The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

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THE DAILY EDGE: 20 MAY 2022: April Fools

The Q1’22 earnings season is coming to an end. For most companies, the quarter ended in March, but for the last bunch of reporters, it ended in April. The January-for-April swap has made a big difference this year, not only for retailers but also for manufacturers.

WMT, TGT and ROST reported sharply declining profits on rather dismal sales. In their conference calls, they all said that sales softened in March but were particularly weak in April in spite of an April 17 Easter. This chart, posted yesterday, illustrates the monthly trend when factoring in inflation: the red line is nominal growth, blue is sales deflated by total CPI and black is sales deflated by faster rising CPI-Goods (see yesterday’s Daily Edge).

Companies with a February-April quarter ditched a strong January for a weak April. Given the continued rise in costs of all kinds, this one month lag produced much poorer profits compared with companies with a January-March quarter. All 3 companies guided for slow sales and weak profits in Q2 suggesting that May remains weak and that this was not a one-off.

The reality is that most Americans are squeezed and they are reacting in a normal and rational way, cutting discretionary spending and trading down. Meanwhile, corporate costs keep rising, squeezing profit margins, amplified by greater markdowns to get rid of bloated inventories.

Executives will also react normally and rationally, cutting costs (mainly labor) and reducing or cancelling orders. Unable to raise prices as easily, retailers and manufacturers will now balk at rising prices, helping slow goods inflation but meanwhile extending the margin squeeze broadly and globally.

Retailers are not the only victims of the weak April as Fortune’s Jacob Carpenter explains:

Data and networking giant Cisco reported during a quarterly earnings call that China’s aggressive shutdown caused supply shortages that cost the company about $300 million, equal to roughly 2.5% of its revenue. Cisco officials also lowered their guidance for the current quarter and the entire fiscal year, in large part due to uncertainty surrounding Chinese imports, sending shares down 15% in mid-day trading Thursday. (…)

Nearly all major tech companies capped their first quarter of 2022 at the end of March, just days after the Chinese government brought the city of Shanghai, home to 26 million people and the world’s busiest port, to a standstill. Cisco, however, concluded its fiscal third quarter in April, giving it a full month of pain from the Shanghai shutdown. (…)

Cisco CEO Chuck Robbins said demand for the company’s products globally remains robust—even as domestic inflation and higher interest rates batter American markets. But an inability to import hardware parts from China will cause damage for months on end, regardless of whether Shanghai fully reopens as planned in June, Robbins said. Cisco now forecasts year-over-year revenue growth in fiscal 2022 of 2% to 3%, down from estimates made in January of 5.5% to 6.5%.

“When they open up and when they do allow transportation logistics to start up, we believe there is going to be a high degree of congestion,” Robbins said. “We believe that there is going to be lots of competition for ports capacity, airport capacity. Combined with the inbound efforts—trying to get raw materials back into the country, etc.—we just believe that it’s going to be impossible for us to catch up on this issue in Q4.”

Robbins’ outlook bodes poorly for a wide range of businesses, including tech companies, electric automakers, and electronics manufacturers. A Bloomberg analysis of earnings call transcripts and financial statements from the first quarter identified more than 180 companies discussing China and its lockdowns.

Apple already predicted in late April that Chinese shutdowns could cost it $4 billion to $8 billion in the current quarter (the company posted revenue of $97.3 billion in the first three months of 2022). A Nikkei Asia analysis found about half of Apple’s top 200 suppliers operate in Shanghai—though some factories there have remained open, with employees temporarily living on-site.

Microsoft said in late April that extended shutdowns into May would hurt its equipment manufacturing, Surface computer, and Xbox console business.

Tesla has operated its Shanghai plant at less than half-capacity or worse for multiple weeks, per Reuters. The factory accounts for roughly 40% of Tesla’s potential output, though that share will decline as two new plants ramp up this year. Longtime Tesla bull Wedbush Securities lowered its price target on the stock Thursday, calling the China snags “an epic disaster so far in the June quarter.” (…)

Robbins echoed the sentiment on Wednesday’s call, signaling that tech companies will remain tethered to China’s COVID whims for the near-future.
“We did not have a plan for a country to shut down,” Robbins said. “And so it takes time to go out and create that geographic resilience, but our teams are working on all of those kinds of things right now.”

We have seen how investors, shocked by worse than expected sales and profits, reacted: WMT -20%, TGT -29%, ROST -25%, CSCO -18%. These are large, established and profitable companies. Their stocks were not selling at outrageous multiples but nonetheless got hammered. These stocks are not in a valuation correction phase like ARKK type stocks, they are in an earnings recession phase.

