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)

Invest with smart knowledge and objective odds

THE DAILY EDGE: 16 JUNE 2020

The surge in coronavirus cases in some states isn’t part of a ‘second wave’

(…) “We are seeing a notable uptick in identified cases in several states,” Raymond James analysts wrote in a June 15 note to investors. “We expected this uptick and anticipate other states will also see upticks as reopenings continue. This isn’t a second wave, this is another swell that is part of the ‘first wave’ of this virus.”

As states and local governments have eased stay-at-home restrictions over the last month, that may have led to the first significant wave of cases in regions that may not have already experienced large increases in case counts. “We’re now recognizing that we’re not going to see the summer break that we had hoped for,” Wen said. (…)

In May, when lockdown orders began to be lifted, the national daily infection rate was around 2.5%, J.P. Morgan analysts said. Most countries in Asia and Europe waited until daily infection rates were below 1.0%.

Daily infection rates are about 5.0% in Arizona and about 2.3% in Texas, “indicating that “state-specific issues may be in play rather than a generalized problem of community spread,” according to the analysts. (…) (MarketWatch)

R is at or above 1 in about a quarter of U.S. states

image
PANDENOMICS
Trump Team Weighs $1 Trillion for Infrastructure to Spur Economy
Empire State Manufacturing Exhibits Unexpected Improvement in June

Economic activity in New York is strengthening. The Empire State Manufacturing Index of General Business Conditions rose sharply to -0.2 during June from -48.5 in May. The rebound far outpaced expectations for an increase to -31.3 in the Action Economics Forecast Survey. The percentage of respondents reporting an increase in business conditions rose to 36.1% from 14.5% in May. The percentage reporting a decline fell to 36.3% from 63.1%. The overall measure is a diffusion index which follows the breadth of change across the state.

Haver Analytics calculates an ISM-Adjusted Index which mimics the construction of the overall purchasing managers’ index. The figure surged upward to 50.0 in June from 40.5 in May. It was the highest level since February.

The subindexes of the report demonstrated uniform improvement. The new orders index rose to -0.6 from -42.5. Thirty-five percent of respondents reported higher orders in June, up from 18% in May, while 36% reported a decline versus 60% last month. The shipments measure rose to 3.3, its highest level since May. The unfilled orders, delivery times and inventories measures rose moderately.

image

Employment indicators improved modestly and remained below the break-even level of 50. The number of employees index rose to -3.5 from -6.1, its best level in three months and far above April’s low. The percentage reporting improvement in employment rose 18% from 15% in May and the percentage reporting a decline was little changed at 22 %. The average workweek measure rose markedly to -12.0 this month from -21.6 in May.

The prices paid index surged m/m to 16.9 from 4.1, but remained well below earlier highs. Twenty-four percent of respondents reported higher prices while seven percent paid less. The prices received index rose to -0.6 from -7.4.

The Expected General Business Conditions index measure in the Empire State Survey surged to 56.5 from 29.1. It was the highest level in roughly ten years and occurred as expected new orders and shipments jumped. The gain reflected only moderate improvement in employment and a decline in the workweek. Expected prices also rose just slightly as did the capital spending figure.

What these diffusion indices are saying is that conditions are stabilizing at a low level.

US Restaurant Traffic Suddenly Craters Amid Second Wave Fears

After three months of slow but consistent improvement in restaurant dining data in the US and across the globe, in its latest update on “the state of the restaurant industry”, OpenTable today reported the biggest drop in seated restaurant diners (from online, phone and walk-in reservations) since the depth of the global shutdown in March. (…)

More charts from CalculatedRisk:

Cass Freight Index – Shipments

As a measure of economic activity, Cass Freight Index shipment volumes dropped 23.6% vs. year-ago levels (Chart 1), slightly worse than the -22.7% y/y change in April. But the absolute index reading nudged up 1.6% sequentially from 0.923 to 0.938.

May’s shipments index was barely higher than April and still at very poor levelsChart 1

U.S. rail traffic shows steady week-to-week improvement into June

Chart 4
US CFOs look to rebuild revenue amid worries of a second wave of COVID-19 infections

PwC surveyed 330 US CFOs and finance leaders between June 8-11, 2020.

