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: November 2018

THE DAILY EDGE: 16 NOVEMBER 2018

U.S. Retail Sales Rose in October Sales at stores and restaurants rose 0.8% after two months of declines, fueled largely by gains in automotive, gasoline and building-and-garden sales

(…) Retail sales for the prior two months were revised lower, to a 0.1% decline in both September and August from a previous estimate of a 0.1% increase in both months. Consumer spending was a major driver of third-quarter gross domestic product, though the revisions suggested spending might not have been as strong as first reported. (…)

Following the retail sales data, private forecasting firm Macroeconomic Advisers cut its estimate of third-quarter GDP growth to 3.4% and lowered its tracking forecast of fourth-quarter GDP growth to 2.5%. (…)

Excluding motor vehicles, sales were up 0.7% in October, and excluding gasoline, sales were up 0.5%. Excluding both categories, sales were up 0.3% last month. (…)

Fluctuations in gas prices can blur the picture. Sales ex-autos and gas stations were up 0.3% MoM, following 0.0% and 0.6% in the previous 2 months. This 3.7% annualized 3-m growth rate is weaker than the 4.7% YoY trend rate with most of the slowdown seen in furniture stores (weak housing market) and sporting goods.

Gasoline stations sales are up at a 19.4% annualized rate in the last 3 months (+16.2% YoY), absorbing a big slice of disposable income, but relief is happening now with gas prices almost back to their year ago level.

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Restaurant sales were weak in the last 2 months (-10.4% saar), partly due to gas prices, but also to rising meal prices. (See UNAPPETIZING)

Given trends in income, taxes and inflation, a weak year-end at retail would be surprising.

Walmart Inc., Macy’s Inc. and Home Depot Inc.have suffered steep share-price losses this week, even after posting relatively robust results. Walmart reported a rise in quarterly sales and boosted its profit outlook for the year Thursday, but its shares slipped 2%, extending their losses for the week to 5.7%.

A day earlier, Macy’s fell 7.2% even after delivering healthy sales growth in its latest quarter and raising its guidance for the year. The department-store operator’s shares continued falling Thursday, sliding 2.9%. The stock is off 15% this week but still up 28% for the year.

Home Depot slipped 0.2% Tuesday after similarly upbeat results, but the home-improvement retailer’s shares are off 4.6% this week, including a 1.4% decline Thursday.

The downturn has extended to other retailers that are scheduled to report results next week. Target Corp. has shed 7.1% this week, while Kohl’s Corp. is off 11%.

Those declines have weighed on the S&P 500’s consumer-discretionary sector, which snapped a four-session losing streak Thursday but is down 10.2% since the start of October. Consumer-staples stocks slipped 0.3% Thursday, taking a hit from Walmart, while the broader S&P 500 climbed 1.1%. (…)

Some analysts said one reason retailers fell even as major indexes stabilized Thursday was that the October retail sales report and other recent strong data points could give the Federal Reserve a freer hand to continue gradually raising interest rates. (…)

Consumer discretionary stocks are down 9.6% from their Oct. 1 peak, fluctuating around their flattening 200dma. Of the 48 discretionary companies that have reported Q3 so far, 77% beat forecasts and their beat rate is a huge 14.3% even though revenues beat by only 0.6%. Big margins gains. CD companies’ earnings are expected to jump 24.9% in Q3 against +13.0% expected on Oct. 1. Their Q4 earnings are seen up 13.5%, down from 17.8% on Oct. 1, slowing to +3.4% in Q1’19.

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Consumer Staples had a near-bear slide during the first half of the year, down 17.2% at one point before recovering 14.7% as investors went defensive.

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Economic Outlook from Freight’s Perspective

(…) the Cass Freight Shipments Index is clearly signaling that the U.S. economy, at least for now, continues to be extraordinarily strong. Simply stated, when shipment volume is up 6.2%, it is the result of an expanding economy. (…) since the end of World War II (the period for which we have reliable data), there has never been an economic contraction without there first being a contraction in freight flows. Conversely, during the same period, there has never been an economic expansion without there first being an expansion in freight flows.

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The Cass Expenditures Index is signaling continued strong pricing power for those in the marketplace who move freight. Demand is exceeding capacity in most modes of transportation by a significant amount. In turn, pricing power has erupted in those modes to levels that continue to spark overall inflationary concerns in the broader economy. With the Expenditures Index up 12.0%, we understand those concerns, but are comforted by two factors: the cost of fuel (and resulting fuel surcharge) is included in the Expenditures Index and the cost of diesel was up 20.9% in October; almost all modes of transportation are using the current environment of pricing power to create capacity. To the extent that pricing is materially exceeding the marginal cost of creating that capacity, market participants are investing heavily in the exact activities which kill pricing power in commodity markets (i.e., expansion of capacity with the belief that current pricing power will endure for an extended period of time).

