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: July 2019

THE DAILY EDGE: 16 JULY 2019

ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES, June 2019

Advance estimates of U.S. retail and food services sales for June 2019, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $519.9 billion, an increase of 0.4 percent (±0.5 percent)* from the previous month, and 3.4 percent (±0.7 percent) above June 2018. Total sales for the April 2019 through June 2019 period were up 3.4 percent (±0.5 percent) from the same period a year ago. The April 2019 to May 2019 percent change was revised from up 0.5 percent (±0.5 percent)* to up 0.4 percent (±0.2 percent).

image

This is from ING this a.m.:

US June retail sales look very strong with the “core” retail sales control group rising 0.7% month-on-month (consensus 0.3%) with upward revisions to the history. Headline sales rose a more modest 0.4% (consensus 0.2%), but even this is a firm figure that suggests the market is too aggressive in terms of pricing for interest rate cuts.

The headline rate was always going to be somewhat depressed given it is a nominal (value) figure and faced having to deal with a near 5% fall in the retail price of gasoline (3.6% on a seasonally adjusted basis, according to the CPI report). Gasoline station sales consequently fell 2.8% MoM. We also knew that the auto component wasn’t going to contribute meaningfully given unit sales were unchanged on the month. Nonetheless the nominal value of motor vehicle and parts sales rose 0.7% MoM in today’s report, suggesting some margin improvement.

It is the core control group that really interests us though. It excludes the volatile food, auto, building materials and gas station sales and better reflects the spending patterns seen in the personal consumer expenditure data, which in turn contributes to GDP. There was broad strength with furniture, clothing and health rising 0.5% while non-store retailers saw sales rise 1.7% MoM for the second month in a row. The year over year growth of this key indicator continues to strengthen and currently stands at 4.6%.

Source: Bloomberg

Today’s retail sales report suggests that personal consumer spending rose robustly in 2Q, probably close to 4% annualised, which in turn will help to keep GDP growth above 2%. Despite this financial markets continue to price in four 25 basis point interest rate cuts from the Federal Reserve over the next 18 months.

Yet, in an environment where growth is solid, core inflation is close to target, unemployment is near 50-year lows and stock markets are at all-time highs, there seems little justification for anything more than precautionary rate cuts. We expect 25bp moves in both July and September as an insurance policy to try and mitigate any negative effects from lingering trade tensions. For us to put more cuts into our forecast, we would need to see a dramatic escalation in the US-China trade conflict that would lead to clear evidence of weaker hiring and investment. At this stage, there is little evidence of this happening.

Economic Outlook from Freight’s Perspective

(…) With the -5.3% drop in June following the -6.0% drop in May, we repeat our message from last month: the shipments index has gone from “warning of a potential slowdown” to “signaling an economic contraction.”

We acknowledge that: all of these negative percentages are against extremely tough comparisons; and the Cass Shipments Index has gone negative before without being followed by a negative GDP.

May and June’s drops are significant enough to pose the question, “Will the Q2 ’19 GDP be negative?”

The weakness in spot market pricing for many transportation services, especially trucking, is consistent with the negative Cass Shipments Index and, along with airfreight and railroad volume data, strengthens our concerns about the economy and the risk of ongoing trade policy disputes. Weakness in commodity prices and the decline in interest rates have joined the chorus of signals calling for an economic contraction.

image

Based on all three months of data for Q2, the Cass Shipments Index is signaling the GDP may be negative, or at least come close to being negative, in Q2. If it does not, since reported GDP often lags the economic activity represented by freight flows, continued weakness in the Cass Shipments Index at the current magnitude should result in a negative Q3 GDP.

image

One has to wonder whether the below has anything to do with the above?

  • Amazon, the new king of shipping
  • “Amazon is about 40% of all e-commerce. If they’re handling half of their own shipments, that’s 20% of the whole market,” Alex Pellas, a logistics expert at market research firm Rakuten Intelligence, says. “That’s huge.”
  • In a dataset provided first to Axios, Rakuten Intelligence followed tracking numbers for millions of Amazon packages per month.
  • Researchers found that nearly half (48%) of Amazon packages are delivered by the company itself.
  • That’s a dramatic shift from two years ago, when the Postal Service delivered more than 60% of Amazon parcels, and Amazon just around 15%.

