Month: July 2018

THIS BEAR HUGS

If it wasn’t for the official launch of a global trade war, the stock market would be soaring on today’s employment report [which], from top to bottom, was stellar. Coming from a bear, that’s a big comment but there certainly was nothing here to be worried about.

(…) let’s keep in mind that this is a coincident ,not leading, indicator. (…) and all the recent data have to be adjusted for the fact that we are coming off the peak effects of the tax stimulus. (David Rosenberg)

Jobless Rate Rises as Steady Hiring Draws More to Labor Force The unemployment rate rose in June from an 18-year low, but steady hiring and more job seekers suggest a strong labor market drew in Americans from the sidelines. Payrolls rose 213,000, while the jobless rate climbed to 4.0%.

(…) Those new entrants to the labor force could provide the raw material needed to support accelerating economic growth nine years after the recession ended.

“It’s clear that we’re not running out of workers,” said Kate Warne, an economist at Edward Jones. “There is additional leeway for job growth to remain strong.” (…)

New entrants to the labor force—be they parents, recent graduates or those previously frustrated by their prospects—have caused the civilian labor force to grow by an average of about 250,000 workers each month this year. That is the best six-month stretch of Americans entering the labor market in more than two years. In June, the share of American adults working or looking for a job rose by 0.2 percentage point to 62.9%. The gain runs counter to the longer-running trend of an aging population that is less likely to work.

A​ greater share of Latino Americans sought jobs last month—and found them. The Latino unemployment rate fell to a record low 4.6%. Labor-force participation ​also ​rose in June for women, black people and those with less than a college education. (…)

Forecasting firm Macroeconomic Advisers lifted its projection for the second-quarter economic growth rate to 4.9% Friday. Barclay’s estimates a 5% rate, well above the recent pace of 2% gains. (…)

Such high rates of economic growth—stoked by new tax cuts and unusually high soybean exports—may not be sustainable. Still, Macroeconomic Advisers projects the economy will have grown 3.1% at the end of this year from the end of 2017—setting 2018 up to the best year for growth in more than a decade. (…)

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  Data Give Fed Comfort With Rate Policy

(…) The report appears to offer something for everyone around the Fed’s boardroom table. It provides support for officials who have argued that the unemployment rate has understated the level of the slack in the economy because of a potential reserve of workers who aren’t actively looking for jobs.

The data provided few signs of a run-up in wage growth. Average hourly earnings of private-sector employees rose 2.7% in June from a year earlier, in line with the pace seen in earlier months this year. (…)

The share of adults aged 25 to 54 who are working ticked up to 79.3% in June, matching the highest level seen during the current expansion. That is up from a recent low of 74.8% in November 2010 but still below the 80.1% high reached during the mid-2000s expansion. (…)

Contrary to the NFIB surveys, Markit’s’ and the ISM’s surveys have yet to highlight strong pressures on wages and overall labor costs. The only exception is in transportation where the widely known trucker shortages are resulting in “transportation costs are going through the roof right now” (ISM-Furniture manufacturer), confirmed by Cass data.

Strangely, the BLS data shows average hourly earnings in “Truck Transportation” up only 3.6% YoY in May and at a below average +1.5% in “Long-distance Trucking” wages where driver shortages are reportedly the most acute. Meanwhile, the PPI “General Freight Trucking is up 5.2% YoY in May and “General freight trucking, long-distance TL” is up 7.7%.

Somebody’s operating margins must be pretty good right now, although truck drivers don’t seem to be complaining nowadays. Strange! Trucking has now recovered all the market share lost in the late 2000’s, even with a shortage of drivers…

Much has been made of the recent uptick in the participation rate but the fact remains that the labor force keeps growing at just about 1.0% YoY. Employment growth has ticked up from +1.4% last September to +1.6% but the growth rate remains tepid overall.

This chart plots U.S. Business Sales growth against wages and Unit Labor Costs:

Business Sales vs the BLS “Payroll Index” which includes hours worked. Americans’ pay checks are growing nicely around 5.0% YoY but corporate America’s revenues are rising even faster, in part thanks to rising oil prices.

