Month: May 2015

U.S. Consumer Prices Climb for Third Straight Month Rising 0.1%, in the latest sign inflation is stabilizing.

Core prices–excluding volatile food and energy categories–climbed 0.3%, the largest increase since January 2013 and only the fourth monthly reading that high since the recession ended.

Compared with a year earlier, overall prices actually fell 0.2% and core prices rose 1.8%. (…)

“While inflation is not a major concern, the pattern of prices is changing,” said Joel Naroff, president of Naroff Economic Advisors. “It used to be hard to find any category where costs were going up but now the opposite is true: Most categories are posting increases.”

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.2% annualized rate) in April. The 16% trimmed-mean Consumer Price Index also rose 0.2% during the month.

Core CPI has accelerated from a 0.07% monthly rate late last year to +0.17% in January-February, +0.23% in March and 0.26% in April. This while the economy, frozen and buried in snow, produced only 0.7% in final demand growth in Q1. It is a blessing that demand was not stronger…

The good news is that we may have seen this movie before.

But this movie has a different supporting character: core wholesale prices are accelerating as well.

Perhaps it’s all due to the West coast ports strike and other transitory factors…

…but Services were not jammed in the ports. CPI-Services, which rose a total of 0.25% (+0.6% annualized rate) between August and December 2014 has accelerated to +1.0% (+3.0% annualized) in total during the first 4 months of 2015. YoY, CPI-Services is up 2.3% in April but at its current pace it would be close to +3.0% YoY by year-end.

Services are 62% of the CPI. Shelter costs, 53% of Services, are up 3.0% YoY in April (+3.2% annualized in last 3 months) while Medical Care Services, 10% of Services, are up 2.6% YoY in April but +4.5% annualized in the last 3 months. FYI, Medical Care Commodities (goods) are up 4.1% YoY and 3.6% annualized in the last 3 months.

Keep in mind that services costs are heavily influenced by wages. So far, wage pressures have come from the higher-skilled positions:

On balance, while wage growth has been rather tepid over the last 12 months (+2.3%) and since the economy began creating jobs in February 2010 (10.5% or 2% per annum), 67 industries have seen wages increase at double (21%) the average with good old American know-how roles well represented among those 67 industries. (…) History suggests that it is only a matter of time before the shortages of labor in the skilled professions begin to spread to other areas of the economy and push the broad measures of wage inflation higher. (LPL Financial)

…but pressure from the bottom has begun (Wal-Mart etc.) and will intensify:

Los Angeles is the fourth city, and by far the largest, to enact a $15 minimum in the past year. The others are Seattle, San Francisco and Emeryville, Calif. (near San Francisco). A $15 minimum has been proposed in New York City, Washington, D.C., and Kansas City, Mo. (…)

In Congress, the latest Democratic proposal calls for a federal minimum wage of $12 an hour by 2020. That would be adequate, if a bit on the low side, and a huge improvement from the current $7.25 an hour, the level since 2009. (…)

On the state level, 21 states that have not raised their minimums in recent years will be forced to face the fact that being a competitive place to do business means ensuring fair pay. (NYT)

Also noteworthy,

• Rents are up 3.5% YoY in April and +3.6% annualized in the last 3 months.
• Owners’ Equivalent Rents: +2.8% YoY in April and +3.2% annualized in the last 3 months.

BTW

Core goods (20% of CPI) have been deflating thanks to tepid demand and the strong USD. But that may also prove transitory. Core Goods prices are down 0.2% YoY in April but they have been rising in each of the last 3 months (+2.2% annualized).

The Fed could soon find itself cornered by rising inflation and sluggish growth, one year before the elections…

BTW, did you miss this in the last Bearnobull’s Weekender: Don Coxe: Bull Market in Bonds Now Ending

(…) the main challenge to the stock market will come not from the stock market itself, but from the bond market, (…)

Remember the May-June 2013 “Taper Tantrum” after Bernanke talked about tapering: the S&P 500 lost nearly 6% in one month even though the trailing P/E was 16.2 (current: 19.1) and the Rule of 20 P/E was 17.7 (current 20.9) with stable inflation (currently rising).