  • Less than a quarter of leaders (24%) anticipate layoffs, down 7% from our last survey, while under a third (30%) expect to implement temporary furloughs—a drop of 6% since our last survey.
  • Facilities and general capital expenditures remain targeted — 78% of CFOs whose companies are considering deferring or canceling investments plan cuts here. Planned spending cuts to other areas are slowing somewhat, however: 48% now expect cuts to workforce efforts, down from 62% in March, and half are considering cuts to operations, down from 54%.
  • Nearly half (47%) of finance leaders expect revenue declines of more than 10% this year. In that grim forecast is a glimmer of optimism, however: Only 13% of US CFOs are now looking at declines of more than 25%, which is a drop from 20% expecting declines five weeks ago.
  • One-third (32%) of US CFOs are very confident in their company’s ability to identify new revenue opportunities.
  • 41% look to alter pricing, among other revenue strategies.
  • 54% of CFOs plan to make remote work a permanent option, up from 43% in our last survey. Only 26% of leaders are concerned about losing productivity due to remote work now, a significant drop from the beginning of the pandemic (63% in our March survey) — while 49% are trying to improve the remote work experience for their people.
  • As they reinvent their businesses, nearly one-third of CFOs (32%) look to tech-driven products and services.
  • Half of US consumers tried new brands or products while home during the pandemic, and 5% used telehealth for the first time.
Business Travel Won’t Be Taking Off Soon Amid Coronavirus After months of doing their jobs from home, many executives and employees say all those hours in the sky and nights away from home may not be necessary going forward.

(…) A major decline in corporate travel spending would have vast implications for the nation’s airlines, hotels and rental-car companies. (…) After 9/11, it took the airline industry six years to recover. (…)

“At the end of the day, if the customer says they need to see us, we’re going to go,” she said. “But we’re finding operating this way is considerably more efficient.” (…)

Ad Spending Will Drop 13% This Year, Ad-Buying Giant Says U.S. advertising spending is expected to plunge by 13% this year, GroupM, the world’s largest ad buyer said, but won’t fall as much as what occurred in 2009 following the financial crisis.

(…) One silver lining comes from the coming presidential election, traditionally a boon for ad spending. GroupM estimates that factoring in the effect of political dollars, overall ad spending is expected to fall by 8%. (…) Digital ad spending is expected to fall just 3%, a far cry from GroupM’s December forecast that expected a 13% increase.

Businesses to Slash Overseas Investment Amid Pandemic Risks New overseas investments will fall by 40% this year and as much as 10% next year, according to new United Nations forecasts, as disruptions from the coronavirus push multinationals to bring production closer to home.

(…) Unctad said profits among the 5,000 largest companies that operate internationally are expected to decline by 40% on average. Some industries anticipate losses.

The Geneva-based research body said FDI would only start to recover in 2022, but would remain subdued through the coming decade as businesses adopt a more cautious attitude to globalization—the process in which production has been split up and spread across the world since the 1980s. (…)

On top of those immediate pressures, Unctad said the growing potential of automation, rising economic nationalism and differences in carbon-emissions standards may also play a part in damping foreign investment flows.

That could hurt growth prospects in developing countries, which have relied on attracting foreign investment and the new technology it brings to drive growth and raise living standards for a low-paid workforce.

“The first rungs on the development ladder could become much harder to climb,” said Unctad Secretary-General Mukhisa Kituyi. “This may call for major policy rethink.” (…)

The World Bank warned earlier this month that developing economies entered the coronavirus pandemic in a more vulnerable position compared with the global financial crisis a decade ago. They have more debt, aging populations, weaker demand for commodities and trade tensions that weakened the international flow of goods and services even before the pandemic started, the World Banks said.

