Month: July 2019

U.S. GDP Growth Eases

Economic growth slowed last quarter, but not as much as expected. Real GDP increased 2.1% (AR) in Q2’19 (2.3% y/y) following an unrevised 3.1% increase during Q1. (…) Data back for five years was revised.

Growth in domestic final sales continued to drive the economy forward with a 3.5% increase (2.3% y/y). It was the largest quarterly gain in a year, underpinned by a 4.3% advance (2.6% y/y) in personal consumption expenditures. That was the strongest quarterly rise since Q4’17 and driven by a 12.9% strengthening (4.4% y/y) in durable goods purchases. Growth was bolstered by a 17.0% advance (9.3% y/y) in purchases of recreation goods & vehicles which came after 12.5% Q1 growth. Spending on motor vehicles improved 15.9% (1.8% y/y) and reversed the Q1 decline. Spending of home furnishings & appliances grew 9.1% (2.7% y/y) after a 1.9% rise. Spending on nondurable goods rose 6.0% (3.4% y/y), the strongest quarterly gain in over 25 years. It was led by a 14.1% jump (4.4% y/y) in clothing outlays. (…)

Consumer outlays on services gained 2.5% (2.1% y/y), the strongest growth in three quarters. Spending at restaurants & hotels increased 4.6% (2.0% y/y) following two quarters of decline.(…)

Stronger government spending also propped up domestic final sales growth with a 5.0% increase (2.4% y/y) which followed a 2.9% rise. Combined, these were the strongest gains in ten years. Federal government outlays jumped a strengthened 7.9% (3.5% y/y) as nondefense outlays surged 15.9% (1.8% y/y) and made up two straight quarters of decline. Defense outlay growth moderated to 2.8%. Growth of 4.6% y/y was up, however, from declines from 2011 to 2016. Spending by state & local governments also picked up to 3.3% in 2019 from minimal growth two years earlier.

Nonresidential fixed investment eased 0.6% (+2.7% y/y) after two years of strong gain. Spending on structures declined 10.5% (-4.6% y/y). (…) Residential investment fell 1.5% (-2.8% y/y) and has been falling since late in 2017.

Charts from The Daily Shot:

• The personal savings rate was revised higher, which should be a tailwind for consumer spending.

Source: @GregDaco

Revisions had a big impact on corporate profit margins. Note how pretax margins have declined since their Q4’17 peak of 15.7%. The drop in Q1 was steep, to 11.7%. The tax reform masked some of this big erosion. Corporate America is not immune to what’s going on…

Note also that margins had been declining for a while before the last 2 recessions. Actually, this has been a feature of all post-war recessions.

Truckers Wrestle With Oversupply of Big Rigs, Falling Freight Rates Companies that bulked up capacity during last year’s shipping boom see demand waning

(…) Many carriers plowed 2018 profits and the gains from the 2017 corporate tax cut into record orders for new equipment, resulting in a growing supply of trucks while cargo volumes in U.S. distribution channels have been sliding.

Bad weather, tepid industrial growth and trade tensions have contributed to sagging business, freight executives say. Companies that pulled imports forward late last year ahead of anticipated tariffs are working through excess inventory piled up in warehouses, and cool temperatures put a damper on spring shipments of produce, beverages and patio furniture. (…)

The average spot market price to hire a big rig was off 18.5% in June from the same month a year ago, to $1.89 per mile, according to online freight marketplace DAT Solutions LLC. Last month on DAT’s platform there were about three loads for every available truck, compared with six loads per truck in June 2018. (…)

But manufacturers are still working through lengthy order backlogs and fleets continue taking delivery of new trucks, said Kenny Vieth, president of transportation industry data provider ACT Research, which tracks orders of equipment including Class 8 trucks, the big rigs used to haul freight over long distances.

“Freight as we measure it is growing at less than 1% in 2019,” Mr. Vieth said. “Our modeling suggests that we are adding about 7% to the U.S. Class-8 market capacity…. So the supply-demand equilibrium is tilting away from truckers right now.”

