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 (22 March 2017): Cracking?

So, the first cracks come from politics. Anybody surprised?

That [Trump] trade went into reverse in Tuesday’s U.S. trading: The S&P 500 fell 1.2%, its first decline of more than 1% this year and biggest drop since October, while the ICE U.S. dollar index, which tracks the dollar against a basket of six currencies, slipped below 100 for the first time since Feb. 6. (…)

The “Trump Lite” trade hinges upon the administration’s getting sandbagged in policy fights, such as the current wrangling over health care. (…)

  • Trump Lobbies GOP on Health Bill, but Holdouts Remain President Trump put his political capital on the line in a late effort to save House Republicans’ health-care legislation, but he didn’t immediately win over conservative skeptics who could scuttle the bill.

(…) Several lawmakers said the president told the group: “I’m afraid you’re going to blow it.’’

Mr. Meadows, whose bloc claims it has enough votes to defeat the bill, said he wasn’t convinced by Mr. Trump—a sign GOP leaders have more work to do to secure the votes needed to pass the bill. (…)

“What we do know is from the last election there is evidence that Republicans who crossed Trump paid a political price in general elections,” said David Wasserman, the House editor at the Cook Political Report. (…)

The full House is expected to vote on the legislation on Thursday. (…)

The fight in Congress over health care could go on for a while. The more of the legislative calendar it chews up, the longer it will take for the corporate tax cut investors are banking on to come to the floor and the longer the odds on it becoming law. That, in turn, should be factored into stock prices. (…)

Moreover, if it does pass, the bill’s prospects in the Senate aren’t good. But before Senate Republicans can come up with their own version of the health-care legislation, they have a Supreme Court nominee to approve.

Then, if the Senate can pass a bill of its own, there will be a House-Senate conference to resolve differences.

It is a process that would come with significant hurdles even in normal times, much less today’s distraction-riddled political climate. At the least, the health-care bill could be sitting on Capitol Hill for a long time.

(…) it is looking as if the legislation might not land on President Donald Trump’s desk until early next year. (…) A year from now, when the midterm elections are looming, it will be hard for Congress to accomplish much of anything. (…)

The Trump rally assumed that the positives would more than offset the potential negatives. It now seems that protectionist measures will take the front seat and that the positives will, or might, come later. On top of “Trump Lite” markets are must also deal with these other realities:

Here is a Trump trade index from TD Securities (a combination of specific currencies, rates, etc.) from The Daily Shot:

MORE SURVEYS

Pointing up There are the ISM and PMI surveys, the NFIB survey, we now get the RSM, filling the gap in the middle:

America’s Middle Market Posts Record-High Growth, Quarterly Index Shows

The first quarter 2017 RSM US Middle Market Business Index (MMBI), released today, posted a record-high composite score of 129.8, up 9.7 points over the previous quarter, and 29.8 points above a baseline reading of 100, which indicates an expanding middle market. RSM US LLP (“RSM”) – the nation’s leading provider of audit, tax and consulting services focused on the middle market, along with the U.S. Chamber of Commerce, the nation’s largest business federation – joined forces to present the MMBI, in collaboration with Moody’s Analytics. (…)

Middle market businesses — those with annual revenues between $50 million and $1 billion — account for 40 million jobs (about one third of all U.S. jobs), 200,000 companies and 40 percent of the nation’s Gross Domestic Product (GDP). These companies contribute $6.2 trillion annually to the U.S. economy. (…)

Nearly 70 percent of respondents expect noticeable improvements in the economy over the next six months, which represents a fresh cyclical high in the index. Half of respondents believe tax reform provides the greatest opportunity for growth, while one in four believe renegotiated trade agreements pose the greatest risk for their business, followed by limits on immigration. (…)

The MMBI also shows that employers are experiencing labor issues on two fronts – tightening of labor supply and a skills gap, coupled with lack of desire for people to take certain jobs:

74 percent of respondents reported a lack of qualified workers available for existing job openings, which also reflects the findings in the monthly Jobs, Openings, Layoffs and Turnovers data produced by the Federal Government.

