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 2017

THE DAILY EDGE (3 March 2017)

U.S. Jobless Claims Lowest Since March 1973 The number of Americans applying for unemployment benefits fell to the lowest level in 44 years last week, more evidence of a healthy labor market.
March Rate-Hike Odds Rise in Shadow of Tepid Data

“We’re as close to our mandates as we’ve been in a very long time. The case for a rate increase in March has come together, and I do think it’s on the table for discussion.” — Federal Reserve Governor Jerome Powell

But:

Eurozone economic growth near six-year high as rates of expansion accelerate across ‘big-four’ nations

Growth of eurozone economic output accelerated to a near six-year record in February. At 56.0, up from 54.4 in January, the final Markit Eurozone PMI® Composite Output Index rose to a 70-month high and was unchanged from the earlier flash estimate.

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Output growth was led by the manufacturing sector. Improved inflows of total new orders and new
export business drove the rate of expansion in manufacturing production to its highest since April
2011. Growth momentum also strengthened in the service sector, with business activity rising to the
greatest extent for over five-and-a-half years.

(…) All of the ‘bigfour’ economies reported stronger increases in output. Growth hit an 18-month high in Spain, a 34-month high in Germany, a 69-month peak in France and was the sharpest since December 2015 in Italy.

Stronger growth of output and new orders had a positive impact on business confidence, which rose
to a new series-record high. Companies indicated that they expect economic and market conditions to improve further over the coming 12 months.(… )

Faster growth of incoming new orders led to a further accumulation of backlogs of work at
eurozone manufacturers and service providers alike. This encouraged job creation in both sectors,
taking the combined rate of increase in employment to its highest in over nine years.

Staffing levels were raised at accelerated rates in Germany, France and Italy. (… )

Cost inflation rose to a 69-month record in February, mainly due to higher purchase prices, the
weak euro exchange rate and increased staff costs. Rising input costs were commonly passed on to clients, as selling prices increased to the greatest extent in over five-and-a-half years.(… )

The rate of expansion in eurozone service sector output gathered momentum in February. The final
Markit Eurozone PMI® Services Business Activity Index rose to 55.5, its highest level since
May 2011 but slightly below the earlier flash estimate of 55.6. The rate of increase in incoming
new work also picked up to a 70-month high.

The growth acceleration was broad-based by nation, with all of the ‘big-four’ service economies
seeing faster expansions of business activity and new orders. (… )

Backlogs of work rose at the quickest pace since May 2011, with increases signalled in all five of the
national service economies covered by the survey. The combination of rising activity, new orders and backlogs led to increased business confidence and also encouraged further job creation.

Positive sentiment rose to a near-six year record, amid widespread expectations among companies
that business activity would be higher in 12 months’ time. Meanwhile, employment rose for the twenty eighth successive month, with the rate of increase the second-fastest over the past nine years. (… )

Input prices rose at the quickest pace since June 2011 in February, reflecting higher staff costs and increased purchase prices (the latter due in part to rising commodity costs and the weak euro
exchange rate). Average output charges also posted a modest increase, with the rate of inflation
accelerating slightly. Germany, Spain and Ireland all saw selling prices rise, in contrast to the further
reductions implemented in France and Italy.

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February data signals stronger growth in Chinese business activity

The Caixin China Composite PMI™ data (which covers both manufacturing and services) indicated a slight improvement in the rate of output expansion across China in February. The Composite Output Index rose from January’s four-month low of 52.2 to stand at 52.6 in February, to signal a moderate increase in overall Chinese business activity.

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The uptick in the headline index was supported by faster growth in Chinese manufacturing production during February. That said, the rate of output expansion was moderate overall, and weaker than those seen in the final quarter of last year. At the same time, services activity growth softened slightly in February, with the latest increase the slowest seen in four months. The seasonally adjusted Caixin China General Services Business Activity Index was down to 52.6 from 53.1 in January, to indicate a modest pace of growth.