Housing Market Around New York City Is Booming Real-estate agents say more home shoppers are looking to buy outside the city, often because they are concerned about a second wave of pandemic-related restrictions.
China is recovering but far too slowly

We are keeping our China GDP forecasts
unchanged at -3.1% YoY for the second
quarter of 2020 and -1.5% for the full year.
Latest figures show that most sectors are still
in deep contraction territory, not least
manufacturing. ING’s Iris Pang says the
Chinese government appears to be wary of
spending more money to help the economy
for fear of racking up even more debt.

Fed Will Amass Corporate Bond Portfolio Using Index Approach The central bank announced a buying scheme to complement existing purchases in exchange-traded funds.

(…) The central bank has deployed a $250 billion lending program to buy outstanding corporate bonds. The central bank said Monday it plans to begin making those purchases on Tuesday by creating a portfolio based on a broad, diversified market index of corporate bonds.

The index will be made up of all the bonds in the $9.6 trillion corporate debt market from companies that satisfy the program’s criteria, including that companies were investment-grade-rated as of March 22 and that securities can be no more than five years in duration.

The Fed began purchasing debt through the program on May 12 by buying exchange-traded funds that invest in corporate debt. It has been buying those assets at a pace of around $300 million a day. (…)

Analysts at Bank of America estimated in April that the Fed could buy up to $419 billion of individual corporate bonds under the criteria it had established, many times more than it could buy by only purchasing exchange-traded funds.

Separately, the Fed announced Monday that a $600 billion effort to lend directly to small and midsize businesses had opened for business. Under that program, banks can sell up to 95% of loans that meet the Fed’s standards to an investment entity established by the Boston Fed. (…)

unnamed (12)

(via Grant’s)

Investors Are Sitting on the Biggest Pile of Cash Ever Grappling with the most economic uncertainty in decades and a head-spinning stretch of volatility in the U.S. stock market, many investors have rushed into money-market funds.

(…) Assets in the funds recently swelled to about $4.6 trillion, the highest level on record, according to data from Refinitiv Lipper going back to 1992. (…) Other measures, like bank deposits, are also at a high.

(…) overall stock positioning among investors remains among the lowest levels of the past decade, according to data from Deutsche Bank. (…)

Other positioning data shows traders have been pessimistic about the recent rally. As stocks rebounded, leveraged funds like hedge funds have accumulated the most bearish position on S&P 500 futures since 2016, according to Commodity Futures Trading Commission data.

CLOs Are Not CDOs, Not Even During a Pandemic The structured products have their problems but are hardly about to topple the banking system.

(…) I don’t want to spend an entire column on a rebuttal (others already have), so suffice it to say I was skeptical when the big reveal was that Wells Fargo & Co.’s exposure to high-rated CLOs was described this way: “The total is $29.7 billion. It is a massive number. And it is inside the bank.” Never trust absolute dollar figures, no matter how large they may seem. As a percentage of total assets, that’s a mere 1.5%. And, remember, triple-A rated CLOs have famously never defaulted.

The crucial question, then, is whether something is different this time. CLOs at their core are simply bundles of speculative-grade loans, sliced into different tranches, with the lower-rated portions suffering the first losses to protect payments to those invested in the top layer. One of the crucial assumptions behind CLOs is that because the debt is backed by companies of varying size and across disparate industries, the likelihood that all the securities would default at once is highly unlikely. That differentiates them from the CDOs of the past, which, in addition to being more complicated in structure, were exposed entirely to individual borrowers and just one part of the economy: the housing market. (…)

Make no mistake, CLOs are under pressure. Moody’s has placed 77.3% of all U.S. CLO tranches rated B or lower on review for downgrade, along with about 60% of those rated Baa or Ba. A handful of those with the most significant deterioration in their underlying loans could even see their Aa rated portions downgraded. To some, that might seem too close to the triple-A tranche for comfort, even if it’s just 0.8% of the notional amount of the Aa debt.

Still, a downgrade doesn’t equal a default. The fact that not a single top-rated slice is even at risk of a rating cut speaks volumes, considering they collectively make up more than 75% of the notional amount outstanding and are the portions sitting on banks’ balance sheets, both in the U.S. and elsewhere.