China’s Economy Weakened Further in July, Early Indicators Show

The slowdown is seen in a Bloomberg Economics gauge aggregating the earliest available indicators on market sentiment and business conditions. (…)

Kudlow says US has ‘ruled out’ currency intervention Trump concerned others countries are weakening their currencies to boost exports

TECHNICALS WATCH

Lowry’s Research saw that “abundant signs of strength accompanied this week’s new all-time highs in the S&P 500 indicating a healthy, ongoing bull market with little evidence of an approaching major market top.(…) This week’s new highs in the S&P 500 were also accompanied by signs of renewed strength in small caps. (..) However, small caps should be closely monitored to determine if this week’s improving breadth was a temporary rebound or the start of a sustained trend.”

However, “Despite this week’s new high in the S&P 500, Buying Power remains far below its Apr. 8 recovery high while Selling Pressure remains well above its Apr. 8 low. Thus far, however, there is little evidence of a change in the Indexes’ long-term trends which remain down for Selling Pressure and sideways for Buying Power (since March 2018). Most important, there is little evidence of the sustained rise in Selling Pressure during a market rally that, historically, has warned of the approaching end to a bull market. (…)”

I personally pay particular attention to Lowry’s chart of supply/demand. My own analysis is that July shows diminishing demand slowly converging towards flattish selling pressure, suggesting little conviction on the buy side. Lowry’s concurs, saying further down in its analysis that “a resumption of the uptrend in Buying Power and downtrend in
Selling Pressure would put the current rally on more stable ground for further appreciable gains.”

Also needing more solid ground:

EARNINGS WATCH

Strong Earnings Allay Fears Over Trade and Growth—for Now Corporate profits are proving to be more resilient than expected in the second quarter, nudging the stock market higher this month and distracting from anxieties about trade and economic growth.

Of the 221 S&P 500 companies that have reported earnings through Friday, 170 have surprised investors with better-than-expected results, according to FactSet. Technology giants Alphabet Inc. GOOG 10.45% and Twitter Inc. TWTR 8.92% both topped expectations, sending shares up 9.6% and 8.9%, respectively, on Friday. Coca-Cola Co. and United Parcel Services Inc. also jumped after reporting results last week.

Average earnings among S&P 500 companies that have reported are up 0.7% from a year earlier, according to FactSet. That has helped improve analysts’ forecasts for earnings to a 2.6% contraction for the quarter, better than the more than 3% pullback they had been predicting last week. (…)

The S&P 500 has risen 2.9% so far in July, extending its gain this year to 21%, largely driven by the expectation of an interest-rate cut from the Federal Reserve. The stock market’s two best months, January and June, coincided with some of the strongest signals from Chairman Jerome Powell that the central bank will cut interest rates this year. (…)

“The ‘Powell put’ is driving the market higher, but the problem in the economy isn’t that rates are too high,” said Liz Ann Sonders, chief investment strategist at Charles SchwabCorp. “What ails us is a global manufacturing recession and business confidence being severely dented by a trade war.”

Industrial manufacturers are on pace to notch the second-biggest contraction in quarterly profits after materials stocks, with earnings projected to fall more than 12% from a year earlier, compared with expectations of a less than 2% pullback earlier this month, according to FactSet. (…)

Meanwhile, technology and communication companies reporting so far have mostly surprised investors to the upside, sending shares of both sectors up more than 5% each this month. (…)

As of Friday, the S&P 500 traded at 17 times its earnings over the next 12 months, its highest level since late September, just before the stock market’s fourth-quarter selloff. (…)

Here’s Refinitiv’s weekly factual account:

Through July 26, 218 companies in the S&P 500 Index have reported earnings for Q2 2019. Of these companies, 75.2% reported earnings above analyst expectations and 17.9% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 20% miss estimates. Over the past four quarters, 76% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 4.6% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.3% and the average surprise factor over the prior four quarters of 5.3%.

Of these companies, 60.0% reported revenues above analyst expectations and 40.0% reported revenues below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 63% of companies beat the estimates and 37% missed estimates.

In aggregate, companies are reporting revenues that are 0.9% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 1.0%.

The estimated earnings growth rate for the S&P 500 for 19Q2 is 0.5%. If the energy sector is excluded, the growth rate improves to 1.2%. The estimated revenue growth rate for the S&P 500 for 19Q2 is 3.6%. If the energy sector is excluded, the growth rate improves to 4.0%.

The estimated earnings growth rate for the S&P 500 for 19Q3 is -0.5%. If the energy sector is excluded, the growth rate improves to 0.8%.