Canada’s Labor Force Grows Most in 6 Years, Raising Jobless Rate

The labor force expanded by 75,600 in June, the biggest one-month increase in six years, Statistics Canada reported Friday from Ottawa. With less than half of new job seekers finding work, the labor force increase boosted the unemployment rate to an eight-month high of 6 percent. Employment jumped by 31,800 last month. (…)

Canada has been producing some of the strongest pay gains in years and that trend continued in June with average hourly wages up 3.6 percent from a year earlier. While down from 3.9 percent in May, it’s still one of the highest readings since the 2008-2009 recession. (…)

The average unemployment rate in the OECD nations is at the lowest level in decades.

Source: @jsblokland (via The Daily Shot)

Wall Street Is Raising More Cash Than Ever for Its Rental-Home Gambit Financiers who loaded up on homes after the housing bust are buying more, betting that high prices and skimpy inventory will make well-to-do families more willing to rent a house, especially if it means access to a good schools.

Eurozone Industrial Production Continues to Falter Output across the 19 countries that use the euro was 0.9% lower in April than in March

(…) although 1.7% higher than a year earlier. That marked the fourth month in five in which industrial production has fallen. It was a sharper decline than had been anticipated, since economists surveyed by The Wall Street Journal last week estimated that output fell by 0.7%.

Each of the eurozone’s five largest members saw a drop in output, with the Netherlands experiencing the sharpest decline at 4.4%. While a slump in energy generation was largely responsible for the overall contraction, most manufacturing also retreated, the exception being the production of tools and equipment. (…)

Economists have largely attributed the first-quarter slowdown to a combination of unusually cold weather, strikes in the eurozone’s two largest members, and a severe influenza outbreak in Germany. But economic data for April, as well as recent business surveys, record little sign of a pickup in the second quarter, which suggests more longer-lasting headwinds may be blowing. (…)

Leading indicators released by the Organization for Economic Cooperation and Development Wednesday suggest a sustained slowdown is under way. Based on a variety of data series that have a history of anticipating swings in future economic activity, the measures now point to easing growth in Germany, France, Italy and the eurozone as a whole.

By contrast, the leading indicators point to stable growth in the U.S. and Japan, as well as pickups in China and India. (…)

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  German Economy Loses Luster as Global Tensions Bite

Germany’s annualized growth rate slowed to 1.2% from 2.5% in the fourth quarter of last year, the Federal Statistical Office said Tuesday. This means that the German economy was growing more slowly than the U.S., which registered growth of 2.3% in the same period. (…)

A ZEW survey showed Tuesday that German economic expectations were unchanged at minus 8.2 points in May, the lowest level since Nov. 2012. (…)

The eurozone as a whole grew at an annualized rate of 1.6% in the first quarter, down from 2.7% in the fourth quarter of last year, according to a revised set of data by the European Union statistics agency Tuesday.

Apart from Germany, economic activity also lost momentum in France, the Netherlands and Portugal. (…)

The weak German exports in particular, were an early indication that the economy wasn’t immune to global tensions and a stronger euro, economists said. The European currency has gained about 8% against the dollar in the past 12 months, eroding the competitiveness of eurozone goods and services. (…)

TRADE

• The Trump Tariff Tracker

• U.S. Exporters Will Be a Surprise Loser From Tariff Fight Who’s the biggest loser when tariffs are imposed on imports? The surprising answer, writes Greg Ip: exporters. Though it’s early Trump’s recent round of tariffs are already hitting exports of soybeans and automobiles.

(…) Economists credit Abba Lerner, then a graduate student at the London School of Economics, for proving theoretically in 1936 that an import tariff was equivalent to a tax on exports.

The practical link was obvious to protectionists and free traders alike as far back as the 1600s, says Douglas A. Irwin, an economist and trade historian at Dartmouth College. They understood that a country that shuts out imports deprives its trading partners of money to buy exports. (…)

Yet even now, exports and imports tend to rise and fall together, proof that the underlying relationship still holds. If the U.S., for any reason, cuts its imports from a trading partner, that country’s economy and currency both weaken, so it buys less from U.S. companies.

If a tariff generated significant new demand for the protected American sector, the resulting boost to prices and jobs would put upward pressure on inflation, interest rates and the dollar, further hurting exports.