Moody’s also casts doubt on whether it will get worse in the coming months. “In recent weeks, the pace of negative corporate rating actions has slowed as our reassessment of ratings based on the shock of the coronavirus and low oil prices has progressed,” analysts led by Peter McNally wrote on June 11. “After the current credit shock materialized in March 2020, the number of global negative rating actions peaked in late March and early April. More recently, these have declined steadily.”

The worst-case scenario, as spelled out by Moody’s, isn’t as dire as it seems. The global 12-month trailing speculative-grade default rate will probably hit 9.5% by March 2021, up from 4.7% last month, and in its pessimistic forecast it’ll reach 16%, higher than at any point in the last 20 years. Drilling down deeper, Moody’s estimates the one-year default rate in the four industries most vulnerable to the coronavirus pandemic with the highest concentrations (on average 1% to 5%) in U.S. CLOs: hotel gaming and leisure, 17.5%; retail, 10.8%; automotive, 15.1%; and durable consumer goods, 15.1%.

Obviously, the next 12 months will be painful for individual holders of those leveraged loans. Moody’s has long predicted that recoveries in a downturn will be lower than the historical average, with first-lien loans recouping closer to 61%, compared with the long-term rate of 77%, and second-lien debt will get just 14% compared with 43%. And, as I wrote last month, funds investing in the riskiest portions of CLOs have suffered a wipeout and haven’t benefited from the rebound in risky assets over the past two months.

Whether speculators face losses is not the question at hand, however. It’s about financial giants like JPMorgan Chase & Co. and Citigroup Inc., two banks flagged as owning $35 billion and $20 billion of CLOs as of March 31, respectively. Setting aside that these are once again absolute numbers, even if Moody’s double-digit default rates over the next year come to pass, investment-grade tranches seem destined to come out unscathed. According to the credit-rating company’s analysis, the cumulative collateral default rate would have to reach 70% to 80% before double-A CLOs take losses, assuming a 60% recovery rate. DoubleLine Capital Chief Investment Officer Jeffrey Gundlach, for one, said on a webcast last week that middle-of-the-capital-structure CLOs were among his picks for most attractive assets, given that he sees a “significant march towards par in their future.”

Certainly, every loan and CLO has its own quirks. Barclays Plc strategists flagged the bankruptcy plans of Acosta Inc. and J.C. Penney Co., which gave CLOs a recovery rate 20 to 30 points lower than other first-lien holders. The problem, they found, was that an aggressive approach from a small group of distressed investors can put CLOs at a disadvantage, in part because many quickly bail on the loans when they’re downgraded, and also because stated investment criteria largely ban purchases of defaulted assets or bridge loans. If this relative lack of flexibility takes a bite out of recovery rates time and again, Moody’s and others may have to reconsider their loss scenarios.

Even still, it’s almost impossible given the evidence to extrapolate widespread losses to the biggest U.S. banks. The Atlantic’s hypothetical stipulates that “later this summer, leveraged-loan defaults will increase significantly,” which goes against the current outlook from Moody’s, and that “holders of leveraged loans will thus be fortunate to get pennies on the dollar as companies default.”

Yes, the equity portions and speculative-grade tranches will face losses. They might even be wiped out entirely. That may seem like a novel concept when the Federal Reserve has taken to backstopping just about all forms of debt, but as S&P Global Ratings has said, that’s just CLOs “working as intended during periods of economic stress.”

There are any number of reasons to fret about America’s recovery from the coronavirus crisis. A repeat financial collapse at the hands of a structured product with a similar sounding acronym isn’t one of them.

PANDEMONIUM

Following days of escalating tensions between the two nuclear-armed neighbors, Indian Army officials confirmed that three troops – an officer and two soldiers, to be more precise – had been gunned down by Chinese forces during a “violent faceoff” in Galwan Valley in the Ladakh region, which rests along the country’s border with China on Monday night.  (…)

THE DAILY EDGE: 19 FEBRUARY 2020

Cass Transportation Index Report January 2020

The turn of the calendar didn’t leave the bad news in 2019, as the Cass Freight Index showed continued weakness in the U.S. freight market. Both the shipments and expenditures components of the Cass Freight Index worsened sequentially and showed decelerating y/y growth. According to the broader stock market levels, there is still optimism out there, but the freight trends have yet to turn. And the Covid-19 coronavirus case count continues to grow, creating uncertainty around containment and eventual impact on global supply chains. Some Chinese factories resumed operation this past week, but they are still not close to 100% production levels. Others have pushed re-opening back to March 1.

