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: March 2016

NEW$ & VIEW$ (29 MARCH 2016):

Pending-Home Sales Jumped 3.5% in February The number of existing homes that went under contract in the U.S. rose in February, a sign of steady momentum for the housing market.

An index measuring pending home sales—a gauge of purchases before they become final—jumped 3.5% to a seasonally adjusted reading of 109.1 in February, the National Association of Realtors said Monday. That was the highest level in seven months. January’s reading was revised down to 105.4 from an initially reported 106.0.

“Steady momentum”? MoM: Dec: +0.9%, Jan: –3.0%, Feb: +3.5%.

YoY in Feb: +0.7% nationwide. NE: +12.6%, Midwest: +2.5%, South: –0.4%, West: –6.2%. (Chart from Haver Analytics)

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Growing labour force belies grim US mood Increasing evidence of a tightening jobs market

(…) Economists at the International Monetary Fund predict that recent gains in the participation rate, which measures those in work or actively looking for a post, are set to continue for a little while longer, rising from the current 62.9 per cent to above 63 per cent in the coming months as the jobs market strengthens.

“It’s part of a cyclical move towards a truly tight labour market. We’re not there yet, but this is the final piece in the puzzle,” said Stephan Danninger, a Washington-based division chief at the IMF. (…)

The period from September 2015 to February 2016 saw the US labour force grow by just over 2m workers, the largest five-month increase since 2000, according to Joseph LaVorgna, an economist at Deutsche Bank. (…)

Mr Danninger said that new people coming into the labour market on average get paid less than those already active, which may be helping suppress wage growth. Once that damping effect has played its course — potentially towards the end of the year — wage pressures could pick up. (…)

Japanese Retail Sales Plunge Most Since 2010

4th monthly decline in a row and absent the tsunami and tax-hike reaction, this is the worst drop since Dec 2010…

WORLD ECONOMY
SENTIMENT WATCH
The Markets Have a Message: Don’t Believe This Rally

(… Some of the highest-risk assets chalked​up spectacular gains​during the recovery. The J.P. Morgan Emerging Markets Currency Index rose 8%, a gain matched in such a short time only once since the index was created in 2000. U.S. junk bonds leaped 8% in price, the biggest jump in the Bank of America Merrill Lynch benchmark over such a short period since the summer of 2009, when the country was just emerging from recession.

U.S. shares didn’t miss out. From its February low, the S&P 500 recorded its biggest gain over an equivalent period since late 2011, rising more than 12% by the middle of last week; it is still up 11%.

Commodity prices, which started to rebound a couple of weeks earlier, have had their biggest rise over an equivalent period since late 2010.

Traders talk of “risk on” times, and the past six weeks rank as one of the biggest risk-on rallies since the global financial crisis.

Yet the picture isn’t one of wild risk-taking, whatever the headlines appear to suggest. Three of the traditional safe assets to which investors fled in January and early February haven’t fallen back as risky assets gained.  The yen, gold and the Swiss franc remain elevated compared with the start of the year, and while they have fluctuated, they are almost as strong as on Feb. 11, the day equities and credit hit their trough.

This is unusual, to put it mildly. Safe assets normally move in the opposite direction to risky assets, as investors switch between fear and greed. U.S. Treasury bonds, another safe asset, have sold off, but by much less than risky assets rose. Yields on the 10-year bond, which rise as prices fall, are up 0.24 percentage point from their low, to 1.87%.

How do these signs of fear square with the stunning rise in equities and emerging markets? Put simply, this has been a misery bounce driven by stronger commodities. It isn’t a rebound to enthuse investors.

Worries have changed, rather than gone away. In February, investors feared recession, deflation, Chinese devaluation, falling profits, excessive emerging-market debt and corporate defaults due to cheap oil. More expensive oil assuaged some of these concerns and prompted a repricing of commodity-linked assets and of inflation-linked assets. That boosted emerging markets, junk bonds and mining stocks, while prompting a flood of cash out of money-market funds.

Consider mutual-fund flows. Cash has poured back into junk-bond funds, emerging-market equity and debt funds, and commodity funds, according to tracking by EPFR Global.