We believe the probability of a 5%+ dip is high this summer and our tactical call remains Down given the S&P now at an even higher PE than a year ago, heightened uncertainty in 10yr yields, weak earnings growth and continued soft economic data. We haven’t had a 5%+ dip this year. Historically 5%+ dips are common and happen at least once a year since 1960, except 1964, 1993 & 1995. It has been 916 trading days (3.6 years) since a 10% correction. Selloff triggers could be a further rise in 10yr yields especially if UE keeps falling amidst slow economic growth and Fed remains unclear on first hike timing, or a jump in the dollar upon the Fed expressing firm intentions to hike in Sept. (Deutsche Bank via BI)

Were equity prices to retreat to 18.0 on the Rule of 20 P/E like in 2013 and 2014, the S&P 500 would lose 15% to 1800 (18.0 – 1.8 x 111.49).

• Yellen: Fed on Track to Raise Rates This Year Federal Reserve Chairwoman Janet Yellen said the central bank is on track to raise interest rates this year but will likely proceed cautiously because inflation is low and growth has again disappointed.

• “I think it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy,” Ms. Yellen said in Friday’s speech.
• “The [Fed’s] objectives of maximum employment and price stability would best be achieved by proceeding cautiously,” she said. The job market, she argued in her speech, wasn’t back to full strength. Even though the unemployment rate has dropped to the relatively low level of 5.4% in April, it “probably does not fully capture the extent of slack” in the economy, she said.
• “The generally disappointing pace of wage growth also suggests that the labor market has not fully healed,” she said.
• It could be “several years,” she said Friday, before the Fed’s benchmark short-term rate is back to a level the central bank considers to be normal in the long-run. (…)
• On Ms. Yellen’s list of forces holding back the expansion, she added a new factor that is getting increased attention inside the U.S. central bank: China, the world’s second-largest economy, is slowing, with uncertain effects on the rest of the world. “Initially the euro-area crisis was the biggest headwind coming from the rest of the world,” Ms. Yellen said, referring to turbulence in the countries that use the euro. Now, she noted, “growth in many other parts of the global economy, including China and some other emerging market economies, has slowed. Weak growth abroad, together with its accompanying implications for exchange rates, has dented U.S. exports and weighed on our economy.”

Mrs. Yellen is walking on eggs, trying to advance towards normality without messing things up. (BTW: US egg shortage could cost consumers $8bn as prices soar)

 But the really important thing that Mrs. Yellen said Friday was this:

The notion that inflation can be too low may sound odd, but over time low inflation means that wages as well as prices will rise by less, and very low inflation can impair the functioning of the economy – for example, by making more difficult for households and firms to pay off their debts.

She omitted “governments to pay off their debts”. Yellen speaks the truth. She knows that only inflation will help solve the debt problems. The fact that the first, and only, example she gives about how “very low inflation can impair the functioning of the economy” is how inflation helps pay off debt is instructive. This is her focus, knowing too well that politicians will not do the job that needs to be done.

The economy needs higher inflation. Governments need higher inflation. The Fed wants higher inflation and it will get it with Mrs. Yellen.

Japan Slides Back Into Trade Deficit Japan slipped back into a trade deficit in April as crude-oil imports rose, but stronger-than-expected exports provided a bright spot for the economy.

The value of exports grew 8.0% on year, down from 8.5% growth in March, while imports fell 4.2%. A plunge in global oil prices since last summer has curbed the value of Japan’s overall import bill.

Exports to the U.S. in April were robust, rising 21.4% in value from a year earlier. Cars, power generating machines were among items pushing up its exports.

Japanese car exports to China, on the other hand, tumbled 50% during the month. A ministry official cited a slowdown in the Chinese economy.

EARNINGS WATCH

The Q1’15 earnings season has closed and the last 3 weeks have been on the weaker side.

Factset:

With 98% of the companies in the S&P 500 reporting actual results for Q1 to date, fewer companies are reporting actual EPS above estimates (71%) and actual sales above estimates (45%) than average. However, the companies that are reporting upside earnings surprises are surpassing estimates by much
wider margins (+6.1%) than average. This surprise percentage is above the 1-year average (+4.1%) and the 5-year average (+5.4%).

As a result of these upside earnings surprises, the blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings growth rate for Q1 2015 is now 0.3%, which is above the estimate of -4.7% at the end of the first quarter (March 31).

If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would jump to 8.0% from 0.3%.

The blended revenue decline for Q1 2015 is -2.9%, which is slightly larger than the estimate of -2.6% at the end of the first quarter (March 31). If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would jump to 2.4% from -2.9%.

