Edge and Odds

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)

Edge and Odds

Invest with smart knowledge and objective odds

Month: October 2015

NEW$ & VIEW$ (15 OCTOBER 2015): Retail Sales Stronger Than Perceived.

U.S. Retail Sales Figures Mostly Disappoint American consumers increased their spending in September amid strong auto sales, but slowing job growth and overseas turbulence has curbed some discretionary spending.

Retail sales rose a seasonally adjusted 0.1% in September from August, the Commerce Department said Wednesday. The increase was largely due to a 1.8% month-over-month increase in auto sales. Excluding motor vehicles and parts, sales at other retailers were down 0.3% in September. (…)

A few bright spots held: U.S. consumers shelled out 0.9% more on clothing and accessories in September than they did in August, and spent 0.7% more at restaurants and bars than the prior month. Restaurant spending is up 7.9% from September 2014. (…)

Discretionary sales were mixed. Electronics, general merchandise, non-store and miscellaneous witnessed a dip in sales this September. However, furniture, clothing, sporting goods and restaurants all posted solid gains. Nondiscretionary sales (gasoline, health care and food) were all weak. ISI estimates that “real consumer spending, based upon the modest downward revisions in the prior two months, is on track to climb +3.3% in 3Q.”

However, sales in the retail control group, which exclude autos, gasoline, building materials & food services and enter the GDP accounts, slipped 0.1% after a 0.2% August rise. This came after a 0.5% jump in July and a 0.3% gain in June.

There seems to be cause to worry about the consumer economy given the dismal trends in sales of the retail control group:

  • Last 2 months: +0.6% annualized
  • Last 3 months: +2.4% annualized
  • Last 4 months: +2.7% annualized

High five But before panicking and overly worry about weak consumer spending, we must recall that goods are actually deflating in the U.S.. Sequentially, the Goods deflator for the PCE series is down 0.8% since December 2014 and –0.2% in the 3 months to August, the last month the data is available. YoY, Goods prices are –2.8% in August with Durable Goods down 2.8% and Non-Durables –3.0%.

In reality, real retail sales remain pretty strong. Given nominal control group sales up 3.4% YoY in September, they must be up 5%+ in volume as we enter the crucial holidays season. This chart from Doug Short shows the resiliency of control group nominal sales in the face of deflating prices.

Control Sales YoY

If retail sales were as weak as the nominal data suggest,

  • retailers would have reigned in employment rather than keep growing their staff 2.0% YoY through September.
  • there would have been many negative pre-announcements from retailers and other consumer goods companies. Pre-announcements by Consumer Discretionary companies were 18 negative and 5 positive for Q3’15, in line with the previous 2 quarters but much lower than for Q4’14 (24/3) and Q3’14 (21/3). Yesterday’s WMT bomb seems more WMT than economy related.

To be sure, deflating selling prices are challenging when costs keep rising. Higher volume and solid markups are required. This is why it is encouraging that so few consumer centric companies have negatively pre-announced in Q3.

EARNINGS WATCH
  • 38 companies (12.5% of the S&P 500’s market cap) have reported. Earnings are beating by 2.5% while revenues have missed by -0.6%.
  • The beat rate is 68% on EPS (70% yesterday) and 39% on revenues (40%).
  • Expectations are for a decline in revenue, earnings, and EPS of -3.6%, -5.3%, and -4.1%. Ex-Energy, these would be +1.8%, +1.9%, and +3.2%. This excludes the likelihood of beats, which have been above 4% over the past three years.
  • BTW, 9 Consumer Discretionary companies have reported so far. Their revenues grew 6.2% and their EPS 13.7%. (RBC)
U.S. Business Inventories Remain Unchanged

Total business inventories held steady during August (2.4% y/y) for a second month. Revisions to the July figures were minimal. These figures suggest inventories will have little effect on real GDP growth this quarter as in Q2.

