Month: December 2018

China Prepares to Increase Access for Foreign Companies China is preparing to replace an industrial policy savaged by the Trump administration as protectionist with a new program promising greater access for foreign companies.

China’s top planning agency and senior policy advisers are drafting the replacement for Made in China 2025, President Xi Jinping’s blueprint to make the country a leader in high-tech industries including robotics, information and clean-energy cars. The revised plan—Beijing’s latest effort to resolve trade tensions with the U.S.—would play down China’s bid to dominate manufacturing and be more open to participation by foreign companies, these people said.

Current plans, they said, call for rolling out the new policy early next year, when the U.S. and China are expected to be accelerating negotiations for a deal to end their bruising trade battle. China has signaled other measures as well, including lowering tariffs on auto imports and increasing purchases of U.S. agricultural products. (…)

The revision is also likely to be treated with skepticism in the U.S. Officials in the Trump administration have called Made in China 2025 a threat to fair competition, saying it encourages state subsidies for domestic companies and forces technology transfer from foreign partners. Some U.S. officials are likely to see the changes as more cosmetic than real. (…)

Chinese officials backing the proposed changes emphasize that China needs to move away from Made in China 2025 and state-led development for its own reasons. Mr. Xi’s economic adviser, Vice Premier Liu He, and other senior officials have criticized Made in China 2025 for creating waste. Cheap loans made available by various levels of government, for example, have led to extreme overcapacity among electric-vehicle battery makers in the past couple of years, making the sector less viable.

A more market-driven approach to upgrading the manufacturing sector would produce better economic returns and help rekindle the Chinese leadership’s commitment to overhauls, the people briefed on the matter said. Mr. Xi has stressed a shift to higher-quality growth, and China this month marks the 40th anniversary of the market-oriented changes that transformed the country from one of the world’s poorest.

Beijing is also planning to announce policies aimed at introducing fairer competition among state-owned, private and foreign firms based on the concept of “competitive neutrality,” the people said. (…) Under the concept, governments are prohibited from favoring state-owned companies over privately owned ones. (…)

U.S. Consumer Prices Flat in November, Posing Dilemma for Fed CPI report suggests underlying inflationary pressures remain stable as the central bank gears up to raise interest rates this month

U.S. consumer prices were flat in November, the Labor Department said Wednesday, restrained by tumbling oil prices last month. With November’s reading, the inflation index was up 2.2% from a year earlier, down from a 2.5% annual change in October and a 2.9% change in July.

A measure of inflation that strips out volatile food and energy categories, so-called core prices, was a bit firmer. The index rose 0.2% on the month, the same pace of growth as in October, and up from 0.1% readings in both August and September. Over a year, it was up 2.2%, staying within a range of 2.1% to 2.3% that has prevailed since March. (…)

Monthly changes in core CPI reveal very stable trends over two-year periods. The 2.0% target has been reached and is proving very stable in spite of stronger GDP growth and increased consumer demand.

Accelerating wage growth has not translated into accelerating prices for Services (63% of CPI) and housing-related inflation (33%) has been stable in the 2.8-3.0% range during the last 18 months. Core Goods prices (20%) are down 0.4% YoY and up only 0.8% annualized in the last 3 months (although up 3.0% annualized in the last 2 months. Tariffs?)

• Good News for Manhattan Apartment-Hunters: Rents Are Down Again

SENTIMENT WATCH

The Bull Case For Stocks Is Compelling An economic slowdown might actually extend the life of the expansion and the bull market in equities.

Good piece from Chuck Lieberman, Chief Economist, and Chief Investment Officer at Advisors Capital Management, LLC.

With my own comments:

(…) The market is now priced for the fear of an imminent recession, which is unlikely. Barring some unexpected adverse shock, equities represent an exceptional buying opportunity.

Let’s start with market valuations. The S&P 500 Index is trading at about 15 times expected 2019 earnings of $178 per share below the average of about 16.2 times over the past 50 years. By itself, this is sufficient to suggest stocks are cheap, but that valuation is skewed by a few very large, rapidly growing firms that are valued at dramatic premiums to the average.