Overall, Q1 was a pretty remarkable earnings season given low expectations. Ex-Energy, EPS have surprised by nearly 8% and grown 8.0% YoY in spite of a low 2.4% revenue growth rate.

However, a closer look reveals that excluding Health Care and Financials, the other sectors performed fairly close to expectations with EPS rising 2.2% (-1.3% expected) on a 0.9% revenue decline (+0.6% expected).

Furthermore,

Bank of America was the largest contributor to earnings growth for the Financial sector. The company reported actual EPS of $0.27 for Q1 2015, compared to year-ago EPS of -$0.05 in Q1 2014. The loss reported by Bank of America in Q1 2014 included a litigation charge of $0.40. If this company is excluded, the blended earnings growth rate for the sector would fall to 6.4% from 13.4%.

Negative pre-announcements are not rising:

At this point in time, 101 companies in the index have issued EPS guidance for Q2 2015. Of these 101 companies, 74 have issued negative EPS guidance and 27 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the second quarter is 73%. This percentage is above the 5-year average of 69%.

But it is below the 75% negative pre-announcements at the same date last year when 105 companies had pre-announced.

On the other hand, the “official” S&P tally shows Q1 EPS at $25.80, down 5.6% YoY and 3.4% lower than the estimate on March 31st. In fact, Q1 EPS came in 4.3% below S&P’s estimate as recently as May 1st. Once again, understand that the various aggregators do not treat “special items” the same way. For example, S&P considered the above mentioned BAC litigation charges as non-operating last year.

As a result, trailing 12-m EPS are now $111.49, down 1.3% from their level after Q4’14. They are expected to trough in Q2’15 at $110.71, down 3.3% from their Q3’14 peak of $114.51. S&P’s trailing EPS will remain depressed until Q4’15 results are in next March. Recall that Q4’14 results were depressed by pension charges totalling $1.05 and which S&P treated as operating costs, unlike most aggregators.

GO FIGURE

I have always thought that Lance Roberts does good stuff. His last piece left me puzzled…(my emphasis)

Bull Market Confirmations & Warnings

From the broader macro-technical perspective, the current bullish trend remains very much intact despite deterioration in market liquidity, equity outflows and weak fundamentals. (…)

It is with this background that I want to update the technical underpinnings of the market.(…)  

I stated previously that I expected the consolidation to resolve itself to the upside due to the underlying momentum in the markets. As I discussed in this past weekend’s newsletter, the resolution of that consolidation has now been achieved.

“This [breakout] suggests that portfolios should remain FULLY ALLOCATED to equities for the time being as the tendency for the markets remains upwardly biased.” (…)

The reality is that the breakout to the upside of the consolidation range IS BULLISH and suggests that markets will go higher in the SHORT TERM.

However, time frames are crucially important. Analysis of short-term market actions are like “7-day weather forecasts.” They are accurate within the first couple of days but start needing revisions as new data is received. While the breakout could last a day, a week, or a month – it will eventually end. The breakout DOES NOT mean that we are beginning the next great secular bull market and that investors should pile in with reckless abandon.

As I noted previously, the underlying technicals of the market continue to suggest an environment where downside risk grossly outweighs the potential for reward.

In order to reinforce the importance of the “buy/sell” indications driven by price momentum, I have stepped the chart out to a much longer time frame on a MONTHLY price basis. As shown, the MACD indicator at the bottom of the chart is confirmed by the price momentum oscillator just above it. Since 1999, there have only been four prior signals with each being critical turning points in the markets.

Furthermore, the markets are long overdue for a more substantial market correction of 10%, or more, following one of the longest unabated bull market runs in history. (…)

The chart below shows Dow Industrials versus Dow Transports in 2000. Notice the divergence in the transportation sector from the industrials. Eventually, industrials caught up to the underlying economic weakness telegraphed by the transportation sector.

Here is the same analysis currently. Notice the problem?

While I do not like historical comparisons, in general because markets rarely play out exactly the same, the warning signs that we are in a late market stage advance are pretty evident. (…)

While the longer-term market dynamics suggest the risk to investment portfolios, being overweight cash in a rising market will lead to “career risk” for portfolio managers and advisors. The markets are sending short-term bullish signals that should be viewed constructively in the short-term, and portfolios should remain tilted more heavily towards equity exposure.