As stated last month, we expect 2Q20 to have the best chance of showing actual y/y growth in domestic U.S. shipments and freight costs, if traditional seasonal freight patterns hold, because 2Q19 was below average in terms of the seasonal surge in activity. Plus, depending on how the aforementioned coronavirus affects supply chains, there could be a 2Q20 wave of import activity (and therefore truck and intermodal) when the Chinese export machine starts churning again.

Shipment volumes dropped 9.4% in January vs 2019 levels (Chart 1), as the index posted its lowest absolute reading in roughly three years. It was also the steepest y/y decline since 2009. This follows a sluggish end to 2019, where many blamed last month’s weakness on timing of the holidays. There could have been a residual impact post-New Years, but with the negative y/y and sequential decline, and the deceleration in the y/y growth rate, we don’t see much good news in this volume number.

Worst y/y growth in shipment volumes since late 200

Chart 1 Jan 2020

Even before the coronavirus issues have any impact on the U.S. transportation market, the freight market is weak, partially due to elevated inventories (although the inventory situation has at least stabilized and is likely improving). On 4Q19 earnings calls, we heard manufacturers and distributors say inventories look like they’re returning to normal levels, but the optimism for 2020 was only modest. Orders are still soft, and the most positive commentary was around the consumer and residential construction.

Chart 2 Jan 2020
Empire State Manufacturing Conditions Strengthen

The Empire State Manufacturing Index of General Business Conditions increased to a nine-month high of 12.9 during February, extending modest gains during the prior two months. A reading of 5.0 had been expected in the Action Economics Forecast Survey. Thirty-four percent of survey respondent reported improved business conditions while 21 percent reported a decline.

The ISM-Adjusted Index, constructed by Haver Analytics, surged to 56.9, the highest level since June 2018. During the last 20 years, there has been 59% correlation between the level of the index and q/q change in real GDP.

Leading this month’s improvement was the new orders index as it surged to 22.1, the highest level since September 2017. The shipments series also jumped roughly ten points. The delivery times returned to positive territory, indicating slower delivery speeds. The inventories index surged to a two-year high while the unfilled orders index turned positive after falling for roughly one year.

Working lower was the employment series to 6.6, its lowest level in six months. Nineteen percent of survey respondents reported increased hiring while nine percent reported a decline. During the last 20 years, there has been a 73% correlation between the index level and the m/m change in factory sector payrolls. The average workweek reading also turned negative. (…)

image

Virus Update

China death toll tops 2,000, global confirmed cases exceed 75,000. (…)

A growing number of China’s private companies have cut wages, delayed paychecks or stopped paying staff completely, saying that the economic toll of the coronavirus has left them unable to cover their labor costs. To slow the spread of the virus, Chinese authorities and big employers have encouraged people to stay home. Shopping malls and restaurants are empty; amusement parks and theaters are closed; non-essential travel is all but forbidden. (…)

A Tax-Cut Idea for Trump By Stephen Moore and Adam Michel

The White House is expected to announce details of its tax cuts for the Trump second term. One idea on the table is to create tax-free investment accounts for lower- and middle-income families.

The plan we’ve suggested to the president would allow families to put up to $10,000 a year tax-free into a savings fund. Ideally, the money would be invested in a stock index fund. The goals would be to increase woefully low private household savings, to make Americans more financially stable, and to reduce dependence on government entitlements. (…)

These new accounts would expand ownership of stock to millions of Americans, thus democratizing the market and sharing the gains, while minimizing risk by investing in a diverse portfolio. This may be the most effective way to reduce wealth inequality.