In line with the trend for overall activity, growth in composite new business quickened to a solid pace in February. Furthermore, it was the second-fastest rate of composite new order growth since March 2013 (after December 2016). A marked rise in new orders placed with manufacturers (the second-strongest in 31 months), helped to lift total new work. Nonetheless, services companies also registered a solid upturn in new order intakes, with the rate of expansion unchanged from that seen at the start of the year. Anecdotal evidence indicated that improved client demand and expansion into new markets helped to drive new orders higher in the latest survey period. (…)

Capacity pressures persisted in February, with backlogs of work rising across both the manufacturing and service sectors. Although marginal, the latest rise in unfinished work at services companies was the fastest seen since the start of 2010. In contrast, the modest accumulation of backlogs seen at manufacturing companies was the slowest seen in nine months. At the composite level, outstanding business rose for the twelfth successive month, albeit marginally.

Average input costs continued to rise sharply at Chinese manufacturers in February, despite the rate of inflation easing to a four-month low. Service providers meanwhile registered only a modest rise in cost burdens that was the slowest since last November. Overall, composite data signalled a further marked rise in average input prices, albeit one that was the weakest in four months.

Reflective of the trend for input costs, composite output charges increased at a softer pace in February. Notably, the latest increase in overall output charges was the slowest seen since September 2016. Manufacturers raised their selling prices at a rate that, though solid, was the weakest recorded in five months. However, competitive market pressures limited the overall pricing power of services companies, which led prices charged for services to be little-changed from the previous month.

Optimism towards future activity growth remained strongly positive in February. While manufacturers reported the highest level of positive sentiment for 21 months, confidence in the service sector fell slightly from January’s 11-month high. At the composite level, sentiment towards the business outlook edged up to its highest since May 2015.

Inflation Returns to Japan Japan’s consumer prices rise for the first time in more than a year in January as higher global oil prices give Prime Minister Shinzo Abe and the Bank of Japan a helping hand in their campaign to overcome deflation.

The core consumer price index rose 0.1% from a year earlier in January after falling 0.2% in the previous month, according to data released Friday by the Ministry of Internal Affairs and Communications. The rise was the first since December 2015. The core index excludes fresh food but includes energy. (…)

The core CPI for the Tokyo metropolitan area—which is less affected by gasoline costs than nationwide price data—fell 0.3% in February. (…)

Short-Dated U.S. Bond Yields Hit Post-Crisis High on Fed Anxiety

The yield on the three-month bill closed at 0.668%, the highest since October 2008, and the yield on the six-month bill settled at 0.832%, the highest since November 2008. The two-year note’s yield settled at 1.322%, the highest since June 2009. The yield on the benchmark 10-year Treasury note closed at 2.498%, up from 2.317% at the end of last week, which was the lowest since November. (…)

SENTIMENT WATCH

(…) Stifel Nicolaus’s Barry Bannister recently boosted his target to 2400 from 2300. Ms. Subramanian earlier this week raised her year-end forecast to 2450 from 2300. The most bullish is Deutsche Bank’s Binky Chadha, who is looking for the S&P 500 to finish the year at 2600. (…)

Source: @jessefelder (Via The Daily Shot)

  • Are US small caps massively overvalued? Here is the ratio of enterprise value to earnings. This has to be making Fed officials a bit uncomfortable.

Source: @credittrader (Via The Daily Shot)

THE DAILY EDGE (2 March 2017): Insiders Selling

Stocks Surge as Global Outlook Brightens The Dow industrials surged more than 300 points to their first-ever close above 21000, underpinned by the Federal Reserve’s growing confidence in the U.S. economic outlook and by investor hopes that President Donald Trump will deliver policies that boost growth.

(…) Stocks were powered in part by new signals from the Federal Reserve that officials are growing confident enough in the economic outlook to raise short-term interest rates as early as a meeting later this month, traders said, as well as by solid data and the generally positive reaction to President Donald Trump’s speech to Congress on Tuesday evening. (…)

“We are closing in on full employment, inflation is moving gradually toward our target, foreign growth is on more solid footing and risks to the outlook are as close to balanced as they have been in some time,” Fed governor Lael Brainard said Wednesday in a speech at Harvard University. “Assuming continued progress, it will likely be appropriate soon to remove additional accommodation, continuing on a gradual path.”