There were government-bond outflows, but almost all of it has been due to a rotation into equally safe inflation-linked government-bond funds.

Within the equity market, the safest, most boring utilities have led the market up. Smaller companies, which almost always outperform in a rising market, have done much less well than usual. The U.S. Russell 2000 index of smaller company shares still is down about 5% this year, even as larger companies stand pretty much where they started January.

Concerns also are evident in the options market, where traders can use put options to protect against share prices falling, or call options to profit from rising shares. The ratio between the two is often watched as a measure of speculators’ willingness to take risk—and indicates far more caution than usual.

The message from the markets is that investors don’t really believe in the rally.

This could be seen as great news for the contrarian. Markets climb a wall of worry, and there still are plenty of concerns out there that can be overcome, helping prices higher.

The best bets on this view are those that lagged behind during the rebound, such as financial or luxury-goods stocks—but given the fear, don’t expect a smooth ride.

Just last week, there were these:

Bloomberg this am:

Barclays Plc is cautioning that commodities including copper and oil are at risk of steep declines, saying that an investor rush for the exits could cause prices to tumble. With signs of investors already becoming wary of the recent rally in copper and data showing that the latest oil rally is not gaining fans, there may be something to the warning.

The Economist:

Big, getting bigger: China’s M&A boom

What do hotel chains, film-makers and semiconductor firms have in common? If they are for sale, Chinese companies want to buy them. Anbang, a Chinese insurer, raised its bid for Starwood Hotels & Resorts to $14 billion yesterday. Globally, merger-and-acquisition volumes are down by roughly 25% in the first quarter from a year earlier. But China’s appetite is insatiable: its spending has more than tripled to $100 billion, accounting for one-third of cross-border M&A announced this year. Slower growth at home and the yuan’s depreciation have boosted the appeal of foreign assets. The bigger story is that Chinese companies have long punched below their weight in global investment, focusing mainly on commodities. They are now ranging more widely, buying high-tech firms and consumer brands. They also tend to offer juicy prices, partly thanks to support from state-owned banks. Global regulators fret about security risks. Sellers, though, are not complaining.

EQUITIES: BACK TO 2 STARS

Factset’s weekly earnings summary:

In terms of estimate revisions for companies in the S&P 500, analysts have made higher cuts than average to earnings estimates for Q1 2016 to date. On a per-share basis, estimated earnings for the S&P 500 for the first quarter have fallen by 9.3% since December 31 (to $26.42 from $29.13). This percentage decline is already larger than the trailing 5-year average (-4.0%) and trailing 10-year average (-5.3%) for an entire quarter.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings decline for Q1 2016 is -8.7% today [-8.4% last week], which is below the expected earnings growth rate of 0.3% at the start of the quarter (December 31). Seven sectors are projected to report a year-over-year decline in earnings, led by the Energy, Materials, and Industrials sectors. Three sectors are predicted to report year-over-year earnings growth, led by the Telecom Services and Consumer Discretionary sectors.

If the Energy sector is excluded, the estimated earnings decline for the S&P 500 would improve to -3.9% [-3.7% last week] from -8.7%.

As a result of downward revisions to sales estimates, the estimated sales decline for Q1 2016 is -1.1% today, which is below the estimated year-over-year sales growth rate of 2.6% at the start of the quarter. Five sectors are projected to report year-over-year growth in revenues, led by the Telecom Services and Health Care sectors. Five sectors are predicted to report a year-over-year decline in revenues, led by the Energy and Materials sectors.

If the Energy sector is excluded, the estimated revenue growth rate for the S&P 500 would jump to 1.8% [1.9% last week] from -1.1%.

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In addition, a higher percentage of S&P 500 companies have lowered the bar for earnings for Q1 2016 relative to recent averages. Of the 119 companies that have issued EPS guidance for the first quarter, 93 have issued negative EPS guidance and 26 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 78% (93 out of 119), which is above the 5-year average of 73%.

Only one additional negative guidance in the last week. Fingers crossed

Thomson Reuters’ tally gives 24 positive guidance so far this quarter, up from 5 at the same time last year but down 5 from the same time in Q4’15. Negative guidance totals 95 so far in Q1’16, down 1 from last year but up 5 from Q4’15.