If the weak April extends through June, the Q2 earnings season could be pretty tough. In just a few weeks, we will start getting the results of companies with a May quarter end followed by the regular quarter bunch reporting April to June starting in about 7 weeks.

Recall these charts I posted on May 17:

(Bespoke)

Philly Fed points to severe ISM contraction

Next week we will get S&P Global’s flash manufacturing PMIs for May. Look for new order inflows.

Through April, China was already seeing a sharp drop in its export orders:

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Global export orders got particularly weak in April, especially at the consumer end:

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Yesterday:

The diffusion index for current activity fell 15 points to 2.6 in May, its lowest reading in two years (see Chart). Most firms (57 percent) reported no change in current activity this month, while the share of firms reporting increases (22 percent) narrowly exceeded the share reporting decreases (20 percent). The index for new orders rose 4 points to a reading of 22.1, and the current shipments index climbed 16 points to 35.3, its highest reading since October 2020. 

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The firms continued to report increases in prices for inputs and their own goods. The prices paid diffusion index — which hit a near-43-year high last month — declined 6 points to 78.9. More than 81 percent of the firms reported increases in input prices, and 17 percent reported no change. The current prices received index edged down 3 points to 51.7. Nearly 52 percent of the firms reported increases in the prices of their own goods, and 47 percent reported no change.

In this month’s special questions, the firms were asked to forecast the changes in prices of their own products and for U.S. consumers over the next four quarters. The firms’ median forecast for the rate of inflation for U.S. consumers over the next year was 6.5 percent, up from 5.0 percent from when the question was last asked in February.

Regarding their own prices over the next year, the firms’ median forecast was for an increase of 5.0 percent, unchanged from February and below the median reported own price change over the past year of 6.0 percent. The firms expect their employee compensation costs (wages plus benefits on a per employee basis) to rise 5.0 percent over the next four quarters, the same as in February. The firms’ median forecast for the long-run (10-year average) inflation rate was 3.5 percent, up from 3.0 percent in February.

(…) While firms generally expected conditions to improve over the next six months, optimism waned for a third consecutive month. The index or future business activity fell eleven points to 18.8, its lowest reading in well over a year. Strong gains in employment, wages, and prices are expected in the months ahead.

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American Stores Have Too Much of the Wrong Stuff Walmart, Kohl’s, Target and other retailers have seen a surge of inventory as they find themselves carrying too much stuff that consumers no longer want so much of.

(…) The latest indication was from Kohl’s, KSS 4.43% which reported Thursday that inventory rose 40% in the quarter ended April 30 compared with a year earlier. A third of that $1 billion increase was a planned stock-up of cosmetics for new Sephora stores inside Kohl’s, a fifth is in-transit merchandise as the company accounts for longer lead times in the supply chain and roughly 8% are Christmas wares that arrived late. Even after accounting for those, though, it still leaves Kohl’s with about 16.5% more merchandise in a year when the company expects overall revenue to stay flat or up 1%. Walmart WMT -2.74% and Target, which reported earnings earlier this week, saw inventory swell by 32% and 43% in the latest quarter, respectively.

Off-price retailers Burlington and Ross Stores ROST -0.11% indicated that they saw closeout inventory start to skyrocket in late February and early March, said Michael Binetti, equity analyst at Credit Suisse, who hosted recent meetings with both companies. (…)

Kohl’s, Target and TJX Cos. all said sales in the home category declined last quarter, for example (Kohl’s posted a 17% drop.) [Same at ROST] (…)

Both Target and Walmart hinted at a more promotional selling environment, which will likely lead retailers’ stretched margins to contract. (…)

U.S. Index of Leading Indicators Fell in April

The Conference Board’s Composite Leading Economic Indicators index fell 0.3% m/m (4.7% y/y) in April after rising 0.1% m/m in March, revised from 0.3%. The Action Economics Forecast Survey had expected no change in April. This was the second monthly decline in the past four months.

The Leading Index is comprised of 10 components which historically have portended changes in overall economic activity. Five of the index’s components fell in April, one was unchanged and four increased. The overall decline was attributed mostly to weak building permits and declining consumer expectations. The still positively sloped Treasury yield curve made the largest contribution.

The Index of Coincident Economic Indicators rose 0.4% (3.0% y/y) in April following a 0.3% m/m increase in March, revised from 0.4%. Each of the index’s four components (nonagricultural employment, personal income less transfers, real manufacturing and trade sales, and industrial production) rose in April.