In a recent National Bureau of Economic Research study, Alessandro Barattieri, Matteo Cacciatore and Fabio Ghironi examined the effect of changes in tariffs in 21 countries (though not the U.S.) and found they tended to reduce both imports and exports. On net, imports fell more, so the trade balance improved, but overall growth suffered because higher prices reduced consumers’ purchasing power, and the higher cost of imported capital goods undermined investment. (…)

The dollar has risen sharply this year, mostly because of rising U.S. interest rates but also because U.S. tariffs have weighed on the currencies of Canada, Mexico, and China. That will tend to damp their purchases of U.S. products, even those unaffected by tariffs. The Texas Alliance of Energy Producers says higher costs and shortages of tubular steel due to the tariffs will hurt drilling and production of oil, the biggest U.S. export success story of recent years.

The end result of Mr. Trump’s efforts to make Americans spend more on American made products is that foreigners will spend less.

• Central Banks Push to Defend Their Currencies Central banks in some emerging markets have started to spend down a $6 trillion stash of foreign reserves to contain currency declines.

• How U.S. and China Tariffs Are Rippling Through U.S. Industries

The WSJ has a long and detailed piece on how tariffs are disrupting several industries. This is my attempt at summarizing this excellent article:

• Manufacturers: “U.S. manufacturers say they will face tough decisions in coming months over whether to raise prices to cover the higher costs [Domestic steel prices are up more than 30% this year]. (…) Some U.S. manufacturers said they may hold off on investing more in more domestic production capacity as long as the trade disagreement unfolds.”
• Autos: China’s imposition Friday of a 40% tariff on all auto imports from the U.S. is likely to hurt Ford Motor Co., Tesla, BMW and Daimler which all ship to China from the U.S.. In turn, Mr. Trump’s proposed 25% tariff could slow the current industry’s momentum, threatening to increase the average price of an imported vehicle by $5,800.
• Auto Parts: “A proposed 25% tariff on imported auto parts would raise the cost of making a car in the U.S. by about $2,000 (…). All told, current and proposed tariffs on auto parts, on materials like aluminum and steel and on imported vehicles could raise the cost of the average car or light truck brought into the U.S. by nearly $6,000, according to the AAPC, and cost the auto industry more than $90 billion a year.”
• Shipping: Friday’s tariffs affect 6% of container capacity moving between the U.S. and China. But that number will grow if more tariffs are imposed on commodities, further impacting an industry fighting over capacity and low freight rates.
• Semiconductors: “Chinese companies won’t be the only ones feeling pinched by the new tariffs. Because of the complex global supply chain for semiconductor manufacturing, some companies in the U.S. have to cope with the new costs, too.”
• Device Parts: The tariff list includes printed circuit assemblies, a component used to make remote controls and automated-teller machines. And many of the pieces used on circuit boards, such as resistors and capacitors, face tariffs as well.
• Movies: “If China decides to use movies to punish the U.S., it could start filling its theaters with imports from Australia, India or other countries instead of from Hollywood.”
• Soybean Farmers: Soybean prices have dropped 18% since the beginning of June to the lowest level in a decade and farmers are reducing their spending. “Soybean tariffs could encourage China to invest further in infrastructure projects in Brazil to help get Brazilian crops to port and beyond more quickly.” On the other hand, “some foreign buyers who typically source soybeans from Brazil at this time of year have turned to the U.S (…)”
• Dairy and Cheese: Double whammy as sales and prices dwindle while equipment costs rise due to tariffs on steel and alu.
• Pipeline Builders: “The tariff’s impact on pipeline companies hinges on whether and how the Commerce Department grants exclusions (…)”
• Medical Devices: Nothing material, so far.
• Distillers: U.S. export prices will rise some 10% in Europe.
• Newspapers: 32% tariffs on Canadian paper benefit a small Washington State co. recently acquired by a PE firm but hurt all newspaper organizations.
• Railroads: “Rising consumer prices could reduce demand and drive down rail volumes. Tariffs on goods coming to the U.S. from China could especially hurt West Coast rail lines (…)”

Tourists, Students, Blockbusters The U.S. runs an expanding services trade surplus with China

Trump doesn’t talk much about the surplus the U.S. runs with China and many other economies — the services surplus. That’s been steadily expanding, as Chinese tourists and students head to the U.S., people watch more Hollywood movies, and import more U.S. software and other intellectual property. In any escalation, China could target these services imports, by restricting tour groups or reducing the number of American movies shown.