71 percent of survey respondents reported issues with intra-industry competition for workers, 68 percent stated that it is difficult to find individuals interested in work in their industry and 69 percent implied that the cost of training for workers remains a challenge. (…)

(…) In the first quarter, 71% of middle-market firms said they expect an increase in revenues, up from 55% last quarter, and 66% expect profits to improve, up from 55%, according to the RSM Middle Market Business Index, produced by the consulting firm RSM and the U.S. Chamber of Commerce. (…)

For this first survey, which was conducted in late January and early February, shortly after the inauguration, a majority of businesses rated health-care reform as “very likely” to be completed in the next two years. Renegotiation of trade deals, reduction of federal regulations, and immigration reform were also rated “very likely” by more than 40%.

But moving down Mr. Trump’s agenda, the odds gradually decrease. Slightly less than 40% think an overhaul of the corporate tax code is “very likely” and only one-third say the same for the proposed infrastructure package. Many businesses are just cautiously optimistic, with about 40% rating the above changes as “somewhat likely.” (…)

(…) We expect wage growth to exceed 4 percent by the end of the year, with risk to the upside related to a pronounced shift in bargaining power to labor from firm owners, a much different dynamic than has been prevalent in the United States since the late 1990s. (…)

At this point, the public has bought into the durability of the cyclical expansion, and wage expectations (currently at 3.6 percent) have improved to their best point since the recession. This mirrors the movement in the compensation expectations index within our own proprietary RSM US
Middle Market Leadership Council survey, which in the fourth quarter of last year pointed to much higher wages by mid-2017. (…)

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Middle market businesses frequently are forced to deal with large company problems with small company capabilities. In the year ahead, middle market businesses will need to adjust to the challenges of recruiting and retaining workers in a labor-market environment where there is a 5 percent premium, on average, to retain workers who have other opportunities. For skilled workers in areas such as value-added manufacturing, technology, life sciences and finance, those premiums may rise into the double digits. (…)

Fingers crossed The Philly Fed non-manufacturing survey shows no signs of “wage pressures.” (The Daily Shot)

HARD DATA WATCH

Not completely hard but interesting:

The Chemical Activity Barometer (CAB), a leading economic indicator created by the American Chemistry Council (ACC), posted its strongest year-over-year gain in nearly seven years. The 5.5 percent increase over this time last year reflects elevated consumer and business confidence and an overall rising optimism in the U.S. economy.

The barometer posted a 0.5 percent gain in March, following a 0.5 percent gain in February and 0.4 percent gain in January. All data is measured on a three-month moving average (3MMA). Coupled with consecutive monthly gains in the fourth quarter of 2016, the pattern shows consistent, accelerating activity. On an unadjusted basis the CAB climbed 0.4 percent in March, following a 0.4 percent gain in February and a 0.6 percent increase in January.

The Chemical Activity Barometer has four primary components, each consisting of a variety of indicators: 1) production; 2) equity prices; 3) product prices; and 4) inventories and other indicators. (…)

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Auto Why are used vehicle wholesale prices important?

Yesterday, I posted on the collapse in used car prices. Wolfstreet.com adds this:

For one, they matter to lenders. Used vehicle wholesale prices determine the value of the collateral for $1.11 trillion in auto loans that have boomed on higher prices, higher unit sales, longer maturities (the average hit a new record of 66.5 months in Q4), and higher loan-to-value ratios (negative equity):

Dropping wholesale prices increase loan losses for lenders as recovery is lower. Declining wholesale values of lease turn-ins, if the trend persists, impacts how finance companies structure the lease terms, thus raising the costs for the customers and putting a damper on leasing activity.