These accounts would be voluntary, and employers would be encouraged to match contributions. Funds could be used after five years for home purchase or improvement, emergency medical expenses, starting a new business, private-school or college tuition, supplementing income after a job loss, or retirement. (…)

Mixed Signals for Chip-Making Gear The specter of export controls hangs over the sector despite President Trump’s backpedal.

The Wall Street Journal reported on Monday that the U.S. Commerce Department was drafting new rules that could restrict semiconductor manufacturers from producing chips for Huawei using equipment from U.S. companies. The changes would require such companies to get a license from the government if they intend to continue producing components for Huawei on American-made gear. Because Huawei is one of the largest chip buyers on the market and purchases them from nearly every major producer, such a rule could have “wide-ranging supply impacts to the semiconductor and consumer markets,” wrote Atif Malik of Citigroup in a note to clients.

It therefore didn’t take long for the backpedal to emerge: In a set of tweets Tuesday morning, President Trump declared that the U.S. “cannot, & will not, become such a difficult place to deal with in terms of foreign countries buying our product, including for the always used National Security excuse, that our companies will be forced to leave in order to remain competitive.” (…)

Chinese Trade Spat Isn’t About Soybeans

(…) The Wall Street Journal reported Sunday that the Trump administration could stop CFM International, a joint venture of General Electric and France’s Safran, from selling more engines to China’s Comac. The engines are used in the flagship C919 jet, and the U.S. fears that they could be reverse engineered. (…)

Unfortunately for investors, the real trade conflict has much more to do with Huawei and CFM than it does with how many soybeans China buys.

The C919 is a central piece of the “Made in China 2025” initiative. Airbus and Boeing don’t appear too worried because the jet is still a generation behind their own A320neo and 737 MAX aircraft, respectively. But the Chinese state owns aircraft maker Comac and can pour a lot more resources into it. It also owns the main domestic airlines, so it can ensure orders. Commitments for the C919 already top 1,000. (…)

Canada: Adding fuel to the housing market

The Minister of Finance, Bill Morneau, announced today a change in the qualifying rate for insured mortgages in Canada (buyers with a downpayment less than 20%). Recall that since October 2016, the federal government requires homebuyers to qualify at the higher 5-year posted rate instead of the contractual rate, a measure put in place to curb household debt. In the current context, this represents a 22% reduction in purchasing power.

Starting in April 2020, the new benchmark rate for homebuyers will be “the weekly median 5-year fixed insured mortgage rate from mortgage insurance applications, plus 2%”, which will be more representative of market conditions as opposed to the more static posted rate. What does this mean for homebuyers looking for an insured mortgage? Given that the new benchmark rate is lower than the posted rate, the maximum amount that can be borrowed increases by 4% according to the latest data available. This should add further fuel to a vigorous housing market which is already supported by the recent decline in mortgage rates and a vibrant labour market. (NBF)

image

The ECB is considering including owner-occupied housing in the consumer inflation calculations.

Source: The Economist; Read full article (The Daily Shot)

  • Here is the potential impact on the CPI.
Source: Pantheon Macroeconomics
Outside of the big 5 tech companies, earnings growth is zero

CH 20200218_faamg_eps_growth.png

As discussed last week, there is a clear split between cyclicals and non-cyclicals in Q4 (chart from Refinitiv/IBES)

image

GS adds that a lower-than-expected effective tax rate (17% vs. 20%) helped Q4 earnings, assuming one has taxable income.

Mega-cap earnings strength contrasts with small-cap earnings weakness. The Russell 2000 experienced a 7% earnings decline during the fourth quarter, as many smaller firms posted weak top-line growth and had difficulty absorbing rising wages and other input costs.

Meanwhile, in Europe, we now have 156 (48%) of the STOXX 600 index reported. The beat rate is 51% and the miss rate 41%

  • Fourth quarter earnings are expected to decrease 0.2% from Q4 2018. It was +5.5% in November. Excluding the Energy sector, earnings are expected to increase 1.3%.
  • Fourth quarter revenue is expected to increase 1.4% from Q4 2018. Excluding the Energy sector, revenues are expected to increase 3.2%.