(chart via The Daily Shot)

China Growth at Its Slowest Since 1992 as Beijing Struggles to Juice Economy China’s economic growth was weakened by trade tensions with the U.S. and businesses holding back from making big investments despite encouragement from Beijing.

The economy grew by 6.2% in the second quarter, down from 6.4% in the period before, official statistics showed Monday. Growth was slower than the 6.3% year-over-year rate forecast by economists. (…)

Investment in bridges, roads and other infrastructure rose 5.8% in the first half of the year compared with 5.6% during the first five months. Factory output was up 6.3% in June from a year earlier, compared with 5.3% in May. (…) Nomura calculated that factory output was up 5.6% on a quarterly basis in the April-to-June period, compared with 6.5% in the first quarter. (…) Exports fell 1.3% in June from a year earlier after rising 1.1% in May, according to official data released last week. (…)

For reasons of its own, the WSJ stopped short at the data and did not report these important stats (courtesy of Andy Rothman)

Nominal retail sales rose 9.8% YoY in June and 8.4% for the first half of the year. This is cooler than the 9.4% pace during 1H18, but still quite healthy. Sales of cosmetics, for example, rose 22.5% in June, and household appliance sales were up 7.7%. Online sales of goods rose 21.1% last month. (…)

Real per capita disposable income rose 6.5% in 1H19, close to the 6.6% pace a year ago. (…) The housing market also held up better than I had expected, given that the government cut spending by half on renovation of low-income units this year. New home sales (by square meter) fell by 1% YoY during 1H19, compared to increases of 3.2% a year ago and 13.5% two years ago.

But that still translates into full-year sales of about 12 million new apartments, and inventories are low, so investment in residential property rose 15.8% during the first half, up from 13.6% a year ago. Housing starts rose 9.9% during 2Q19, down from 16.6% a year ago.

Another important factor is that the surveyed unemployment rate has been relatively stable: 5.1% last month, compared to 4.8% a year ago. (…)

Slowing China = ammo for the U.S. in trade negotiations? Think again:

  • The US manufacturing sector activity has caught up with the global slump.

Source: Morgan Stanley Research (Via The Daily Shot)

(…) Indeed, its own measure of China’s economic activity — the CMI — slipped for the third consecutive month to 4.8% in May.

Optimism at Chinese companies falls to survey low in June

The latest IHS Markit Business Outlook survey shows the net balance of firms predicting a rise in activity declining to +9% from +16% in February. Furthermore, the latest reading is the lowest observed across all monitored countries, contributing to the weakest global average (+18%) on record. (…)

image

  • But see how the U.S. has fared in the past year:

image

This next chart is from Bloomberg:

C-suite confidence in U.S. has faltered for better part of a year

Tariffs on China Don’t Cover the Costs of Trump’s Trade War

(…) Mr. Trump’s tariffs on Chinese imports raised $20.8 billion through Wednesday, according to data from United States Customs and Border Protection. Mr. Trump has already committed to paying American farmers hurt by the trade war $28 billion.

The president has rolled out two rounds of financial support for farmers: a $12 billion package that was announced last July, of which nearly $10 billion has been spent, and an additional $16 billion announced in May.

The government has provided no such benefit to the myriad other businesses, including plane makers, technology companies and medical device manufacturers, that have lost contracts and revenue as a result of Mr. Trump’s tariffs and China’s retaliation against American goods. (…)

There is little sign, though, that China’s loss is America’s gain. Much of the business activity is shifting to other low-cost countries, like Vietnam, with a transition cost attached for American companies that depend on them. (…)

But the monthly pace of revenue collection from tariffs has not increased this year. That’s because America is importing fewer Chinese goods than it did a year ago, which has canceled out the higher tariffs on a larger share of Chinese goods.

That decline appears to be the product of an overall slowdown in trade — which has contributed to weakened exports for American manufacturers — and the shift in supply chains to other countries. Imported goods from Vietnam have risen more than 30 percent this year from a year ago, Commerce Department data show.

Tariff revenue would likely surge if Mr. Trump followed through on his threat to impose tariffs on nearly all Chinese goods.