Ms. Brainard’s comments were striking because she has been among the Fed governors most resistant to raising rates in recent years. That she now appears on board with another move suggests Fed Chairwoman Janet Yellen has a growing consensus behind her. (…)

signs are building that the global economy is emerging from a long period of deflationary pressure marked by excess capacity in factories and labor markets. On Wednesday, German annual inflation was reported at 2.2% in February, its highest level in 4½ years. Annual inflation across the 19-nation eurozone is expected to rise above 2% when February data are reported Thursday. In Japan, data due Friday are expected to show the primary inflation gauge—consumer prices except fresh food—rose in January from a year ago, turning positive for the first time in 13 months.

In the U.K., inflation is at a two-year high of 1.8%, and the Bank of England expects it to rise toward 3% this year. That is partly the result of a sharp drop in the sterling’s value following the nation’s vote to leave the European Union. Food chain Greggs warned on Tuesday it is facing increased inflationary pressures, as a weaker currency makes imported food more expensive.

Inflation isn’t a good thing in itself; it eats away at the purchasing power of take-home pay and savings. But for years, central bankers have fretted that low inflation was a sign of weak global demand and underused resources, and an indication of their own failure to use low interest-rate policies to reach inflation targets. (…)

Some companies are scrambling to adjust. (…) “With components getting so expensive, we’ve had to increase our prices. That’s really squeezed our profits.” (…)

Underlying momentum in the economy remains modest. Forecasters this week marked down their expectations for U.S. growth in early 2017 after weak readings on consumer spending, international trade and construction outlays. Macroeconomic Advisers on Wednesday projected gross domestic product would expand at a 1.6% annual rate in the first quarter, compared with a 1.9% growth rate in the final three months of 2016. (…)

High five The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2017 is 1.8 percent on March 1, down from 2.5 percent on February 27.

Evolution of Atlanta Fed GDPNow real GDP forecast

  
Global Manufacturing PMI at 69-month high in February

The rate of expansion in global manufacturing production accelerated to a three-year high in February, underpinned by stronger growth of total new orders and rising levels of
international trade. Business confidence also improved, encouraging faster job creation.

The headline J.P.Morgan Global Manufacturing PMI™ rose to a 69-month record of 52.9 in February, up from 52.7 in January. PMI indices tracking trends at consumer, intermediate and investment goods producers pointed to a broad-based improvement in operating conditions. Rates of expansion were broadly similar across all three sectors. Growth was led slightly by the consumer goods industry, whereas intermediate goods was the only category to register a faster rate of expansion than in January.

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National data suggested that developed nations tended to fare better than emerging markets during February. PMI levels edged higher in the euro area (70-month high) and Japan (35-month high) to offset mild decelerations in the rates of expansion in the US and the UK.

Although the rate of improvement across emerging markets remained weaker than that for developed nations, it was nonetheless slightly faster than in January. This stronger upturn mainly reflected growth accelerations in China, India, Vietnam and the Czech Republic. (…)

February saw international trade flows strengthen, as highlighted by new export orders rising to the greatest extent in almost six years. Improved rates of growth were signalled by both developed and emerging nations.

Average input prices continued to rise at a marked pace in February, with the rate of inflation remaining close to January’s 68-month record. Companies passed on part of the increase in costs to clients, leading to higher selling prices. Moreover, rates of increase in output charges during the past four months have been the fastest registered by the survey since mid-2011.

Auto U.S. Light Vehicle Sales at 17.5 million annual rate in February

Based on a preliminary estimate from WardsAuto, light vehicle sales were at a 17.47 million SAAR in February. That is down about 1% from February 2016, and unchanged from last month. This was below the consensus forecast of 17.7 million for February.