Retail inventories increased 0.3% (4.5% y/y) in August, after a 0.7% jump. Motor vehicle & parts inventories advanced 0.2% (6.0% y/y). Outside of the vehicle sector, inventories gained 0.4% (3.7% y/y) paced by a 0.7% rise (6.4% y/y) in building materials. Elsewhere, increases were moderate. Furniture & home furnishings inventories gained 0.4% (-0.7% y/y) while clothing & accessory inventories also rose 0.4% (6.2% y/y). (…)

The business sector inventory-to-sales ratio inched higher to 1.37, equaling its highest level since June 2009. The rise reflected increases in each business sector. The merchant wholesale I/S ratio rose to 1.31, its highest level since early 2009. Retailers’ I/S ratio gained to 1.47, equaling its high for the economic recovery. In the manufacturing sector, the I/S ratio rose to 1.35. It has moved roughly sideways all year, staying near the recovery high.

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We sure need the consumer!

U.S. Producer Price Decline Is Broad-Based

large imageThe overall Final Demand Producer Price Index fell 0.5% in September (-1.1% y/y) following an unrevised zero change in August. It was the first decline since April. Prices excluding food & energy also fell 0.3% (+0.8% y/y) and reversed a 0.3% increase.

Final demand goods prices (35% of the total index) fell 1.2% (-5.1% y/y), down for the third straight month. The latest decline was led by a 5.9% drop (-23.7% y/y) in energy prices. Gasoline prices were off 16.6% (-42.8% y/) and home heating oil prices fell 6.5% (-44.1% y/y). Residential natural gas prices reversed most of the prior month’s gain and declined 1.1% (-11.8% y/y) and residential electric power costs eased 0.1% (+1.0% y/y). Food prices declined 0.8% (-2.9% y/y), off for the second time in three months. Egg prices have been quite volatile and fell 18.2% m/m, but they have risen by roughly three quarters y/y. Beef & veal prices fell 7.9% (-3.3% y/y) while bakery product prices gained 0.1% (1.1% y/y). Fresh & dry vegetable costs rose 14.7% y/y, but dairy product costs were off 15.0% y/y.

Final demand goods prices excluding food & energy remained stable (0.2% y/y) after falling 0.2% in August. Core finished consumer goods rose 0.2% (2.6% y/y) after two months of remaining unchanged. Core consumer nondurables costs improved 0.2% (3.4% y/y), following two months of no change or slight decline, but consumer durables rose 0.3% (1.6% y/y). Private capital equipment costs improved 0.1% (1.3% y/y) while those for goods for government purchase declined 0.2% (-0.1% y/y). Prices of goods for export fell 0.5% (-3.6% y/y), down for the third straight month.

Final demand services costs (63% of the total index) declined 0.4% (+1.0% y/y) and reversed the August increase. This was led by trade services, which fell 0.4% (+2.1% y/y); trade services represent the margins charged by retail and wholesale dealers and merchants. Prices for transportation of passengers fell 1.8% (-6.6% y/y), repeating their August weakness. Prices for transportation and warehousing of goods in September also repeated the prior month’s 0.3% decline (-2.4% y/y). Other services, including financial, health care and communications, among others, fell 0.3% (+1.0% y/y) after a 0.2% rise.

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Fed Doubts Grow on 2015 Rate Increase The chances of a Fed rate increase in 2015 are diminishing amid new signs of anemic economic activity, a disappointing development for central-bank officials who have been hoping to move this year.

Lackluster readings on consumer spending, inflation and jobs have virtually eliminated the chances of a move this month. (…)

Still, the soft retail and inflation reports won’t inspire much confidence among Fed officials, especially a couple of weeks after the Labor Department reported the pace of hiring slowed in September and was weaker than first thought in July and August. U.S. exports are also now on track to decline this year for the first time since the recession. (…)

China Credit Growth Rebounds as Monetary Easing Spurs Loans

Aggregate financing rose to 1.3 trillion yuan ($205 billion), from an originally reported 1.08 trillion yuan in August, according to a report from the People’s Bank of China. (…)

New yuan loans rose to 1.05 trillion yuan, compared to a median estimate of 900 billion yuan in a survey of economists. M2 money supply increased 13.1 percent from a year earlier, matching economists’ median forecast.

China monetary conditions index started to show a rebound since July.