All this puts pressure on new vehicle sales, further pushing automakers to pile on even larger incentives in order to move the units, grapple with inventories, and keep plants open. This works for a while – there’s nothing like big-fat incentives to bring out reluctant buyers. But incentives, when everyone is doing them, are front-loading sales. This is ultimately self-defeating and gets very costly even as sales begin to decline. It was a contributor in the collapse of the industry during the Financial Crisis.

And there are well-established patterns of customers switching between new vehicles and late-model used vehicles. Large incentives by automakers put pressure on late-model used vehicles. In turn, falling prices on the used vehicle side cannibalize sales from the new vehicle side. In other words, they compete with each other, often on the same dealer lot. Especially if demand is lackluster despite the incentives, these patterns can trigger a downward spiral that is difficult to get out of.

More problems at the mall:

The company is initially planning to close 400 to 500 stores as it reorganizes operations, said the people, who asked not to be identified because the deliberations aren’t public. Payless had originally looked to shutter as many as 1,000 locations, and the number may still be in flux, according to one of the people.

Payless’s bankruptcy would add to a tumultuous year in retail, with several bankruptcies and hundreds of store closings — even at companies that aren’t distressed. The industry is racing to try to adapt to more online purchasing and a shift away from mall shopping. (…)

But the next shoe to drop is much bigger:

At the other extreme of the wealth scale:

Global Art Sales Fall 11% to Lowest Point Since Financial Crisis
CANADA

Unlike the U.S., where the majority of the post-election gains have been in the sentiment indicators, Canada is experiencing solid and relatively broad-based increases in its most critical indicators. (…)

Manufacturing sales in January climbed 0.6 percent, exceeding consensus, which called for a 0.3 percent decline. Meanwhile, wholesale trade surged 3.3 percent, blowing out the expectations of a mild 0.5 percent gain, and total sales on the retail level advanced 2.2 percent in January — the strongest monthly increasesince March 2010 (2.6 percent) — bettering the expected 1.5 percent gain. (…)

Other, and perhaps greater, risks to sustainable sales gains are the uncertainties surrounding tax and trade policy with the U.S. Canadians have beenassured that the still unknown trade policywill only be “tweaked” from the present NAFTA agreement, while the potential for a border adjustment tax continues to loomin the markets. The imposition of a bordertax would be economically-compromisingfor both countries, particularly imperiling Canada’s trade and manufacturing activity.

So, before any upgrades to the Canadian economy are made based on the better-than-expected economic reports, it would be wise to see some clarity in those looming risks of policies, energy trends and the sustainability of gains in sales. (Bloomberg Briefs)

THE DAILY EDGE (21 March 2017)

How Tight Is the U.S. Labor Market?

Research from the Federal Reserve Bank of San Francisco:

The current low unemployment rate compared with previous labor market peaks has raised some fears regarding whether the labor market has become too tight. In this Letter, we use a new method to isolate the effects of demographic changes on unemployment, and we find that the demographic-adjusted unemployment rate is still 0.3 to 0.4 percentage point higher than it was at past labor market peaks. This indicates that the labor market may not be quite as tight as the headline unemployment rate suggests.

An important caveat to this conclusion is that our analysis focuses only on the effects of demographics on aggregate unemployment. As emphasized in recent research, however, other labor market changes also may have affected aggregate unemployment since the mid-70s (see, for example, Daly, Hobijn, Sahin and Valletta 2011).

Given the caveat, the 0.3-0.4 pp gap is insufficient not to call this a peak.

HARD DATA WATCH
Economic Outlook from Freight’s Perspective – Gentlemen, Start Your Engines!

Both the Shipments and Expenditures Indexes have been positive for two months in a row. The 1.9% YoY increase in the February Cass Shipments Index is yet another data point which strongly suggests that the first positive indication in October may have indeed been a change in trend. In fact, it now looks as if the October Cass Shipments Index, which broke a string of 20 months in negative territory, was one of the first indications that a recovery in freight had begun in earnest.