  

U.S. Construction Spending Falls in January

The value of construction put-in-place fell 1.0% in January (+3.1% y/y). This decline did follow upward revisions to December and November, with December now up 0.1% versus -0.2% reported initially, and November up 1.5%, revised from 0.9%. The latest decline compares to expectations in the Action Economics Forecast Survey for a 0.5% increase.

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From the Fed’s latest Beige Book:

  • Labor markets remained tight in early 2017, with some Districts noting widening labor shortages.
  • In general, wages in most Districts rose modestly or moderately, with a few reporting some pickup in the pace of wage growth. A number of Districts noted that shortages of skilled workers–particularly engineers and IT workers–were driving up their wages, and there were also some reports of labor shortages in the leisure and hospitality, construction and manufacturing industries.

One of today’s Bloomberg feature articles:

Stocks Aren’t Overvalued

(…) Rather, they seem reasonably close to fair value. As for the future, many factors may emerge that can increase or decrease the attractiveness of stocks, albeit with more potential positives than negatives. So on balance, there’s reason to be cautiously positive on the equity-market outlook.

(…) So although stock indexes are at record levels, valuations are not. And that’s the only sensible criteria by which to judge whether the stock market is expensive.

The price-earnings multiple is one key metric to judge valuations, though it suffers from some weaknesses. Since 1954, the S&P 500 P/E trailing multiple has averaged about 16.6. But this encompasses very high P/E periods, such as the 1950s and the 1990s and exceptionally low P/E periods, such as the 1970s. Using a simple average treats radically different periods equally, which is simplistic, naïve and wrong.

While the current market P/E is somewhat above average, that average is a meaningless mix of high and low interest rates and P/E multiples over very different economic environments. As anyone who has ever worked with a dividend discount model understands, high interest rates imply low P/E multiples and low interest rates imply high equilibrium P/Es. If we focus on those periods when inflation and interest rates were low, as they are today, the implied equilibrium P/E multiple is well above the historical average, but also above the prevailing multiple in today’s market. Indeed, with interest rates still close to record lows, the appropriate equilibrium for the market’s P/E multiple should be high. (…)

Decide by yourself whether stocks are fairly or overvalued:

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It is true that “using a simple average treats radically different periods equally, which is simplistic, naïve and wrong.” Hence the Rule of 20 which says fair P/E is 20 minus inflation. By this time-tested rule, the S&P 500 Index is currently 12.5% overvalued.

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Some people have already made up their mind, voting with their feet…and wallet:

Company insiders are dumping stock at levels ‘rarely seen,’ report indicates

In the last week, insiders’ sale transactions on the NYSE outnumbered their purchase transactions by more than 11 to 1, according to Vickers, a publication of Argus Research. The 11.47 reading is 3.5 standard deviations above the mean, according to Coleman.

The report gives context on the historical relationship between the market and its insider readings:

“The last time we saw both reading at such elevated levels was in early 2014, when the total reading hit 8.3 and the NYSE/ASE reading was 6.16. In response, the S&P 500 fell from 1844 to 1741 between 1/22/14 and 02/03/14. On February 14, 2007, the NYSE/ASE reading was 11.77 and the Total reading was 7.99 Again, the S&P 500 fell — this time from 1455 to 1387 within a matter of days.”

Vickers tracks its sell/buy ratio over a period of varying time lengths in order to get a better idea of whether one week is part of a bigger trend. Its longer-term eight-week ratio for all U.S. stocks shows this is not just a short-term trend, with 5.98 buy transactions for every sale over the last two months. On the chart below, the eight-week sell/buy ratio is tracked inversely on the right scale, with the stock market on the left scale. The research shop does it this way to illustrate the divergence between insiders and the market: The Dow Jones industrial average keeps going higher, yet insiders keep dumping stock.

Writes Coleman: “The number of insiders participating in the selling is significant. That would seem to imply that equities might be ripe for some level of correction.”

Here’s another measure:

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