TR estimates that Q1’16 EPS will decline 6.9% YoY (–6.7% one week ago).

The S&P 500 Index is sitting 0.6% above its 200-d. m.a. (2018) which is still declining.

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The high yield market has calmed down as commodity prices firmed up and perceived recession risks have diminished.

The credit risk premia for sectors outside of commodities falls under the historical average of 582 bp, implying a somewhat positive outlook. Though the overall high yield spread is still well above the 323 bp cycle low set in mid-2014, current bond prices support projections for modestly positive sales and profit growth. During the previous credit cycle downturn, it was only after profits broadly shrank throughout 2007 that the business outlook turned negative across a wide range of industries amid an extended recession. (Moody’s)

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We have been having a volatile but sideways equity market over the last 24 months. Why?

  • The earnings backwind has disappeared. We now have it on the nose.
  • Inflation has gone up, hurting P/E ratios.
  • Central banks are short of ammo and the Fed wants to walk away…
  • The economy provides little hope for much better days which could help offset the above.

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Although there are many reasons experts give for why U.S. equities have remained range-bound for so long, the Deutsche Bank team finds the argument for the persistent negative data surprises as especially compelling. They said that the negative data surprises have stretched on for what has become the longest period ever recorded.

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And although the data surprises did climb from negative into neutral multiple times over the last 15 months, pushing U.S. stocks to the top of the range, every time they did, a shock roared through the markets, dragging them right back down again. (Valuewalk)

Hmmm…we sure need the consumer to consume! But today’s PCE data are disheartening. Consumers just continue to save their energy savings.

Meanwhile, this equity market is not very appealing:

  • Equity valuations, though not excessive, are not cheap.
  • Earnings are trending down.
  • Inflation is trending up.
  • Interest rates are trending up, that is unless the economy trends lower…
  • The economy has no solid momentum.
  • The Fed wants to step aside…
  • …With nothing really happening on the fiscal side.
  • Technicals are not strong.
    • The 200-d. m.a. is still falling.
    • The recent rally has been weak overall.
    • Nearly half of the NYSE common stocks are still in down 20% or more from their 52-w highs.

This latest rally is running out of fuel. I don’t like this volatile rating but I am nevertheless retreating back to 2 stars.

More earnings risks:

A global crackdown on tax avoidance has forced a surge of warnings by multinational companies that higher payments are set to hit their earnings.

A Financial Times analysis of company filings revealed that more than twice the number of US companies alerted investors to the risk of higher taxes in their 2015 accounts than a year earlier.

Nearly a fifth of the 136 US companies sounding an alert were technology companies such as LinkedIn and Yahoo .

Tax structures that were once used to maximise returns to shareholders risk becoming a liability as governments close loopholes to raise revenues and respond to public anger over aggressive avoidance. (…)

Nearly £1bn a year will be shaved from corporate earnings in the UK alone after the government announced last month that tax breaks on interest costs would be cut.

Other global anti-avoidance initiatives include a crackdown on the “double Irish” structures used to shift corporate profits from low-tax Ireland to a zero tax country such as Bermuda. Countries such as France are also looking to force tech companies to pay tax on business from foreign-based entities.

A third of the US warnings came from companies in the pharmaceuticals, insurance and asset management sectors, including private equity businesses such as KKR, Blackstone and Carlyle. (…)

European companies have also stepped up their warnings on tax issues.

New reporting rules were highlighted as a potential threat by companies including Syngenta, a Swiss agribusiness. It said greater transparency on the allocation of taxable profits, “may lead governments to restrict or disallow currently legitimate and accepted tax planning strategies”.

Just eight out of the 29 tech companies citing Beps-related risks had issued similar warning in the previous year. Even so, some companies have long noted the possibility of tax problems in the “risk warnings” sections of their accounts. Google has included a warning that tax outcomes could “materially” affect financial results in its accounts for at least the last 10 years.

Priceline, the online travel company, has expanded its tax warnings sixfold in the last five years. Its latest accounts use 2,700 words to set out a series of challenges, including a claim by the French tax authority that its subsidiary Booking.com has a permanent establishment in France. (…)

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