Unlike in January, the February sequential pattern looked very promising (in January the YoY was up 3.2% but was down 6.4% sequentially). Since February is always one the weakest freight months for most modes of transportation (truck, rail and parcel), the sequential strength emboldens our view that the recovery is not a ‘flash in the pan’ but real. We also continue to receive almost-daily reports of stronger shipment volume in all modes from both hard data sources and industry anecdotes, which we will outline later in this report.

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The Cass Freight Expenditures Index also continued to signal a turn in trend. Expenditures (or the total amount spent on freight) turned positive for the first time in 22 months in January, albeit against an easy comparison. Not since 2011—when the economy was still climbing out of the recession—had this index been so low. Our Expenditures Index in January 2016 was the worst in five years, as demand had weakened and crude oil had fallen below $30 a barrel. Although February 2016 was also weak, it was not nearly as weak as January 2016 and hence a slightly tougher comp. Since fuel surcharges are included in the Expenditures Index, fuel was a negative bias in the data last year.

Conversely, over the last several months, we have observed that part of the increase was a result of the steady increase in the price of fuel over the last six months. But, we are also seeing some improvements in pricing power of truckers and intermodal shippers. As an example, the proprietary Cass Truckload Linehaul Index (which measures linehaul rates and does not include fuel) only fell 0.8% on a YoY basis in the month of February, which was less than the 1.5% and 0.9% declines posted in November and December, respectively. The proprietary Cass Intermodal Price Index (which does include fuel) faired even better, increasing 4.9% in February. This was an acceleration from the 1.5% increase it posted in December and marked the fifth consecutive YoY increase after 21 consecutive months of decline.

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Hotels: Hotel Occupancy Solid in early March

From HotelNewsNow.com: STR: US hotel results for week ending 11 March

The U.S. hotel industry reported positive results in the three key performance metrics during the week of 5-11 March 2017, according to data from STR.
In a year-over-year comparison with the week of 6-12 March 2016:
• Occupancy: +0.8% to 67.4%
• Average daily rate (ADR): +3.9% to US$128.61
• Revenue per available room (RevPAR): +4.8% to US$86.72
emphasis added

The following graph shows the seasonal pattern for the hotel occupancy rate using the four week average.

Used Car Prices Plunge Most in Any Month Since 2008, Only 2nd February Decline in 20 Years

According to NADA Used Car Guide, wholesale prices on used vehicles are getting crushed. (…)

Automakers grew incentive spending once again in February, making it the 23rd month in a row where spending was increased. On average, spending reached $3,594 per unit versus $3,043 per unit in February 2016 according to Autodata. (…)

Compared to January, days’ supply fell by 11 days in February, landing at 74 days for the period. Looking back, February 2016 saw a supply of only 69 days according to Wards Auto. (…)

NADA partially blames late tax refunds for some of the declines in March. (…)

WE know that used car prices are set to weaken given the tsunami of cars getting off-leases this year and next. The good news is that inventories are being worked down.

Sample(Bespoke)

Oil Drops as U.S. Drilling Growth Threatens to Counter OPEC Cuts
Oil prices climb on talk that OPEC could extend supply cut

Meanwhile in China:

  • The Capital Economics GDP tracker (economic activity proxy) has converged with the official figures.

Source: Capital Economics via The Daily Shot

(…) At the conclusion of the annual session of China’s rubber-stamp parliament last week, the government pledged to “contain excessive home price rises in hot markets”. (…)

In recent days, authorities in Beijing and four provincial capitals — Guangzhou, Zhengzhou, Changsha, and Shijiazhuang — have all introduced new property tightening measures. They include higher downpayment requirements on second homes and restrictions on purchases of second or third homes. The moves add to restrictions rolled out in other capitals this month, including Nanjing, Qingdao and Sanya in the resort island of Hainan. (…)

Ninja Barriers to Trade Are Multiplying Fast Absent from the communiqué was the normal commitment to free trade

Trade barriers are on the rise as protectionism takes hold.