As we explained in previous months, we do not fear long-term inflationary pressure as technology provides multiple ways to ever increase asset utilization and price discovery in all parts of the economy especially in transportation. In fact, we are continuing to see more signs that ELDs (Electronic Logging Devices), which initially hurt the capacity/utilization of truckers (especially small truckers), are becoming an ever-smaller impediment to capacity utilization. Many of the truckers which were the most adversely effected are now getting most, if not all, of the original loss in utilization back. This is especially true in the Dry Van and Reefer (temperature control) marketplaces of trucking. Even the Flatbed segment of trucking, which initially faced the greatest challenges with productivity after the adoption of ELDs, has begun to adapt.

(…) The current level of volume and pricing growth is signaling that the U.S. economy is growing, but that level of growth may have reached its short-term expansion limit. The 6.2% YoY increase in the October Cass Shipments Index is yet another data point confirming that the strength in the U.S. economy continues. This is a deceleration from the low double-digit levels achieved in the first five months of 2018, and even a slight deceleration from the 8.2% achieved last month. We are confident that the increased spending on equipment, technology, and people will eventually result in increased capacity in most transportation modes. That said, many modes are continuing to report “limited amounts of capacity” or even “no capacity” at any price shippers are willing to pay.

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(…) That these percentage increases are still strong and strong against tough comparisons explains why our economic outlook continues to be bullish, why transportation capacity is constrained, and why realized pricing is so strong.

As we have discussed in previous reports, Dry Van trucking volume serves a similar role to container volume in predicting retail sales. When studied using the DAT Dry Van Barometer, a clear pattern of strong volume growth that exceeds capacity growth, which is driving pricing power, remains.

Bottom line – the DAT Dry Van Barometer is giving us real-time indications of stronger demand and tighter capacity in this key freight group. Indicating that the consumer economy is not only alive and well, but growing robustly.

In a similar fashion to the DAT Dry-Van Barometer, the DAT Flatbed Barometer is indicating that the U.S. Industrial economy is alive and well and accelerating. (…)

Fingers crossed Trump and Xi Likely to Get Only Framework Trade Deal, Ross Says

The U.S. still plans to raise tariffs on Chinese imports in January with President Donald Trump and China’s Xi Jinping likely at best to agree to a “framework” for further talks to resolve trade tensions at an upcoming meeting, Commerce Secretary Wilbur Ross said. (…)

It can’t be expected that the two presidents will “get into intimate details — how much LNG and how much this and that. It’s going to be big picture, but if it goes well, it’ll set the framework for going forward,” Ross said. “We certainly won’t have a full formal deal by January. Impossible.” (…)

The U.S. has a long list of demands with 142 items, which will take some time to discuss “let alone to resolve them and let alone to put them on paper,” the secretary said.

Ross’s comments are a sign of what appears to be a growing appetite in the Trump administration to reach a deal with China to bring an end to the escalation of tit-for-tat tariffs that have unnerved investors and companies around the world. But they also were an acknowledgment of just how hard securing a deal will be.

People familiar with the discussions say the list of potential concessions presented by Chinese negotiators this week didn’t include any major new offers or pledges for action on broader U.S. concerns over Beijing’s industrial policy.

He said, though, that he remained confident that a deal would eventually be made, though big questions remain about when that would happen. (…)

Thumbs up Thumbs down Confused smile Investors are clearly, justifiably, very worried about the Nov. 20 meeting between Xi and Trump, as are probably every corporate executive in the world. The Brexit mess is pretty minor against the possibility of a major trade war that would impact the whole world. Any agreement to hold fire and keep talking will be welcome. While this seems to me the most likely scenario, eventually leading to a mutual face saving accord, the risks of being wrong are such that it seems best to keep some dry powder for now.

(…) “The circumstances may come where Asean will have to choose one or the other,” Lee said on Thursday night at the close of a regional summit hosted by the 10-member Association of Southeast Asian Nations. “I hope it does not happen soon.” (…)

The Brexit endgame: Deal or no deal With British Prime Minister Theresa May facing a political crisis after reaching a Brexit deal on Tuesday, Amanda Sloat describes what the EU-U.K. withdrawal agreement entails, how key issues were resolved, and the highly uncertain road ahead.

THE DAILY EDGE: 15 NOVEMBER 2018

Inflation Jumps, but Is Likely to Slow The consumer-price index increased 0.3%, the largest monthly gain since January

Yes, everything points to slower inflation in coming months.