SENTIMENT WATCH
Wal-Mart Surprises Market With Dim Outlook Retailer’s shares sink 10% after it predicts profit decline next year

Wal-Mart Stores Inc. surprised investors Wednesday by predicting profits would drop as much as 12% next year as the world’s biggest retailer by revenue spends heavily to increase wages, improve its cavernous stores and boost online sales.

Wall Street analysts were expecting per-share earnings to be flat or rise as much as 7% from this year.

The company’s leaders, who are in the process of revamping its stores to lure back disaffected shoppers, also warned that they now expect sales growth for the current fiscal year, which ends Jan. 31, to be relatively flat. In February, the company had projected sales growth of 1% to 2%. (…)

Weak Pricing, Pulled Deals Define IPO Market In a clear sign of trouble, supermarket chain Albertsons delayed its plan to sell stock, while payment processor First Data priced its offering lower than its bankers had expected.
There’s a Growing Divide at the Fed, and It’s Time to Brace for Higher Volatility

Despite all the debt ceiling drama, Neil Dutta, head of U.S. economics at Renaissance Macro, says the Federal Reserve has supplanted Congress as the biggest source of policy uncertainty emanating from the nation’s capital. (…)

BlackRock warns of market volatility Fink says new paradigm will produce ‘big winners and big losers’

Larry Fink, chief executive of the world’s largest asset manager, BlackRock, warned that financial market volatility will continue until the Federal Reserve clarifiesmonetary policy. (…)

“There is so much uncertainty in the world and that is leading to more volatility,” Mr Fink said, blaming the conflicting signals from Fed governors on the timing of an interest rate rise. “Some of the official authorities are guilty of, instead of being a calming influence, through their mixed messages, inflaming the markets.” (…)

“We do not have a world where the tide is rising for everybody,” he said. “We are in a new paradigm where there will be big winners and big losers. Countries still focusing on the paradigm of cheap labour and commodities are going to have a harder time.” (…)

Dollar at two-month low as Fed easing whispers start

Having obsessed for months about when U.S. interest rates will start to rise, traders began thinking that maybe, just maybe, they might have to fall again, given limp U.S. retail sales, the biggest producer prices falls in eight months and a $22 billion hammering for the world’s biggest retailer Wal-Mart. (…)

NEW$ & VIEW$ (14 OCTOBER 2015): China, Fed, Earnings.

China Inflation Eases, Pressuring Beijing for More Stimulus

According to National Bureau of Statistics data released Wednesday, China’s consumer-price index rose 1.6% in September from a year earlier, slower than a 2.0% rise in August. (…)

A high-base comparison with year-earlier figures and nearly flat pork prices after a series of sharp monthly increases over the summer helped reduce consumer inflation, official data showed. (…)

Non food prices climbed 1%. Prices of consumer goods increased 1.4%, while services increased 2.1%.

Yu Qiumei, an economist with the statistics agency, said in a statement that food prices declined 0.1% from a month earlier in September while nonfood prices increased 0.2%. (…)

China’s producer-price index dropped 5.9% in September from a year earlier, in line with expectations and matching a drop in August. (…)

According to the People’s Bank of China, loan demand in the manufacturing sector fell to 49.3 in the third quarter, the first time it has been below 50 since the central bank started releasing the data in 2004. This compares with 53.1 in the second quarter of 2015 and 59.3 in the third quarter of 2014.

Rich Nations Lose Emerging-Markets Motor New weakness in China’s economy heightens concerns that developing countries are weighing on rich ones

(…) “It’s clear that the slowdown in emerging markets is having an impact on developed markets,” said Adam Slater, a senior economist at Oxford Economics in London. “Emerging markets have been a very positive force for world growth over most of the last 10 years, and now the big contribution is dropping away.”

New evidence is emerging that developing countries are buying fewer capital goods and higher-end products from richer countries. In addition to China’s announcement that its consumer-price index rose just 1.6% in September from the same period a year earlier, Indonesia, Southeast Asia’s largest economy, imported 16% fewer goods for its factories in the year through August.