The Imperfect Science of How Much Tariffs Will Hurt Economists try to model tariffs’ impact but actually believe it could be much worse

(…) The number-crunching models economists use to build their forecasts suggest the ultimate effect of the tariffs that have been put in place so far will have a minimal effect on the $20 trillion U.S. economy. Moody’s Analytics model, for example, shows that the tariffs will shave all of 0.03% off U.S. gross domestic product in the third quarter, rising to 0.1% next year.

But Mark Zandi, Moody’s Analytics chief economist, isn’t as sanguine about the tariff effects as his model is. “If anything, we’re significantly underestimating the disruption this will have on the U.S. economy,” he says. (…)

The models also don’t address how in modern supply chains, where goods can be imported and exported multiple times through the manufacturing process, tariffs can be magnified as they come on top of one another. That could make the proposed up-to-25% tariffs on autos particularly onerous because car parts can cross borders multiple times. JPMorgan Chase economists point out that less than half of the content of cars sold in the U.S. is sourced domestically. (…)

Under Mr. Zandi’s model, if the administration proceeded with all the tariffs it has floated — the car tariff and the additional 10% tariff on $400 billion in Chinese goods — and China and other countries responded in kind, the hit to GDP next year would go to 0.5% from 0.1%. In an extreme case, where the U.S. put a 25% tariff on Chinese imports, and China responded in kind, the hit would rise to 1.3%. That is a big bite out of the 2.4% growth economists expect next year.

Add all the things that aren’t in his model and the reality of any of those scenarios could be much more dire.

World Bank CEO Adds to Voices of Worry Over Global Debt Pileup

(…) World debt, including household debt, ballooned to $237 trillion in the fourth quarter of 2017, according to calculations by the Washington-based Institute for International Finance. That’s more than $70 trillion higher than a decade ago. (…)

EARNINGS WATCH

Don’t Worry About the Earnings Slowdown Yet Earnings growth probably wasn’t as torrid in the second quarter as in the first, but was still plenty strong

(…) Expectations that earnings will continue to slow throughout this year and next are part of why the stock market has struggled lately. But that shouldn’t get in the way of the fact that second-quarter earnings reports may be substantially better than estimates. (…)

Here’s Factset’s weekly summary:

Overall, the estimated earnings growth rate for Q2 2018 of 20.0% today is above the estimated earnings growth rate of 18.9% at the start of the quarter (March 31). Five sectors have recorded an increase in expected earnings growth since the beginning of the quarter due to upward revisions to earnings estimates, led by the Energy, Materials, and Information Technology sectors. On the other hand, five sectors have a recorded a decrease in expected earnings growth due to downward revisions to earnings estimates, led by the Consumer Staples sector.

The estimated (year-over-year) revenue growth rate for Q2 2018 is 8.7%. If 8.7% is the final growth rate for the quarter, it will mark the highest revenue growth reported by the index since Q3 2011 (12.5%).

The revenue growth rate of 8.7% is fascinating given inflation, the slowdown in Europe, the USD strength and rising trade issues.

Thomson Reuters has other stats:

Through Jul. 6, 20 companies in the S&P 500 Index have reported earnings for Q2 2018. Of these companies, 90.0% reported earnings above analyst expectations and 5.0% reported earnings below analyst expectations. In a typical quarter (since 1994), 64% of companies beat estimates and 21% miss estimates. Over the past four quarters, 75% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 4.6% above estimates, which is above the 3.2% long-term (since 1994) average surprise factor, and below the 5.3% surprise factor recorded over the past four quarters.

In aggregate, companies are reporting revenues that are 1.4% above estimates.

Ex-Energy, EPS are expected to increase 17.0%.

The estimated revenue growth rate for the S&P 500 for Q2 2018 is 8.1%. If the energy sector is excluded, the growth rate declines to 7.0%.