  • Core CPI growth remains below 0.2% MoM (+1.6% annualized in last 3 months)

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  • Core Services have decelerated throughout 2018, indicating that there is no major cost-push from wages:

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Sticky-Price CPI Rose in October
The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 2.0 percent (on an annualized basis) in October, following a 2.7 percent increase in September. On a year-over-year basis, the series is up 2.4 percent.

  • The Sticky-Price CPI is showing no signs of acceleration. If anything, it is suggesting slower inflation ahead:

  • The flexible cut of the CPI (brown line below) -a weighted basket of items that change price relatively frequently- tends to react much faster to demand/supply conditions. It has turned up in 2018 but remains subdue within its recent range:

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The recent drop in oil prices adds to downward pressures on inflation throughout the economy. All good for the world economy, interest rates, profits and non-energy equities. Caveat:

One reason there is little apparent tariff effect on prices might be that companies, having seen earlier sets of tariffs from Washington, raced to import goods before the tax went into effect. In the third quarter, goods imports rose an annualized 10.3% from the second quarter, according to the Commerce Department, and inventories swelled.

That could help retailers and other consumer-facing companies keep prices low during the coming holiday shopping period, but the cushion on prices will only last so long.

If President Trump follows up on his plan to raise the tax on the goods hit with tariffs in September to 25% at the end of the year, prices could experience a sudden lurch. (WSJ)

In the meantime, the Rule of 20 P/E has fallen below 19.0 at 18.9 while the Rule of 20 Fair Value (yellow line) keeps climbing with rising trailing earnings and slowing inflation. Fair Value is now 2868, up 19% from its January level as trailing EPS have jumped 21%.

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Global Economic Slowdown Deepens
Fed Tracking World Growth Worries, Powell Says

(…) “You’ve seen a bit of a slowdown—not a terrible slowdown,” Federal Reserve Chairman Jerome Powell said Wednesday evening. “You still see solid growth, but you see growing signs of a bit of a slowdown. And it is concerning.”

One-time events played a role in some of these bumps, including a typhoon and earthquake that hit Japan and bottlenecks at German auto plants associated with new emissions standards.

But across the globe, economists and business executives warned about a common denominator that is hurting growth: trade battles among the U.S., China and others. Tariffs are hitting some businesses, and worries about the impact of worsening trade discord are also weighing on sentiment. (…)

“I’m very happy about the state of the economy now,” he said. “Our policy is part of the reason why our economy is in such a good place right now.”

One risk is that U.S. economic growth could slow in coming years as recent fiscal stimulus from tax cuts and spending increases wears off, Mr. Powell said during a moderated discussion at the Dallas Fed with the reserve bank’s president, Robert Kaplan.

A separate challenge is that U.S. growth continues to outpace the rest of the world, putting strains on some emerging-market economies that face headwinds from a stronger dollar.

“The U.S. economy is just really strong, and it is stronger than many other major economies right now,” he said. (…)

Mr. Powell said Wednesday the main challenge facing the Fed now is to consider how much further and at what pace to raise rates. He said the central bank would evaluate “really carefully…how the markets and the economy and business contacts are reacting to our policy.” (…)

Mr. Powell said Wednesday he was optimistic the U.S. economy could sustain a higher growth rate, which could potentially allow for faster growth without a large increase in inflation. “You always want to be on the optimistic side of this economy,” he said. (…)

China Outlines Possible Trade Concessions to U.S. Before G20, Sources Say

The commitments for now fall short of the type of major structural reforms that President Donald Trump has been demanding, two of the people said, cautioning that a long road lies ahead in negotiations. One person said that talks between the world’s two largest economies are continuing and constructive. (…)

Most of the document appeared to be a rehash of previous changes already made by Beijing, such as raising equity caps on foreign investment in certain industries, according to one person. It did not contain the sort of commitment to change industrial policies such as Xi’s “Made in China 2025” that Washington has been seeking, according to one person familiar with the discussions.

Two other people familiar with the talks also said the Chinese offer was a sign of what they characterized as constructive discussions between the two sides ahead of the planned G20 meeting between the two leaders. (…)

Treasury Secretary Steven Mnuchin and Xi’s main economic emissary, Liu He, spoke last Friday for the first time in months. Since then, lower-level discussions have been held and Larry Kudlow, the head of Trump’s National Economic Council, on Tuesday said the two capitals were in touch “at all levels.”

On the American side, the discussions are currently being led by Mnuchin and the Treasury, which has raised questions among some observers about the process.