Such grim data is reflected in the eurozone, which on Wednesday blamed a fall in industrial output in August on large developing economies such as China; in Germany, which this month announced a surprise fall in manufacturing orders in August and the lowest exports in seven years; in Japan, whose factory output was weaker than expected in the same period; and in the U.S., where exports for that month were their smallest since 2011. (…)

Emerging markets increased their share of manufacturing and exports to 52% of global gross domestic product compared with 38.3% just 15 years ago, according to Oxford Economics.(…) Minutes from the European Central Bank’s governing council meeting in September reveal lower GDP growth forecasts for the euro area: to 1.4% this year and 1.7% in 2016 from 1.5% and 1.9% three months ago. The bank said the revised outlook in part “reflected lower external demand owing to weaker growth in emerging markets.” (…)

While China accounted for 10% of world trade from 2000 to 2014, it contributed 15% to global growth, according to Oxford Economics. In that time, Brazil, India and Russia combined accounted for 15% of world trade and contributed 23% of its growth. (…)

Punch It’s all relative. From a U.S. perspective, exports, and exports to China, remain relatively less consequential:

The Russian government is debating whether to place limits on how much the rouble is allowed to strengthen against the US dollar in order to reduce the economy’s reliance on oil, gas and metals, according to a senior government official.

The proposal is part of a broader discussion among Moscow’s economic policymakers over how to use the pressures of the extended economic slump brought on by low oil prices and western sanctions to force through long-delayed structural reforms and boost export competitiveness.

“In case the economy weakens, the rouble can fall freely and we will not intervene. But in the course of at least two to three years, it cannot strengthen more than, for example, 55 or 50 to the [US] dollar,” said a senior official. (…)

Most Fed Regional Boards Favored Discount-Rate Rise in September The boards of directors at eight of the 12 regional banks in the Federal Reserve system voted last month in favor of increasing the rate for direct loans from the Fed to 1 percent from 0.75 percent, according to details released by the U.S. central bank on Tuesday.

Divisions have burst into the open at the top of the Federal Reserve over when to lift interest rates, casting a fresh cloud of uncertainty over the US central bank’s strategy for withdrawing its monetary stimulus.

In the past two days, two members of the US Federal Reserve board have signalled they are opposed to a near-term increase in interest rates, questioning the approach adopted by chair Janet Yellen amid divisions over the outlook for inflation.

Daniel Tarullo said in a CNBC interview on Tuesday that his current expectation was that it was not appropriate to raise rates this year, joining fellow governor Lael Brainard in favouring a wait-and-see approach. (…)

The interventions further cloud muddy communications from the Fed about the policy outlook, at a time when investors have been calling for a sense of where the Fed is heading. Given the divisions in the central bank, however, there is a risk of further confusion in the weeks ahead.

  • Fed officials universally accepting slowing payroll growth

While views on the appropriate path of policy have varied, Fed officials seem to be in the process of providing reassurances to the market that even if payroll growth slows from here it will not be a cause for concern. On Friday, Dudley and Lockhart promoted the narrative that even if jobs ease back a bit (to something resembling the more recent NFP prints) it is still more than enough to absorb the growth in the labor force. Even the uber-dovish Evans noted employment is not worrying him and the long-run sustainable payroll growth rate is south of 100k. Vice Chair Fischer chimed in over the weekend, and Williams and Bullard have made similar comments in recent days.

So what that means is this view seems to be held across the full dove/hawk spectrum. In our view, this is likely part of an effort to lift expectations regarding a December liftoff. This all goes back to the idea that if they truly want to start the tightening process at yearend— keep in mind we think by then they will already be 6 months late to the tightening party—they are going to have to sell the idea very hard. (RBC Capital)

  • BULLARD: SUB-200K PAYROLL GAINS MAY BECOME THE NORM IN NEXT FEW YRS
  • DUDLEY: 120-150K JOBS/MONTH ENOUGH TO PUSH U/E RATE DOWN
  • EVANS: LONG-RUN SUSTAINABLE JOBS GROWTH TO BE SUB-100K/MONTH
  • FISCHER: SLOWER RECENT JOBS GROWTH STILL ENOUGH TO ERODE SLACK
  • LOCKHART: RECENT JOB GAINS STILL MORE THAN ENOUGH TO ACCOMMODATE TREND GROWTH IN LABOR FORCE
  • WILLIAMS: JOB GAINS STILL SIGN ECONOMY IMPROVING, 100-150K “WOULD BE GOOD TO ME”
    Source: RBC Capital Markets US Economics, Bloomberg, MNS
Mounting Full-Time Employment Shows Less Slack for Yellen’s Fed