Source: @WSJ; h/t Tom via The Daily Shot

Conservative House Republicans Say They Have Votes to Block Health Bill Conservative House Republicans said they have enough votes to block the GOP’s legislation to dismantle the Affordable Care Act, as House leaders proposed changes to the bill in an effort to draw support.
Trump’s Slipping Approval Could Delay Tax Reform

(…) A continued decline in President

Trump’s approval rating could embolden Democrats and some members of his own party to resist the new legislation, which may eventually weigh on markets. Tax reform, one of the primary drivers behind recent market performance, has

taken a back seat to priority one: repealing and replacing Obamacare and passing a new budget.

The administration’s plans for substantial infrastructure spending may not occur until after tax reform has been completed. Meaning the expected implementation time for the aspects of the president’s plans that would most benefit markets continues to move further out in time.

Disagreements over the AHCA may not weigh too heavily on markets, but delays or strong resistance over tax reform could have a significant impact. (Bloomberg Briefs)

President Trump’s Proposed Budget’s Impact on Infrastructure

On Thursday, March 16, President Trump released his first proposed budget as president. Often referred to as the “skinny” budget because it is released soon after a President assumes office, the budget proposal included many cuts to infrastructure programs that in the past have been successful.

The following statement is from Norma Jean Mattei, President, American Society of Civil Engineers regarding the release of President Trump’s proposed budget for Fiscal Year 2018:

“President Trump’s proposed budget would eliminate funding for many of the programs designed to improve our nation’s infrastructure, which last week was graded a ‘D+’ in ASCE’s 2017 Infrastructure Report Card. This budget unfortunately does little to raise that grade for our aging roads, water systems, dams, and other infrastructure, the deficiencies of which currently cost each American family $3,400 per year in disposable income. (…)

While the Administration has suggested that the cuts made in the FY18 budget will be restored through an infrastructure-specific package, that is not the way to effectively invest in, modernize, and maintain our aging and underperforming infrastructure. Government programs that have proven successful should continue to be funded through authorizations and appropriations, to ensure consistent funding from year to year.”

Ghost A new form of ‘portfolio insurance’ sparks fears Popularity of trend-following funds — and their promises — carries echoes for some of 1987 crash

On Wall Street, bad ideas rarely die. They often go into hibernation until resurrected in a new form. And portfolio insurance — a leading contributor to the 1987 “Black Monday” crash — is, for some, making a return to markets.

Institutional investors are allocating billions of dollars to “risk mitigation” or “crisis risk offset” programmes that are designed to act as a counterweight when markets are in turmoil. They mostly comprise long-maturity government bonds and trend-following hedge funds, which tend to do well when equities plummet.

But some analysts and fund managers worry that if taken to extremes, allocations to trend-following “commodity trading advisors” hedge funds, in particular, could play the same role as an investment concept called portfolio insurance did in 1987, when it was blamed for aggravating the worst US stock market collapse in history. (…)

CTAs, which are also called managed futures funds, are computer-driven vehicles that take advantage of financial markets’ tendency towards momentum. Assets that have gone up tend to go up further, and assets that are falling typically continue to slide. CTAs therefore often automatically bet against an already-falling market, shorting it to profit from further declines, and usually thrive when other strategies are unravelling. (…)

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Boy Girl Money Rookie Currency Traders Are Causing Trouble at Crucial Moments

(…) Tucked deep into a report on foreign-exchange market liquidity was a brief paragraph on how rookie traders could be partly to blame — along with falling volumes and the growing prevalence of electronic trading — for the flash crashes that have roiled the $5.1-trillion-a-day currency market over the past two years. One case the BIS found particularly worrisome was the time last October that the pound plunged 9 percent in a matter of minutes during early trading hours in Asia. The organization concluded that “less experienced” traders handicapped by a limited knowledge of which algorithms to use at that moment “amplified” the rout. (…)