Mnuchin is seen as an advocate within the administration of a deal, while others such as Robert Lighthizer, the U.S. trade representative, have been pushing to continue raising pressure on Beijing to try to push for more meaningful reforms. (…)

Scissors, who has previously advised the Trump administration on its China trade stance, said in an interview Wednesday the most likely outcome of the Trump-Xi meeting at the G20 was a “cease fire,” or a deal to avoid any further escalation in tariffs while the two sides hold deeper discussions.

But he said the chasm between the two sides on issues such as Chinese industrial policy and intellectual property theft remained vast and that any post-G20 negotiations were likely to be difficult as a result. (…)

The president has deferred until next year a decision on imposing 25 percent tariffs on imported automobiles and is considered likely to hold off on new trade restraints on Chinese imports when he meets China’s President Xi Jinping later this month at the Group of 20 summit — refraining for now from moves that would mean higher prices for American consumers.

Larry Kudlow, the director of the National Economic Council, this week also publicly rebuked a prominent advocate of hard-line trade measures, White House adviser Peter Navarro, saying he was “way off base” with recent remarks assailing Wall Street supporters of a compromise with China.

“The recent market turmoil, House election result and angst in farm states has the Trump team rattled on trade,” said one multinational executive, who spoke on the condition of anonymity to speak freely about White House deliberations. “The president still wants to pull the trigger on crazy stuff like an autos tariff, but he’s lost some of his swagger, and a lot of people around him are saying he needs to back away from extreme action.” (…)

Favorite Stock Market Crystal Ball May Have a Crack in It High-yield bonds, one of the stock market’s best-known bellwethers of doom and gloom, might be missing a beat when it comes to predicting the next meltdown.

(…) So far, the evidence is leaving investors scratching their heads. High-yield credit spreads—the extra yield investors demand to hold junk bonds over ultrasafe Treasurys—narrowed in the months leading up to the S&P 500 slumping 7% in October, its worst month in over seven years. Junk bonds outperformed during that selloff, with the ICE BofAML U.S. High Yield Index declining only 2% last month.

That could mean all is well with stocks. But some wonder if the predictive power of junk bonds won’t work this time. Changes in the market, central banks distorting asset prices, and the surge of tech stocks, which don’t tend to issue junk bonds, has sapped high yield of its previous highly predictive quality. (…)

I don’t pretend to know exactly why HY bonds are still holding except to suggest that investors probably are not sniffing a recession just yet and that the enormous profits this year are obviously helping debt ratios. That said, the hunt for yield still seems very much present:

The Case of the Disappearing Collateral Investors are literally giving away the store to squeeze out meager returns from the picked-over market for corporate debt.

Demand for riskier bonds and loans has been so intense that companies selling them are able to move valuable assets beyond the reach of creditors. And investors continue to make it easier for them to do so by agreeing to terms in new debt sales that offer them fewer and fewer protections. (…)

The erosion in lender protections—which has made it easier for businesses not only to shift assets from lenders but issue more debt and use asset-sale proceeds for purposes other than paying down debt—is expected to have meaningfully negative impact on debt investors during the next wave of bankruptcies. The typical recovery on leveraged loans will likely decline to 61% of face amount in the next downturn, compared with the 77% historical average, according to Moody’s Investors Service. (…)

“Look Ma, no hands”Not using hands!

Uber Posts Slower Sales Gains, Widening Loss Ahead of 2019 IPO Results for the three months ending in September show that Uber is still growing quickly but is likely to be unprofitable for some time.

The ride-hailing company on Wednesday announced third-quarter revenue rose 38% from a year earlier to $2.95 billion, but that was less than the second-quarter year-over-year jump of 63%. Its loss widened to $1.07 billion from $891 million in the second quarter.

Uber has accrued roughly $2.5 billion in losses this year, not including the sale of its unprofitable businesses in southeast Asia and Russia. Last year, Uber lost about $4.5 billion. (…)

In documents for a bond offering last month, Uber said it expected it wouldn’t reach a profit for at least three years. (…)

Unicorns (e.g. Uber, WeWork, AirBnB, Palentir) seem to be piling up losses at the same rate that their valuation is rising. According to Grant’s, CB Insights counts 287 unicorns worldwide with a collective value of $952 billion, most losing money and most planning a 2019 IPO. The last time we saw something similar was in the late nineties. Maybe they lost their window. Tech stock indices are the only sectors left with a rising 200-day moving average, but for how long. The FAANGs have lost 18% of their combined market cap since Aug. 30.

Devil Big Tobacco Warns Against Menthol Ban

Will they put their warning on packages?