Excluding the “FANG” group of stocks (Facebook, Amazon.com, Netflix, and Google-parent Alphabet, plus throw in Microsoft for good measure), the remaining 495 stocks in the S&P 500 are priced at less than 13 times expected 2019 earnings. That’s not the only sign of cheapness. The appropriate price/earnings multiple for the stock market is inversely related to the level of interest rates, since valuations are discounted flows of future earnings. With rates still at historically low levels, stock multiples should be decidedly above historical averages. Historically, with inflation around 2 percent, the average price earnings multiple has been around 19 times earnings.

The facts:

• Expected EPS for 2019 are $175.95 per IBES/Refinitiv.
• The average P/E on forward EPS is 15.8 since 1968 but is is 13.0 since 1953 and 12.9 since 1983. Pick your period! At 2655, the S&P 500 is selling at 15.1x forward EPS.
• The median P/E on forward EPS is 15.8 since 1968, 12.5 since 1953 and 12.4 since 1983.
• Actually, the Rule of 20 says 2% inflation means fair P/E of 18.0, but on trailing earnings. Inflation is actually 2.2% so fair P/E = 17.8. It is now at 16.5 on trailing EPS (pro forma for the tax reform over 12 months), about 8% undervalued.
• According to Ed Yardeni, the forward P/E on IT stocks is 16.0 vs 15.4 on S&P 500 ex-IT. Here’s the LT chart FYI:

According to Value Line, more than 100 companies trade at forward price/earnings multiples below 8. There hasn’t been so many cheap since the peak of the credit crisis in late 2008, when forward earnings projections were probably not worth much anyway. The last time the market saw more stocks with single-digit price/earnings multiples was in 1984, after inflation was coming off its peak of 10 percent, 30-year Treasury bond yields were coming down from 15 percent, and Fed policy rates had decreased from above 20 percent.

The facts:

• 42 S&P 500 companies trade below 8x forward P/E, 89 below 10.0x and 141 below 12.0x.
• The median P/E on S&P 500 companies is 16.0x right on its 50 year median (15.8) but well above its longer term level of 12.5.
• Using the Morningstar/CPMS universe of 2171 companies, 213 (9.8%) trade below 8x, 397 (18%) below 10.0x and 617 (28%) below 12.0x. The median is 16.9x.

Beware using forward multiples. They can prove elusive in tough conditions.

(…) The retreat in stock prices reflects a fear that the Fed might raise rates sufficiently to precipitate a recession, or that one may be underway already. This seems to be fear run amok. Some point to the slowdown in housing as signaling weakness, although there are multiple factors at work here. More expensive homes are under exceptional pricing pressure because of the loss of property tax deductions. In the Northeast, lower-priced homes continue to sell rapidly, mid-priced homes sell slowly, and expensive homes sell by appointment, if that frequently. In multiple communities, homes priced above $1.5 million to $2 million have two years’ supply on the market.

The facts:

• It is true that the housing market is weak in the Northeast, particularly in the NYC area, but the Northeast is the smallest housing market in the U.S.  and housing weakness is seen across the USA. The truth is that all interest rate sensitive sectors are weakening in a typical cyclical fashion when the Fed is hiking.

The nearly inverted yield curve is another factor used to project a recession. It is factually true that every recession in the post-World War II period has been preceded by an inverted yield curve. However, not every inverted yield curve is followed by a recession. Plus, the average period between inversion and recession is more than two years. Purveyors of the doom-is-nigh thesis are getting ahead of the data.

Nothing could be more attractive for corporate profits and stock prices than for the economy to continue expanding at a moderate 2 percent pace while rates remain low. The mere suggestion of some sort of detente between the U.S. and China on trade could trigger a massive rally and a new manic phase. And that would be entirely consistent with the market’s normally erratic behavior.

Agreed, with the caveat that the consumer sector needs to remain solid and that the Fed proves flexible and timely. Inflation has slowed measurably per the PCE deflator below 2.0% which should allow at least a pause in the Fed’s hiking expedition. At 2.0%, any economy is fragile to any kind of shocks.

And, speaking of potential shocks:

• Is 2019 Going to be the Year of the Profit Margin Problem?

