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: December 2016

THE DAILY EDGE (7 December 2016)

Surprised smile Economic confidence in the US is at multi-year highs. (The Daily Shot)

  • Investors Business Daily Economic Optimism Index:
  • Gallup Economic Confidence Index (as of December 5th):

Gallup adds:

The recent increase in economic confidence appears mostly to be a reaction to the presidential election — chiefly among Republicans, who are much more likely to view the economy positively after Donald Trump’s victory. Republicans have shifted dramatically from a decidedly negative evaluation of the economy before the election to a positive one after it.

Economic Confidence Index, by Political Party, Recent Weekly Averages

  • The Trump Trade is alive and well, with banks and small caps continuing to outperform.
  
U.S. Productivity Rose at 3.1% Rate in Third Quarter The cost of labor in the U.S. grew more quickly than previously thought in the spring and summer, the latest sign that Americans’ wages are picking up.

(…) But the government made big revisions to unit labor costs, a measure of the expense imposed on firms to compensate workers for their output. Such costs grew at a 0.7% rate in July through September, more than double the agency’s initial estimate of a 0.3% gain. (…)

Unit labor costs grew at a 6.2% pace in the second quarter, up from the prior estimate of a 3.9% increase. (…)

Before the third quarter, productivity had declined for three consecutive quarters. Productivity was flat in the third quarter compared with a year earlier. From 1947 to 2015, productivity grew an average 2.2% a year. (…) (Table from Haver Analytics)

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U.S. Factory Orders Surge as Aircraft Soars

Manufacturing sector orders jumped 2.7% during October (1.3% y/y) following a 0.6% September gain, revised from 0.3%. Durable goods bookings increased 4.6% (1.8% y/y), revised from the advance estimate of a 4.8% rise. Transportation orders increased 12.0% (5.1% y/y) as orders for nondefense aircraft & parts nearly doubled m/m (26.3% y/y).

Orders outside of the transportation sector increased 0.8% (0.5% y/y).

Unfilled orders increased 0.7% (-1.1% y/y) after three straight months of 0.2% decline. Outside of transportation, order backlogs improved 0.2% (0.7% y/y).

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High five However, after removing defense and aircraft orders (which tend to be volatile), the situation isn’t as rosy. On a year-over-year basis, capital goods orders and shipments continue to languish. (The Daily Shot)

Home Construction Loan Volume Picks Up the Pace

The volume of U.S. home construction loans grew at the fastest rate in more than two years in the third quarter, according to federal data, a sign that tight postrecession lending conditions might be easing for home builders. (…)

Access to capital has been especially difficult for small private builders, who are responsible for nearly two-thirds of single-family home construction across the country. (…)

The latest quarterly data on home construction loans studied by the NAHB shows that the volume of outstanding loans increased by 4.8% in the third quarter, to $68.3 billion. That marks 14 consecutive quarters of growth for such loans.

A separate NAHB survey of builders and developers found that credit conditions were improving last quarter, with 23% of those surveyed reporting easing credit conditions and 71% saying conditions remained about the same. (…)

U.S. Trade Deficit Widened Sharply in October The U.S. trade deficit widened sharply in October as exports weakened following a summer surge, and imports jumped, setting up a likely drag on overall economic growth in the final months of 2016.

The trade gap for goods and services surged 17.8% from a month earlier to a seasonally adjusted $42.6 billion in October, the Commerce Department said Tuesday. That was the steepest one-month rise since March 2015, and took the deficit to its highest level since June. (…)

Exports fell 1.8% from September, the largest drop since January, and imports rose 1.3% in October. The fall in exports included declining shipments of soybeans, corn and consumer goods while the import rise included stronger domestic demand for foreign-made pharmaceuticals, cellphones and capital goods.

On a non-seasonally adjusted basis, imports from China and Mexico hit their highest levels in a year. Exports to China were the most since December 2013 and exports to Japan were at the highest level since August 2014. (…)

Exports during the first 10 months of the year were down 3.1% from the same period in 2015, and imports declined 2.9% year-to-date, according to Tuesday’s report. (…)

TRUMP CARDS

The Trump story has been remarkable, not really on its impact on the bull and bear population, but mainly on the denizens of the “correction camp” as these Yardeni charts illustrate. Bullish investors (per Investors Intelligence) are back at their usual high number of hopefuls but they have been joined by a significant number of short-term nervous willies who suddenly decided that the odds of a correction vanished the morning of November 9. That has left the few bears still growling with barely anybody to share any notion of cautiousness on the forthcoming renewal of American Greatness.