(…) On Monday, Mr. Trump signed an executive order requiring that 95 percent of the steel and iron that goes into projects funded by federal contracts eventually be American made, up from 50 percent. (…)

Powell Concession on Too-Tight Fed Underlines Shift Toward Cuts

Jay Powell last week to the Senate Committee:

“We’re learning that interest rates — that the neutral interest rate — is lower than we had thought and I think we’re learning that the natural rate of unemployment is lower than we thought,” the Fed chief said. “So monetary policy hasn’t been as accommodative as we had thought.”

THE DAILY EDGE: 15 JULY 2019: No Longer A Mad World?

China Trade Data Points to Sagging Economy

Chinese exports fell 1.3% in June from a year earlier, after rising 1.1% the previous month, the General Administration of Customs said Friday. Imports fell 7.3% in June versus a 8.5% drop in May. (…)

China’s exports to the U.S. fell 7.8% in June from a year earlier, extending a 4.2% decline in May, customs data show. Imports from the U.S. tumbled 31% from a year earlier. The bilateral trade surplus widened to $29.92 billion—the highest in seven months—from May’s $26.9 billion.

Bucking the trend, exports to Southeast Asian countries surged nearly 13% in June, extending May’s 3.5% growth, possibly a sign of transshipping to circumvent the tariffs. (…)

Left hug Right hug New face on China’s trade team worries White House

The Trump administration is increasingly concerned about prospects for a trade deal with China, amid an unexpected reshuffling of the Chinese negotiating team and a lack of progress on core issues since the Group of 20 (G-20) summit in Japan, according to United States officials and senior Republicans briefed on the discussions.

Commerce Minister Zhong Shan, regarded by some White House officials as a hardliner, has assumed new prominence in the talks, participating in a Tuesday (July 9) teleconference alongside Chinese Vice-Premier Liu He, who has headed the Chinese trade team for more than a year. (…)

“Zhong is a hardliner’s hardliner,” said former White House chief strategist Stephen Bannon, who remains close to several Mr Trump advisers.

Mr Zhong, who joined the Communist Party at 18 years old, is the second veteran trade official to be added to the Chinese team in recent weeks. In April, Mr Yu Jianhua, one of China’s most experienced trade negotiators and its ambassador to the United Nations Office in Geneva, returned to Beijing to bolster Mr Liu’s delegation. (…)

Hopes for a deal also have been dented by China’s failure to make large new purchases of US farm products – despite US President Donald Trump’s claim at the G-20 that Chinese President Xi Jinping had agreed to place such orders “almost immediately” – and the lack of any announced schedule for the next round of direct talks. (…)

“This has to be seen as a loss of confidence in Liu He and the desire of the leadership to bring in someone more politically savvy,” said Mr Dennis Wilder, a former China analyst at the Central Intelligence Agency. “I am sure his instructions are to get tougher with the US.” (…)

Mr Trump told his trade team before the Tuesday call to secure the new Chinese orders for soybeans and wheat he believed he had been promised in Osaka, Japan.

But Mr Zhong and Mr Liu offered no specific commitments, leaving negotiations at a virtual standstill, according to a White House official who spoke on the condition of anonymity because the official was not authorised to speak publicly. (…)

“Republicans in general are frustrated that the Chinese have been so uncooperative at this stage, and it’s now clear this is going to be a slow process,” said conservative economist Stephen Moore, an informal Mr Trump adviser. “They keep backpedalling, and the hardliners in China play right into the hands of hardliners in the US.” (…)

 How China’s Hidden Debt Is Getting Even Riskier

In a bid to boost the economy, China this week announced it would allow local governments to borrow more to fund infrastructure investment. As part of this push, it will let municipalities use the proceeds of special-purpose bonds(6) as equity in railroad, highway and other projects.(3) Previously, local governments weren’t able to use such debt as seed capital. (…)

China’s new policy could amount to an additional $13 billion to $19 billion of project capital from special-purpose bond issuance through the rest of this year, S&P Global Inc. analysts estimate. In theory, adding equity helps secure bank financing, too. Beijing said the usage of special-purpose bonds’ proceeds for project capital would be closely monitored. (…)

Beijing seems to be backtracking on its deleveraging efforts and going back to its old playbook. The stakes are only getting higher and the risks murkier.