China Moves to Address U.S. Economic Concerns Beijing agrees to reduce auto tariffs and buy more American products, but key differences remain

Beijing sought to ease tensions with Washington as its top trade negotiator told U.S. officials that China was planning to reduce auto tariffs and boost purchases of soybeans and other crops, according to people in both capitals briefed on the discussions. (…)

Washington is also readying a host of additional measures to take against China. Federal prosecutors are expected to unseal criminal charges shortly against hackers linked to the Chinese government, The Wall Street Journal reported last week. The hackers allegedly engaged in a sophisticated multiyear scheme to break into U.S. technology service providers to compromise the networks of their clients.

The U.S. is also preparing to use export controls, indictments and other tools to counter the theft of intellectual property. (…)

Officials in both Beijing and Washington insisted the Huawei controversy wouldn’t derail talks. (…) On Tuesday, President Trump told Reuters in an interview he would intervene with the Justice Department on the Huawei matter if it helped secure a trade deal, connecting two issues that his aides had earlier said were separate. (…)

On Tuesday morning, Mr. Trump wrote on Twitter that “very productive conversations” were taking place with China. “Watch for some important announcements!” (…)

Beijing is also considering other changes to try to settle the trade dispute, including making changes to the Made in China 2025 plan, said people familiar with the matter. The a state-led industrial policy—aimed at enabling Chinese companies to dominate industries from artificial intelligence to robotics—is a focal point of U.S. complaints that Beijing engages in unfair trade practices that put foreign firms at a disadvantage to Chinese companies. (…)

Clearly, both Xi and Trump want a deal. Now, add these next 3 items:

• China Default-Risk Jumps to 2005 High, Says Moody’s Analytics

The research group’s measure of expected default frequency has risen above early-warning levels for about 25 percent of corporate borrowers. (…)

“If the Chinese economy were to slow further or, worse still, if the economy were to enter a sustained downturn, we would likely see corporate credit risk start to increase sharply,” he said. (…)

“All of these industries are construction-related and the rise in credit risk mirrors the fall in construction activity over the past several years,” the report said. (…)

Watch China housing!

• US farmers hit by soaring storage costs Trade war double whammy as soyabeans go unsold and tariffs push up cost of metal bins

• Apple Is Considering Moving iPhone Output If Tariffs Hit 25% Apple has long used China as its production base for everything from its signature device to iPads and Macs.

(…) A 10-percent tariff could result in an earnings-per-share decline of just $1 for Apple, should all its hardware sold in the U.S. be subject to the levy and the company absorbs the cost, RBC analyst Amit Daryanani wrote in a Nov. 28 research note. That compares with the average 2019 Apple-EPS estimateof $13.32, according to data compiled by Bloomberg.

However, a more severe scenario of a 25 percent tariff — absorbed by Apple — could result in an EPS decline of about $2.50, he added. (…)

U.S. Producer Prices Edge Higher

The headline Final Demand Producer Price Index using new methodology ticked 0.1% higher (2.5 % y/y) during November following a 0.6% October increase. No change in the index had been expected in the Action Economics Forecast Survey. Producer prices excluding food & energy rose 0.3% (2.7% y/y) after a 0.5% jump. A 0.2% gain had been anticipated. The PPI excluding food, beverages and trade services is another measure of underlying price inflation. It also rose 0.3% (2.8% y/y) last month following a 0.2% increase.

The PPI using the old methodology fell 0.8% during November (+1.6% y/y) following a 0.8% October decline. Prices excluding food & energy improved 0.3% (2.4% y/y) after holding steady in October.

The moderate gain in producer prices overall reflected a 0.3% increase (2.6% y/y) in services prices. It followed a 0.7% rise. (…) Goods prices decreased 0.4% (+2.2% y/y) last month after a 0.6% October rise. Goods prices excluding food & energy eased 0.3% (+2.5% y/y) following no change. Durable consumer goods prices held steady (1.7% y/y) after a 0.2% decline. (…)

Food prices strengthened 1.3% last month (0.4% y/y) after a 1.0% increase. (…) Construction prices improved 0.2% (5.1% y/y) after a 1.9% strengthening.

Prices for intermediate demand processed goods declined 0.7% (+4.3% y/y) and offset a 0.8% rise during October.