Revisions were somewhat better last week, particularly for large caps.

Blended growth rates for Q2 (blending actual earnings from companies having reported with expected earnings from the others) are flat overall for Q2 but sectorial trends differ markedly:

A few other interesting facts:

• In dollar terms, earnings are set to decline 1.7% YoY in Q2 and –2.9% in Q3 after –0.8% in Q1. Stock buybacks are keeping the per share numbers near the zero line in Q2 and Q3 after +1.6% in Q1.
• S&P 500 companies’ revenues are expected up 3.6% in Q2 and 3.5% in Q3, a sharp slowdown from +5.7% in Q1 and +7.2% on average in 2018.
• The big meaningful surprise so far this quarter is the 9.2% expected earnings gain from Financials, from +5.6% expected on July 1st. Financials account for 20% of total S&P 500 share-weighted earnings. This is in spite of Financials’ revenues rising only 1.2% and generally lower net interest margins. And the Fed is about to cut rates…
• Technology earnings, 18% of the total, are still expected down 4.0% in Q2 and –6.3% in Q3, after –1.1% in Q1 and +10.3% in Q4’18. Unless equities completely disengage from earnings, this is not a good trend. Technology revenues are down 0.7% in Q2 and are seen down 0.6% in Q3. The hopes are high for a Q4 rebound.

More importantly, however, is that trailing EPS keep declining. They were $163.19 on Friday, down from $163.99 at the end of June. This, coupled with inflation at 2.1%, is resulting in the Rule of 20 Fair Value (yellow line) declining to 2921 from 2953 at the end of June, the first decline since September 2018.

With a Rule of 20 P/E of 20.6, the S&P 500 Index is 3.3% above Fair Value, its first foray into the “Rising Risk” area since September 2018.

Here’s the chart on the actual P/E using trailing operating EPS, currently at 18.5x. The LT average is 13.7. For a more positive reading, one can use the 18.9 average since 1993, but please consider that this period includes the dot.com era…

I have been posting on the Japan-South Korea dispute. Today’s WSJ had this:

An escalating dispute between Japan and South Korea has Silicon Valley technology suppliers on edge. American trade groups warn the tensions between two of the world’s leading tech producers could inflict lasting damage on global supply chains that are already fraying under disrupted U.S.-China relations. Japan is weighing whether to broaden new export curbs on chemicals needed to make memory chips and phone displays, fields where South Korea produces most of the world’s supply, the WSJ’s Timothy W. Martin writes. Production delays could threaten the availability of everything from smartphones to Amazon.com Inc.’s cloud-computing data servers. South Korea is Japan’s third-largest export market, and companies there are burning through stockpiles and hunting for alternate suppliers. The American Chamber of Commerce in Korea is urging Japan and South Korea to make a fair settlement and says a protracted dispute “will have negative implications globally.”

• Trump rejects Apple request for tariff relief on Mac Pro parts iPhone maker had sought exclusions for certain components made in China

WHY CHINA MATTERS

From a recent McKinsey report:

• China accounts for 35% of global manufacturing output. Although it accounts for only 10% of global household consumption, it was the source of 31% of global household consumption growth from 2010 to 2017. Moreover, in many categories including automobiles, spirits, luxury goods, and mobile phones, China is the largest market in the world, accounting for about 30% (or more) of global consumption.
• China accounts for more than 20% of global consumption in 17 of 20 categories in manufacturing, and China’s share of services consumption has also increased. This implies that companies looking for sources of growth may not be able to afford to overlook opportunities in China.
• China accounted for 40% of global mobile phone sales in 2017, 64% of battery electric vehicles sales, and 46% of semiconductor consumption. According to an MSCI index, the US information technology sector makes 14% of its revenues in China.
• By 2030, 58% of Chinese households are likely to be in the “mass affluent” category or above. (,,,) Chinese urban consumers are devoting a greater share of their income to discretionary spending. Spending on food declined from 50% of total household consumption in 2000 to 25% in 2017. This is already similar to urban consumers in developed countries today – Japan at 26%, South Korea at 29%, and the USA at 17%.
• (…) growth in Chinese consumption in the period to 2030 is likely to be about $6 trillion, comparable to that of ther US and Western Europe combined, and double that of India and the ASEAN combined.