The Index of Lagging Economic Indicators increased 0.4% m/m (4.2% y/y) in April, down from a 0.7% m/m gain in March, revised from 0.6%. Three of the index’s seven components contributed positively to the overall increase in April, led by commercial and industrial loans, while three subtracted with one unchanged.

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From Advisor Perspectives:

For a better understanding of the relationship between the LEI and recessions, the next chart shows the percentage-off the previous peak for the index and the number of months between the previous peak and official recessions.

Smoothed LEI

Profits and Margins Plunge In Q1: Expect More Margin Contraction As Fed Squeezes Inflation

Based on the preliminary data from the GDP report, operating profits fell roughly 10% in Q1 relative to Q4. A decline of that magnitude would drop aggregate company profits back to the Q1 2021 level, or nearly $300 billion below the record level of Q4 2021.

The plunge in operating profits reflects a sharp drop in margins. Real operating profit margins for Non-Financial Companies hit a record high of 15.9% in Q2 2021, dropped to 15.2% in Q4, and probably fell 100 to 150 basis points in Q1 2022. To be sure, Q1 earnings reports from large companies such as Amazon, Wal-Mart, and Target confirm a sharp contraction in operating margins due to rising input costs.

More margin contraction lies ahead, especially if the Fed successfully squeezes inflation to 2%, down from 8%, and limits any significant fallout in the labor markets. For reported consumer price inflation to drop 600 basis points over the next year or so, producer prices for many companies involved in production and distribution would drop twice as much, if not more. And if overall labor costs are unchanged, the hit to profit margins, or the ratio of profits from sales after all expenses, will be significant.

Past cyclical slowdowns offer some perspective on significant margin contraction when monetary policy simultaneously slows demand and price inflation. For example, in 2000, consumer price inflation dropped 200 basis points, but producer prices for finished goods and intermediate materials fell between 600 and 1000 basis points. That dropped triggered the most significant cyclical contraction in real profit margins (700 basis points).

The potential disruption to business operations in 2022 is more significant than in 2000 because the Fed faces a bigger inflation problem. That means a substantial decline in operating margins is the most considerable risk to the equity market. Investors forewarned.

U.S. Existing Home Sales Continue to Fall in April as Houses Become Less Affordable

Existing home sales declined 2.4% (-5.9% y/y) during April to 5.61 million (SAAR) from 5.75 million in March, revised from 5.77 million. It was the lowest level of sales since June 2020 according to the National Association of Realtors (NAR). The Action Economics Forecast Survey expected a smaller decline in sales to 5.65 million units in April.

The fall in existing home sales included a 2.5% decline (-4.8% y/y) in single-family home sales to 4.99 million, a 22-month low, from 5.12 million in March. In fact, single-family home sales have reversed all of their post-pandemic gains. Sales of condos and co-ops weakened 1.6% (-13.9% y/y) to 620,000, the lowest level since July 2020.

Home sales in all regions of the country have deteriorated in the past three months from their recent highs. Sales in the South were off 4.6% to 2.49 million in April, down 15.3% from January. In the West, sales fell 5.8% in April to 1.14 million, down 10.2% from January. Although existing home sales in the Northeast ticked up 1.5% to 670,000, these sales were down 14.1% from January. Likewise, sales in the Midwest increased 3.2% to 1.31 million, but were nevertheless down 12.7% from January. (…)

On a y/y basis, which eliminates much of the seasonality, the supply of homes on the market was 10.4% lower. The supply of homes on the market remains extremely low at 2.2 months at the current selling rate. For comparison, the months’ supply hovered around 4.0 in the years prior to the pandemic. (…)

The median price of an existing home increased 4.4% (14.8% y/y) to a record $391,200 last month, with gains in all major regions. The average price of an existing home rose 2.9% (9.2% y/y) to $397,600 in April. The price data are not seasonally adjusted. (…)

According to the NAR, housing affordability has fallen sharply in recent months. As a result, NAR calculates that the qualifying income for a new home has increased by 20.9% since the start of the year to $72,096. The decline in affordability is one reason for the recent sharp drop in existing home sales.

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China Unexpectedly Cuts Key Rate as Growth Crumbles China’s central bank cut a benchmark interest rate, a shift that economists said would likely help the moribund housing market but bring only limited relief to the struggling economy.

