew at an annualized 3.7% pace. (…)

Spending by companies on new equipment and other capital expenditures rose an annualized 9.9% in the April-June quarter. Meanwhile, for the first time in four quarters, exports from Japan fell an annualized 1.9% in the April-June period from the previous three months. That was partly because of a slowdown in the global smartphone production cycle, although economists expect demand to pick up.

After two decades in which prices generally fell, Japan is finally seeing modest inflation, albeit far from the central bank‘s 2% target. In June, the core consumer-price index rose 0.4%, marking a six-month winning streak. (…)

Overall wages fell 0.4% in June compared with the year-earlier month as companies paid smaller summer bonuses. (…) (Chart from FT)

OPEC Swings to Panic Stations

(…) So the latest report from the Paris-based IEA, published on Friday, is a nasty shock. It has just found another 230 million barrels of oil in storage that will need to be drained before balance is restored.

That is a lot of oil. To put it in perspective, it increases the build-up in inventories since the beginning of 2014 by almost 25 percent. An output cut of 1 million barrels a day would take another six months to drain it. (…)

How do you suddenly find 230 million barrels of oil? By realizing that the countries who were driving demand growth over the past couple of years weren’t driving it as fast as you thought.

The IEA also cut its assessment of 2016 demand in non-OECD countries by 420,000 barrels a day, with China accounting for more than a quarter of that. With no similar reduction in its assessment of supply, all of the oil that was not consumed, around 157 million barrels, must have gone into storage. The rest comes from the smaller revisions that the IEA made to its 2015 demand numbers. (…)

The IEA’s revisions cut by 800,000 barrels a day the amount of oil the world may need from the group in the current quarter. That is almost as much as the combined production of OPEC’s three most recent joiners: Ecuador, Equatorial Guinea and Gabon. Inconveniently, this reduction coincides with a jump in the group’s production by 200,000 barrels a day in July, according to Bloomberg estimates.

Based on the latest figures, the IEA now expects global stockpiles to rise this quarter — not fall. A forecast for a small draw in the final quarter would leave global inventories unchanged over the second half of 2017.

And next year suddenly looks a lot worse than it did a month ago, too. If OPEC’s current aggregate production level is carried forward for the whole of 2018, global oil inventories would rise by around 170 million barrels. That’s about six times as big as the inventory drawdown for 2017. (…)

EARNINGS WATCH

Factset:

Overall, 91% of the companies in the S&P 500 have reported earnings to date for the second quarter. Of these companies, 73% have reported actual EPS above the mean EPS estimate, 9% have reported actual EPS equal to the mean EPS estimate, and 18% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (70%) average and above the 5-year (68%) average.

In aggregate, companies are reporting earnings that are 6.1% above expectations. This surprise percentage is above the 1-year (+4.7%) average and above the 5-year (+4.2%) average.

In terms of revenues, 69% of companies have reported actual sales above estimated sales and 31% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is well above the 1-year average (56%) and well above the 5-year average (53%).

In aggregate, companies are reporting sales that are 0.7% above expectations. This surprise percentage is above the 1-year (+0.5%) average and above the 5-year (+0.5%) average.

The blended earnings growth rate for the S&P 500 for the second quarter is 10.2% today, which is slightly higher than the earnings growth rate of 10.1% last week. The blended sales growth rate for the S&P 500 for the second quarter is 5.1% today, which is equal to the sales growth rate of 5.1% last week.

If the Energy sector were excluded, the blended earnings growth rate for the remaining ten sectors would fall to 7.8% from 10.2% and the blended revenue growth rate for the index would fall to 4.3% from 5.1%.

At this point in time, 94 companies in the index have issued EPS guidance for Q3 2017. Of these 94 companies, 59 have issued negative EPS guidance and 35 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 63%, which is below the 5-year average of 75%.

Another great quarter. Note that Thomson Reuters’ data show Q2 EPS up 12.0%. +9.3% ex-Energy. Every sector is recording margins higher than last year, except Consumers Discretionary where margins are down 0.2% to 7.1%. Several retailers will be reporting this week.

The blended earnings growth rate for the S&P 500 for Q2 2017 is 10.2%. For companies that generate more than 50% of sales inside the U.S., the blended earnings growth rate is 8.5%. For companies that generate less than 50% of sales inside the U.S., the blended earnings growth rate is 14.0%.

At the sector level, the Information Technology and Energy sectors were the largest contributors to earnings and revenue growth in Q2 for companies with less than 50% of sales inside the U.S.

The blended sales growth rate for the S&P 500 for Q2 2017 is 5.1%. For companies that generate more than 50% of sales inside the U.S., the blended sales growth rate is 4.7%. For companies that generate less than 50% of sales inside the U.S., the blended sales growth rate is 6.0%.

Another interesting fact revealed by Capital IQ is that the percentage of S&P 500 companies reporting a share count reduction of 4% or more is 14.3% in the first half of 2017, down from an average of 23.3% in the previous 2 years. On the flip side, the percentage of companies reporting a share count increase of 4% or more is 11.1% in the first half of 2017, up from 9.2% in the previous 2 years. Share buybacks are not contributing as much to EPS growth. RBC calculates that buybacks are adding 1.4% to EPS growth in Q2.

Also, MarketWatch reports that companies in the S&P 500 generated a cash surplus of $60 billion during the second quarter, compared with a $22 billion deficit to investment spending over the last 12 months, according to data provided by J.P. Morgan.

FYI

• The median S&P 500 stock is off 8.2% from its 52-week high and the average is off 11.7%.
• 212 S&P 500 stocks are down more than 10% from their 52-week high. 84 stocks are down 20% +.
• 39% of small-cap stocks are down 20% or more from their 52-week highs.

China a sweet spot for U.S. companies’ earnings in second-quarter

Whether they sell construction equipment, semiconductors or coffee, many major U.S. companies have reported stronger second-quarter earnings and revenue from their Chinese operations in recent weeks. (…)

Caterpillar Inc, a bellwether for industrial demand in China and beyond, reported its sales in Asia-Pacific rose 25 percent in the second quarter – thanks to China. Shipments of large excavators to Chinese customers more than doubled in the first half of the year.

“We now expect demand in China to remain strong through the rest of the year,” Brad Halverson, Caterpillar’s group president and chief financial officer, told investors.

Caterpillar’s Japanese rivals Komatsu and Hitachi Construction Machinery Co reported similar strength in demand for heavy machinery. Komatsu’s China sales almost doubled in the firm’s April-June quarter. (…)

In the chip industry, Skywork Solutions <SWKS.O), which according to Goldman Sachs gets about 85 percent of its sales from China, reported its fiscal third-quarter revenue rose 20 percent, thanks in part to demand from Chinese phone maker Huawei. And Qualcomm, which gets around two thirds of its revenue from China, said last month that China remained a strong growth story for the company.

And many other foreign companies are also doing well. The European liquor industry is benefiting from a resurgence in Chinese consumer demand. (…)

NOW, THIS IS SCARY!

Dear gods, when European junk bonds pay the same as US Treasurys do, there is really something out of whack in the world. Look at that spike in European junk in 2009 and the one back in 2002. European junk bond investors have never been more complacent. The reach for yield is staggering. The participants in that market think that Draghi and the European Central Bank have their backs. If the situation starts to get volatile, they expect the ECB to step in. But the ECB would have to change its mandate in order to buy junk bonds, and that means getting the more conservative members of the eurozone to agree. I hesitate to bet on that. This could be the European equivalent of the Big Short in the next global recession. (John Mauldin)