This does not mean that the current bull market will not eventually end – it will. The longer the bull market advances unabated, the greater the risk becomes of a significant correction. This is where prudent portfolio management and risk controls will pay large dividends over the media’s “buy and hold” mentality.

But don’t worry

Pay attention. When the time to act comes…I will let you know. The majority of investors, advisors and portfolio managers will react emotionally to the decline. You need to be prepared, willing and be proactive, rather than reactive, to the correction when it comes.

I doubt that Ed Viesturs would hire Roberts as a sherpa…(SUMMIT FEVER).

About the Transport divergence, Horan Capital Advisors says not to worry:

Divergent Performance Between Transports And Industrials Likely Not Indicating Broader Economic Weakness

(…) As the below chart shows the transportation index has underperformed both the Dow Jones Industrial Index and the broader S&P 500 Index. This underperformance began to accelerate in mid-March. For investors though, evaluating the actual causes of weakness in the transports will provide insight into the slowing rail segment of the market and whether these factors are broad based ones or simply industry specific ones.

According to Horan, the reasons for the weak Transports are coal and frac sands (oil) specific with another hit from rail equipment maintenance. There was also weak airlines, more specifically UAL but the whole group is down 20% YTD, and trucking, mainly due to the port strike. In all

In conclusion, I believe there are unique factors that have negatively impacted the transportation sector of the economy that are not necessarily due to broader economic weakness, i.e., change in coal demand and one time rail track service issues. One will need to see confirmation of this point of view as additional data unfolds in the second quarter though.

I thought equity investors were capable of discerning special or one-off events and look beyond, especially in a bull market. It may be that investors other than Horan Capital Advisors have gone through the latest (May) AAR Rail Time Indicators:

Besides coal, commodities showing carload declines in April 2015 from April 2014 include primary metal products (mainly steel, down 16.9%, or 9,256 carloads); grain (down 3.7%, or 3,910 carloads); iron and steel scrap (down 14.4%, or 3,168 carloads); and stone, clay, and glass products (down 7.1%, or 2,941 carloads — cement and ground minerals are the biggest components of this category; crushed stone is not included).

In fact, out of 20 categories, only 5 showed YoY gains in April, down from 8 in March, 11 in February and 18 in January.

Here’s what I wrote May 12:

This last chart from the AAR sums up the situation: manufacturers have produced much more than they shipped in recent months. Given the high correlation, something significant must happen shortly. Either shipments turn up sharply or production stops.

I also included this chart, noting that the Institute for Supply Management’s Purchasing Managers Index (PMI) for New Export Orders declined 3.1% in March, a statistic that tracks with the export drop in March. In April, however, the PMI New Exports Orders rose 8.4 percent, signaling an increase next month.

Beware those “transitory factors”. You may be on the wrong track.

Don’t Count on Happy Returns for U.S. Stocks The fizz is out of the stock market’s Champagne. Money managers widely agree that future U.S. stock gains probably will be limited, simply because stocks have gotten so expensive.

Mr. Kostin, Goldman Sachs Group Inc.’s chief U.S. stock strategist, last week forecast no price gain at all for the S&P 500 over the next 12 months, with the index’s only return coming from dividends. For the coming 10 years he projected just 5% yearly total returns, with nearly half from dividends. That means the index value would rise only about 2.7% a year for a decade. (…)

The short term is complicated by the expected Federal Reserve rate increase, which Goldman forecasts for September. Mr. Kostin projects a small stock gain before rates rise, followed by a choppy period that would leave the S&P 500 a year from now virtually unchanged from Friday’s 2126.06 close. He bases that partly on stock behavior the last three times the Fed started raising rates, back to the early 1990s. (…)

For S&P 500, Expensive Is New Cheap as Bull Market Plods On

With oil’s rebound helping U.S. energy producers recover from a 27 percent plunge, the least-expensive industry in the Standard & Poor’s 500 Index just became banks, where the median company trades at 17.6 times earnings from the past 12 months. That’s no bargain: only once has the cheapest sector commanded a higher valuation, a quarter century of data compiled by Bloomberg and Leuthold Group show. (…)

“Higher P/E stocks don’t frighten me, necessarily, given what stage we’re at in the market cycle,” Peroni, a fund manager at Advisors Asset Management in Conshohocken, Pennsylvania, said by phone. His firm oversees $14.7 billion. “This tends to be the most exciting and rewarding stage of the market anyway.”

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