As I said last week, earnings guidance and revisions are more important to monitor than Q2 results given the above mentioned challenges.

The estimated earnings growth rate for the S&P 500 for Q3 2018 is 23.3%. If the energy sector is excluded, the growth rate declines to 20.2%.

Last week was the first week when Down revisions exceeded Up revisions on S&P 500 companies. Only 3 sectors are seeing Down revisions: Consumer Staples (-9.0%), Real Estate (-1.2%) and Telecoms (-4.0%)

Revisions remain positive for ex-500 companies:

S&P 400 sectors seeing Down revisions are Consumer Staples (-13.9%) and Telecoms (-10.0%).

S&P 600 sectors seeing Down revisions are Real Estate (-3.2%) and Utilities (-5.3%).

Meanwhile, trailing earnings are on the rise again as the 20 companies having reported Q2 rose their EPS 30.8%!! Trailing EPS are now $146.75 from $146.12 after Q1.

Pro forma the tax reform for the past 12 months, assuming a 7% accretion, trailing EPS are about $151, including Q2 estimates. On that basis, the Rule of 20 P/E is 20.6.

• Wage Gains Threaten to Squeeze Retail, Industrial Profits Higher labor costs pose risk to some U.S. companies already facing trade-related tensions, limited pricing power

Firms from dollar stores to hotel operators to fast-food chains have warned in recent months that higher labor costs have been a drag on their profits—a potential headwind for the nine-year stock-market rally as it struggles for momentum ahead of the second-quarter earnings season. (…)

Economists at Goldman Sachs predict that every percentage-point increase in labor-cost inflation will drag down earnings of companies in the S&P 500 by 0.8%. In total, the bank estimates labor costs equate to 13% of revenue for companies in the S&P 500. (…)

According to a report from Bank of America Merrill Lynch Global Research, 10% of companies in the S&P 500 mentioned higher labor costs as a factor that weighed on their first-quarter results, up from 8% in the fourth quarter and the highest level since the bank began tracking the data in late 2015. (…)

Labor costs equal 21% of revenue for companies in the industrials sector, and analysts expect that a percentage-point increase in labor-cost inflation would dent the sector’s earnings by 1.5%. (…)

A National Association of Business Economics survey for the first quarter showed 56% of respondents reported rising wage costs—the highest share since the survey’s inception in 1982—but only 28% of respondents reported charging customers higher prices. (…)

According to Goldman, a percentage-point increase in wage inflation would reduce earnings in the consumer-discretionary sector by 1.1%. And Bank of America notes that operating margins have begun to soften in the sector—which houses the most labor intensive companies in the market. (…)

Meanwhile, companies in the leisure industry, many of which sit in the S&P 500’s consumer-discretionary sector, are the most exposed to increases in the minimum wage, Goldman says. Hotel operator Marriott International Inc. cited a tightening labor market and rising wages in its first-quarter earnings call as it reported declining profit margins in North America.

“When we look at cities across the country, there aren’t any places where wages, labor costs are growing at 2%,” Marriott Chief Executive Arne Sorenson said at a Goldman conference in early June. “They’re growing at faster rates.”

Overall, however, EBITDA margins are still rising as this KKR chart illustrates:

• US banks count on tax cut windfall to boost profits World trade nerves and mortgage slowdown threaten revenues

TECHNICALS WATCH

The sitting bull:

Lowry’s Research says that there has been little change in the condition of the market where both the primary and intermediate term uptrends remain intact. “At the time of
the June 12th rally highs in the major price indexes there were abundant signs of a healthy bull market including new highs in the Adv-Dec Lines, new lows in Selling Pressure, a new rally high in Buying Power and a new high in our Unweighted Operating Companies Only (OCO) NY Price Index. Thus, the probabilities are the pullback from the June
12th rally high represents a normal correction in an ongoing bull market.”