(…) The People’s Bank of China on Friday cut its benchmark rate for loans of five years or more to 4.45% from 4.6%, the biggest single reduction since the rate entered the bank’s policy armory in 2019. It had made a 0.1 percentage-point cut in early 2020.

The rate is used to price most mortgages, and the cut follows a decision by the central bank Sunday to lower the floor for rates on home loans to first-time buyers.

The cut was unexpected, given that the earlier this week central bank had left unchanged another key policy rate, charged on loans from a medium-term lending facility that funnels cash to commercial banks. On Friday, the PBOC said it would also keep the benchmark rate for one-year loans unchanged at 3.7%. (…)

The PBOC’s cautious response to China’s slowdown shows how the U.S. Federal Reserve’s interest-rate policy is rippling around the world.

The prospect of rapid interest-rate increases in the U.S. is sucking capital out of China and other developing and emerging markets as investors chase better returns. China’s debt and equity markets posted a net outflow of $43 billion in the first quarter, the largest on record, according to the Institute of International Finance, an industry association based in Washington, D.C.

As well as possibly intensifying capital outflows, easing too aggressively would also risk weakening the currency, potentially spurring inflation and testing the limits of China’s managed exchange-rate system. (…)

The gravitational pull from tighter Fed policy is being felt across Asia, adding to pressure on the region’s central banks to jack up interest rates to restrain accelerating inflation.

The central banks of India, the Philippines and Malaysia raised rates this month, joining a policy shift already under way in economies including South Korea and Singapore. Indonesia’s central bank and the Bank of Thailand are expected to begin tightening within months, leaving China and Japan as the only major economies still in easing mode. (…)

MAZES!

The word “maze” dates from the 13th century and comes from the Middle English word mæs, denoting delirium or delusion. The maze is the very symbol of confusion and disorientation, the trap that confounds efforts to escape.

Now, find your way, if you can.

@TimmerFidelity

Also trying to find his way in his own maze:

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WSJ

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Chart: Danielle Alberti/Axios

When I first put this flow chart together over the weekend, my best guess was that it would go “yes” all the way and that Musk would end up buying Twitter at a small discount to his original $54.20 offer.

  • Since then, Musk’s literal -posting (he fired off the poop emoji at Twitter’s CEO) has vaporized the goodwill needed for the two sides to come to any new agreement.
  • As a result, the chances of this ending up in the Delaware Court of Chancery have never been higher.

If it does end up in court, the judge will be well within her rights to grant Twitter “specific performance” — that is, to order Musk to buy the company, as he is contractually obliged to do.

  • If he disobeys that order, no one has a clue what might happen.

Does even a Delaware court have any appetite to get into a massive fight with Elon Musk?

Go deeper: I went into detail this weekend about specific performance and the reason why Musk can’t just walk away from the deal while paying a $1 billion termination fee.

This is a financial farce in need of an ending that ensures that the mega-rich also follow the rules. Another example of what too much money can do…

THE DAILY EDGE: 20 AUGUST 2021

U.S. Initial Unemployment Claims Fall to Pandemic-Era Low

Initial claims for unemployment insurance were 348,000 in the week ended August 14, down from 377,000 in the prior week (revised from 375,000). The four-week moving average decreased to 377,750 from 396,750 in the previous week. The Action Economics Forecast Survey consensus for the latest week was 365,000.

Initial claims for the federal Pandemic Unemployment Assistance (PUA) program edged higher, but by just 5,532 to 109,379 in the August 14 week from 103,847 the week before; the earlier number was revised down slightly from 104,572. This was the third successive rise, but each has been modest. The PUA program provides benefits to individuals who are not eligible for regular state unemployment insurance benefits, such as the self-employed. Given the brief history of this program, these and other COVID-related series are not seasonally adjusted.

Continued weeks claimed for regular state unemployment insurance in the week ended August 7 fell 79,000 to 2.820 million from an upwardly revised 2.899 million in the prior week, originally reported at 2.866 million. In the August 7 week, the associated rate of insured unemployment remained at its pandemic low of 2.1%

Continued weeks claimed in the PUA program increased by 56,881 in the week ended July 31 to 4.878 million,. Continued weeks claimed for PEUC benefits fell 66,081 to 3.786 million, yet another new low since the week ended January 16, 2021. The Pandemic Emergency Unemployment Compensation (PEUC) program covers people who have exhausted their state unemployment insurance benefits.