SENTIMENT WATCH

The Great Cheapening: Global Stock Valuations Now at Five-Year Lows

The forward price to earnings ratio for global stocks is at five-year lows, having dropped to about 13.3 times. That’s down from more than 16 times in early 2018, according to FactSet’s World stock index, which includes tens of thousands of listed securities around the world. (…)

Earnings-per-share of stocks listed on FactSet’s World Index are expected to rise about 15.9% in the next 12 months.

That’s down from the highs of above 25% earlier this year, but well above the 5.8% average seen in the past five years. (…)

Understand that the above discusses forward P/Es. David Rosenberg and many CFOs would be wary of those today:

RECESSION MATH

The excellent David Rosenberg is bearish and his current narrative fits his views. His GDP math is pretty simple:

• lagged impact of Fed’s QT: –1.0%
• fiscal stimulus withdrawal: –1.0%
• negative wealth effect (equities, homes): –1.0%
• corporate deleveraging: –0.5%

“The damage has been done,” leaving 2019 with a modest 0.5% contraction like in 1954, 1958, 1974 and 1980. A spreading trade war: another –0.5%.

Many U.S. Financial Officers Think a Recession Will Hit Next Year Almost half of U.S. chief financial officers believe a recession will strike the U.S. economy by the end of 2019, with the tight labor market and growing trade tensions driving economic jitters among corporate America.

(…) Additionally, more than 80% of U.S. CFOs think a recession will strike by the end of 2020, according to the Duke University/CFO Global Business Outlook survey released Wednesday.

“All of the ingredients are in place: a waning expansion that began in June 2009—almost a decade ago—heightened market volatility, the impact of growth-reducing protectionism, and the ominous flattening of the yield curve which has predicted recessions accurately over the past 50 years,” said Campbell Harvey, a director of the survey. (…)

The CFOs also were concerned about recent international trade disputes. The Trump administration’s growing trade frictions with foreign countries, particularly China, have led many firms to put investments and other business moves on hold until tensions clear up.

On top of that, CFOs from around the world are pessimistic, too. Almost all executives surveyed in Africa think their countries will be in recession by the end of next year, as do 86% of CFOs in Canada. Sixty-seven percent of executives thought the same in Europe.

“The U.S. outlook has declined, and moreover the outlook is even worse in many other parts of the world, which will lead to softer demand for U.S. goods,” said John Graham, another director of the survey. (…)

If you missed yesterday’s Daily Edge:

Charles Schwab’s Jeffrey Kleintop finds that an inversion of the 10y-3m U.S. yield curve has preceded each global recessions by about one year since 1970 and should be used as a signal for non-U.S. stock markets:

(…) Why is the U.S. yield curve so much better at gauging global economic conditions? For one thing, the U.S. is the world’s largest economy and a major source of demand for global companies. In addition, the U.S. government bond market is the largest and most liquid in the world, which may mean it better reflects global conditions and is less susceptible to domestic influences than other countries’ bond markets. (…)

Word-ex-U.S. equities are now officially in a bear market, down 20.1%:

• The S&P 500 is off 10.1% from its Sep. 20 peak:

• But U.S. small caps are down 18.1% S&P 600) or 17.3% (Russell 2000):

Notice the unsupportive 200-day moving averages.

Trump, Top Democrats Clash Over Spending Bill President Trump sparred in public with top Democrats, declaring he would shut down the U.S. government if Congress refused to fund his proposed border wall.

Huawei’s Meng Wanzhou Granted Bail by Canadian Judge Huawei’s finance chief must reside at Vancouver homes and adhere to a curfew while awaiting a decision on her extradition to the U.S.

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  Former Canadian Diplomat Held in China

Canadian and U.S. officials said they were concerned about the detention of a former Canadian diplomat in China, as Ottawa found itself at the center of an increasingly tense diplomatic standoff over the arrest in Vancouver of a senior executive at Huawei Technologies Co.

Michael Kovrig, a senior adviser with Brussels-based nonprofit International Crisis Group, was detained in Beijing on Monday evening by state-security officials, the group said in a statement. He recently traveled to China to work on a research report on North Korea, a person familiar with the matter said Tuesday.

It wasn’t clear whether Mr. Kovrig’s detention was related to that work. His mobile phones were switched off, and China’s foreign ministry didn’t respond to questions about his situation. (…)

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  US considers China travel warning after ex-diplomat held