• Merrill’s sentiment indicator continues to show a healthy degree of nervousness about the market. (The Daily Shot)

Source: BofA Merrill Lynch Global Research

Two great investment minds:

• Byron Wien: No Recession in Sight

(…) We believe that the current business cycle has at least several more years left to run. The major signs that would herald the beginning of the next recession are not yet in place. Unemployment is low and likely to decline further; wages are rising, but not sharply; the Federal Reserve is tightening, but real interest rates are zero; inflation is moving higher slowly; the yield curve is not inverted; profits are increasing; and the leading indicators are still rising. Until some of these indicators change, the expansion is likely to continue. (…)

Our bullish thesis will likely be tested this summer. Mid-term election year stock market performance is notoriously bad. Historically, the market has corrected an average of -18.9% from peak to trough leading up to the election, based on data going back to 1962. But July in particular is typically the most painful month, as history shows it is the month when the market loses its gains, turning negative in the year to date column. Over the years there have been many theories attempting to explain the weakness seen around mid-term election, none particularly good, but still the pattern seems to persist. The summer months may be rough but we are optimistic for year end, and stick with our S&P 500® target of 3,000. (…)

Geopolitical factors as well as the continuing health of the world economies are critical to the continuance of the expansion of the United States. Business done abroad accounts for more than 40% of the earnings of the Standard & Poor’s 500. If overseas economies slow down or geopolitical events interrupt the continued expansion of the world economy, then the current positive cycle in the United States may come to an end earlier than we now expect. Short of that, the conditions that historically have brought on a recession, an overheated economy, rising inflation and higher interest rates, do not appear to be in prospect. Actually, a somewhat slower global economy may contribute to a longer U.S. business cycle because pressure on interest rates and inflation would be diminished. Right now, the United States equity market is assuming that all of these macroeconomic and geopolitical events will be resolved favorably. That seems somewhat unrealistic. For that reason, although I still think earnings will drive stocks to new highs before year-end, I am cautious over the next few months.

• Overheating Ahead  The economy by itself is heading for higher inflation (Richard Bernstein)

(…) A late-cycle increase in inflation is normal. Product and labor markets tend to tighten, and delays and shortages become more common as increasing activity strains the limits of the economy. It took longer than normal for the recent US economy to reach these late-stage constraints because of the slow growth trajectory of the recovery and expansion.

However, the business cycle has not been repealed, and inflation has been building as it always does during late-cycles. Investors appear unaware of how high US inflation already is relative to inflation rates around the world. Chart 2 shows that the US currently has the highest inflation rate in the world among developed nations. (…)

Longer vendor delivery times suggest demand is outstripping supply, and prices rise when demand is greater than supply. Vendor delivery times are not only lengthening, but are currently among the longest in the history of our data. (…)

Anecdotal evidence regarding labor union activity also reflects the current tightness of the labor market. Workers typically don’t form unions and strike when they are worried about job security. However, union power is apparently gaining as workers realize replacement workers are very difficult to find. (…)

It is somewhat surprising to us that investors seem more caught up in the political hype of fiscal stimulus than in assessing the investment implications of injecting significant stimulus into a late-cycle economy. It also appears to us as though public policies will exacerbate the late cycle’s bottlenecks, which could further spur inflation. (…)

At RBA our analyses suggest that accelerating nominal growth may be the next important investment theme, and few investors appear to be appropriately positioned should that occur.

INTERESTING CHARTS

Source: BofA Merrill Lynch Global Research (via The Daily Shot)

From Bloomberg:

• Sell Tesla. That’s the opinion of a high share of Wall Street analysts. Of 31 covering the stock nearly a third say sell. Compared with S&P 500 members, that’s tied for the most in absolute numbers and near the top based on the proportion of bears. Wall Street firms rarely tell clients to get rid of a stock. But niceties are out the window for Tesla, which is still burning through cash.
• Mall landlords want to stop tenants from fleeing their dying properties. They’ve long offered clauses that let them out of their leases if an anchor like a department store closes and decimates foot traffic. But as more retail giants shutter, the owners aim to get rid of those provisions. Running a mall these days is no walk in the park, as a turn playing Bloomberg’s arcade-style video game shows.
• Be careful what you wish for. Investors have been pressing oil companies to boost returns and increase payouts at the expense of exploration. But now, reserves at oil majors have fallen, and the reinvestment ratio is at its lowest level in a generation. The result, according to analysts at Bernstein, could be oil shortages and prices rising to $150 a barrel or beyond.