In the week ended July 31, the total number of all state, federal, PUA and PEUC continued claims was 11.744 million, down 311,787 from the week before. This is another low since March 28, 2020, that is, just as the pandemic was emerging, and down sharply from the pandemic peak of 33.228 million reached in the week ended June 20, 2020. These figures are not seasonally adjusted.

Bespoke adds:

That was also 16K below expectations and the first better than expected print in six weeks. While recent releases have disappointed relative to forecasts, this week did mark the fourth week in a row that claims have dropped.  That is the longest stretch of consecutive declines since a six-week streak ending on June 4th. (…)

Seasonally adjusted continuing claims missed expectations by 20K this week, but at 2.82 million, this week’s reading still marked a third consecutive decline.  As such, claims are still at the lowest level of the pandemic and are closing in on coming within one million from the March 2020 levels. (…)

(Bespoke)

From Axios:

  • Walmart CFO Brett Biggs and Target CEO Brian Cornell both made comments this week indicating consumer traffic in their stores has remained consistent over the last month. Both companies raised guidance for the full year.
  • According to Bank of America’s debit and credit card spending data, which is a bit more comprehensive, spending growth cooled notably in the seven days ending Aug. 14. “A main reason behind the moderation over the last several weeks has been due to a pullback in spending on leisure services, which we define as travel (airlines + lodging), entertainment and restaurants/bars,” Bank of America head of U.S. economics Michelle Meyer wrote.
  • Bank of America economists have maintained their official Q3 GDP growth forecast of +7.0%. But following the disappointing July retail sales report, they warned that GDP growth appeared to be tracking at closer to 4.5% growth for Q3.
  • Not everyone is cutting due to the spread of the Delta variant. “We don’t expect the latest COVID wave to have a major growth impact,” TD chief U.S. macro strategist Jim O’Sullivan wrote this week. “We expect real GDP to slow from a still-very-strong 7% [rate for Q3].”

BTW, Goldman Sachs is at +5.5% for Q3’21.

Chase’s Card Spending Tracker does not look so weak through Aug. 15:

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Although Travel and Entertainment has slowed down:

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U.S. Leading Indicators Continue to Increase in July

The Conference Board’s Composite Index of Leading Economic Indicators increased 0.9% (10.6% y/y) during July following a 0.5% June rise, revised from 0.7%. The 1.2% May increase was unrevised. A 0.8% rise in the July index had been expected in the Action Economics Forecast Survey. The Leading Index is comprised of 10 components which tend to precede changes in overall economic activity.

The stronger increase in the leading index occurred as the leading credit index, the spread between short and long term interest rates and stock prices contributed more to the index rise. The length of the factory workweek, building permits, fewer initial jobless insurance claims and higher factory sector orders also added modestly to the rise. None of the ten component series contributed negatively to the index change.

The Index of Coincident Economic Indicators increased 0.6% in July (4.8% y/y) following an unrevised 0.4% June gain. The index rose 0.1% in May. Each of the four component series contributed positively to the July rise, as they did in June, including industrial production, nonfarm payrolls, personal income as well as manufacturing & trade sales.

The Index of Lagging Indicators rose 0.6% last month (-1.3% y/y) after no change in June. The average  duration of unemployment and the change in the services CPI had the greatest positive effects on the index change in July.

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INFLATION WATCH

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(Data from ApartmentList.com)

Wage growth is coming

Global equity funds see biggest weekly inflows in nearly 2 months-Lipper

Global equity funds lured their biggest weekly inflows in two months in the week ended Aug. 18, bolstered by strong corporate earnings and sustained hopes of an economic recovery.

According to Lipper data, global equity funds received $19.64 billion, the biggest inflow since late June.

U.S. equity funds attracted the majority of the money, securing inflows worth $13.3 billion, while Europe and Asian equity funds lagged, bagging just $4.5 billion and $0.5 billion respectively.

The majority of inflows going to North America was likely “a defensive measure towards burgeoning risk from the East”, said OCBC in a report. (…)

Fund flows into global equities bonds and money markets

  • Feeding the frenzy:

Source: GMO (Via Barry Ritholtz)

China Passes One of the World’s Strictest Data-Privacy Laws China approved a sweeping privacy law that will curb data collection by technology companies, but that policy analysts say is unlikely to limit the state’s widespread use of surveillance in the country.
COVID-19
AstraZeneca Antibody Drug Prevents Symptomatic Covid-19 in Trial The company said it would seek regulatory approval after a study showed strong efficacy in preventing symptomatic Covid-19, offering a potential alternative to vaccines for people who refuse shots or for whom they aren’t effective.

From NBF:image

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