(…) The number of Americans working part-time for reasons related to the economy dropped by 447,000 in September from the prior month to 6.04 million, the fewest since August 2008, according to figures from the Labor Department. The level has dropped by a little more than 1 million over the past 12 months. (…)

The Federal Reserve Bank of Atlanta has put together a gauge that attempts to better estimate sluggishness in the labor market. The so-called Z-Pop ratio measures the share of the working-age population putting in full-time hours, working less than a full week by choice or not wanting to work at all.

The share of people who are content with their labor market status is on the rise, in part because of the decline in involuntary part-time work. About 92 percent were fully utilized or satisfied with their employment status in September. The remaining 8 percent were counted as under-utilized.

The ratio is “consistent with a tightening labor market,” John Robertson, an Atlanta Fed economist who’s worked on the project, said in an e-mail.

The Z-Pop ratio is closer to pre-recession levels than other measures, including the share of the working-age population with jobs, and also shows more marked improvement in recent months.

Gauges such as the employment-population ratio are being damped by the exodus from the workforce of retiring baby boomers, which is less related to the state of the economy. (…)

EARNINGS WATCH
  • 30 companies (9.0% of the S&P 500’s market cap) have reported. Earnings are beating by 2.9% while revenues have missed by -0.9%.
  • The beat rate so far is 70% on EPS and 40% on revenues.
  • Expectations are for a decline in revenue, earnings, and EPS of -3.6%, -5.3%, and -4.2%. Ex-Energy, these would be +1.8%, +1.9%, and +3.1%. This excludes the likelihood of beats, which have been above 4% over the past three years.
  • Yesterday JP Morgan reported a $1.0 billion litigation cost, a 40 bps drag on S&P 500 earnings growth. (RBC Capital)
CLSA Just Stumbled On The Neutron Bomb In China’s Banking System

(…) According to CLSA estimates, Chinese banks’ bad debts ratio could be as high 8.1% a whopping 6 times higher than the official 1.5% NPL level reported by China’s banking regulator!

As Reuters reports, the estimate is based on analysis of outstanding debts for more than 2700 A-share companies (ex-financials) and their ability to repay loans. Or in other words, if one backs into the true bad debt, not the number given for window dressing purposes by Chinese “regulators”, based on collapsing cash flows, what one gets is a NPL that is nearly 10% of all outstanding Chinese debt.

Reuters has some more details on the methodology:

  • Two consecutive years of a co’s interest coverage (EBITDA/interest expense) below 1x or losses for two successive years qualifies for debts to be treated as “bad” in CLSA’s analysis.
  • By these measures, wholesale & retail and manufacturing sectors boast the highest implied NPLs at 21.1% and 15.8% respectively, taking into account total debt
  • While China’s real estate sector has been the most aggressive in adding debt, profitability at developers in tier-1 cities has held up well, muting the overall NPLs for the sector
  • Developers in tier-2 and tier-3 cities, however, show high implied NPLs
  • As bad debts rise, burden falls on PBOC to ensure sufficient liquidity so that Chinese banks can gradually absorb the credit costs, CLSA says.

Yes, the PBOC’s burden most certainly rises, and what a burden it is: here’s why.

The chart below shows the history of total Chinese bank assets: as of the latest official data, the number is roughly $30 trillion.

If one very conservatively assumes that loans are about half of the total asset base (realistically 60-70%), and applies an 8% NPL to this number instead of the official 1.5% NPL estimate, the capital shortfall is a staggering $1 trillion.

In other words, while China has been injecting incremental liquidity into the system and stubbornly getting no results for it leading experts everywhere to wonder just where all this money is going, the real reason for the lack of a credit impulse is that banks have been quietly soaking up the funds not to lend them out, but to plug a gargantuan, $1 trillion, solvency shortfall which amounts to 10% of China’s GDP!

Omega Advisors’ Leon Cooperman: 7 Thoughts About the Markets