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Factset tells us that during the first two months of the fourth the Q4 bottom-up EPS estimate for the S&P 500 Index dropped by 2.0% (to $30.91 from $31.55).

During the past year (4 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 3.8%. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 3.4%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 3.9%. (…)

One of the sectors contributing to the below average decline in the bottom-up EPS estimate for the S&P 500 over the past two months is the Information Technology sector. This sector has recorded an increase in the bottom-up EPS estimate of 0.8% (to $13.26 from $13.15) during the first two months of the quarter. This 0.8% increase is well above the average decline of 4.0% over the past year and the average decline of 3.6% over the past five years in the bottom-up EPS estimate for this sector during the first two months of the quarter. (…)

The Energy sector has recorded the largest increase in expected earnings growth since the start of the quarter (to 3.4% from -1.3%). (…)

Of the 108 companies that have issued EPS guidance for the third quarter, 73 have issued negative
EPS guidance and 35 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68% (73 out of 108), which is below the 5-year average of 74%.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings growth rate for Q4 2016 is 3.3% today. On September 30, the expected earnings growth rate was 5.3%. (…)

Analysts currently expect earnings and revenue growth to continue in 2017.
For Q1 2017, analysts are projecting earnings growth of 11.5% and revenue growth of 8.0%.
For Q2 2017, analysts are projecting earnings growth of 10.7% and revenue growth of 5.7%.
For all of 2017, analysts are projecting earnings growth of 11.4% and revenue growth of 5.7%.

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On the Rule of 20, the only positive is that the Rule of 20 “fair value”, which reflects trends in trailing earnings and inflation (yellow line below) has bounced back after reaching a 12-month low in July, thanks to a 2.9% rise in trailing EPS and stable inflation.

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Based on Q4’16 estimates, trailing earnings could reach $118.19 (TR) by mid-March. The Rule of 20 P/E is thus 20.8x trailing EPS three months hence. This elevated number leaves little room for a strong upward move unless investors get so giddy to venture higher into overvalued territory. There have been 17 major market peaks since the Great Depression. The average Rule of 20 P/E at these peaks has been 21.7 (median 22.0).

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Here are other ways to look at the risk/reward ratio at this point:

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With such poor odds, Mr. Market better have solid trump cards in his hand.

If you prefer more conventional valuation measures, Goldman has them lined up in this table:

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Corporate insiders don’t seem to trust their own hand as they see it.

(…) A total of 3,500 insiders at Russell 3000 companies have unloaded their own stock in the last three weeks, while 467 purchased shares, according to data from The Washington Service, a Bethesda, Maryland-based provider of insider trading data and news. The number of sellers was higher than the monthly average of 1,832 sellers this year through October. Sellers have also increased from the comparable year-ago period, and buyers have decreased. (…)

Insider buying and selling doesn’t necessarily presage gains or declines in a given firm’s shares, of course. But Wall Street watches the data because insiders are understood to have the best information about their companies’ prospects, and are also typically veterans of their industries with longer-term horizons.

While they have historically tended to sell more than buy, their behavior since the election diverges from investors, who have exhibited a rapid shift in sentiment and poured money into equities. (…)

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“The big increase in insider selling makes sense because we’ve been making all-time market highs,” said Aaron Jett, the Los Angeles-based vice president of global equity research at Bel Air Investment Advisors, which oversees about $8 billion. “A huge portion of their wealth could be tied up with that one stock so they could want to sell to diversify.”

It is normal for executives to sell into market strength, according to Mr. Jett. That said, a prolonged period of outsize selling by insiders would be concerning, he noted.

(…) in the last month, 891 insiders of U.S. financial companies sold shares, compared with 425 executives who added, data from The Washington Service show.

Both Mr. Clissold and Mr. Jett said it is more valuable to pay attention to a pickup in executive buying rather than selling, since sales can occur for personal, idiosyncratic reasons, while stock purchases tend to indicate confidence in the company. (…)

Punch Where the big increase in insider selling makes much less sense is that it is occurring at the end of 2016:

  1. why not wait just a few weeks to defer tax payments by 12 months to April 2018?
  2. why not wait just a few weeks to potentially avoid the 3.8% Obamacare’s net investment income tax which the Trump camp wants to eliminate?
  3. why not wait just a few weeks to potentially benefit from lower capital gains tax rates promised by Republicans?

Insiders’ use of the trading window following quarterly earnings reports has been rising as the year progressed. Sellers steadily increased while buyers became fewer and fewer. Note that the November data on the chart only includes trades after the election.