(…) Furthermore, little is actually known about the loans. China’s foreign assets are now worth $6 trillion, but outside of the government in Beijing, nobody knows much about where that money has been invested and what conditions and risks are attached. Because China doesn’t completely open its books to international organizations like the World Bank and the International Monetary Fund (IMF), there is a lack of needed transparency, says IMF head Christine Lagarde.

Now, though, with the release of a new study by a German-American team of academics under the leadership of Harvard professor Carmen Reinhart, Largarde will have a clearer picture. For months, the economists dug through both known and unknown source material, compiling the most comprehensive analysis yet of Chinese foreign loans. And the image that has resulted does nothing to assuage concerns about the financial power being exerted by Beijing.

On the contrary: The data shows that many countries in the poorer regions of the world have accepted far more credit from China than previously known. And the loans frequently come with onerous conditions that are strongly oriented toward Beijing’s strategic interests and increase the risk that many countries in the developing world could plunge into financial crisis. “The West still hasn’t understood how profoundly China’s rise has changed the international financial system,” says Christoph Trebesch, a co-author of the study from the Kiel Institute for the World Economy. (…)

To ensure that the loans are paid back, the contracts guarantee Beijing a number of rights, such as access to foodstuffs, raw materials or the profits of state-owned companies in the recipient countries. (…)

The German-American study […] argues that many payments from Beijing are masked because they go straight to state-owned companies operating in recipient countries. The balance sheets of those companies, though, are frequently not accounted for in official financial statistics. The result is that a large chunk of Chinese development loans is concealed from Western governments and international organizations. The study found that the amount of foreign debt held by China is around 50 percent higher than is documented by official statistics.

The discrepancy is particularly large in those countries that are already heavily indebted. In Ivory Coast, for example, debt levels are $4 billion higher than previously thought. The difference in Angola is $14 billion and in Venezuela it is $33 billion. Because the Beijing government tends to charge high interest rates, many emerging and developing countries suffer, according to the study, from “growing annual debt service obligations.” That means their interest rate payments continue to rise, which increases the danger that they may ultimately default.

Study authors note that the situation is reminiscent of the late 1970s, a time when large banks from the U.S., Europe and Japan provided billions in loans to Latin American and African countries rich in commodities — credits that flew under the radar of international monitoring agencies. When prices for many raw materials crashed, countries like Mexico could no longer service their debts and much of the developing world slid into a debt crisis that set them back for years.

Today, the situation is hardly any different. Once again, many developing countries have accepted huge loans. And once the hidden money flows from China are included, as the study shows, the debt loads being carried by many countries are again as high as they were in the 1980s. The authors write that the situation looks “strikingly similar.”

Already, there are initial indications of an approaching crisis. Pakistan was recently forced to apply for an emergency IMF loan because it was no longer able to service its massive Chinese debt load. In Sierra Leone, the government stopped the construction of an airport that China had intended to finance. Meanwhile, IMF Managing Director Lagarde hardly holds a speech in which she doesn’t mention the dangers facing global financial stability. (…)

U.S. Producer Prices Rose Slowly in June The modest gain in the overall producer-price index masked divergent behavior in two of its most volatile components, energy and trade services

The producer-price index, a measure of the prices businesses receive for their goods and services, rose a seasonally adjusted 0.1% in June from a month earlier, the Labor Department said Friday. (…)

Energy prices plummeted 3.1% in June from the previous month, while trade services, which measures profit margins in wholesale and retail businesses, jumped 1.3%. Prices for food, which also show large month-to-month swings, jumped 0.6% in June.

Excluding food, energy and trade services, prices were flat from May. (…) Compared with June 2018, the overall producer-price index was up 1.7% last month. Excluding food and energy, the index was up 2.3%.

If the PPI is any indication, the U.S. manufacturing sector is in near-deflation. Final demand core goods prices have been flat for 3 months while intermediate demand processed and unprocessed goods are deflating.

image

image

EARNINGS WATCH

The game people play…This is from Factset:

S&P 500 WILL LIKELY REPORT EARNINGS GROWTH IN Q2 2019

(…) Over the past five years on average, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.8%. During this same period, 72% of companies in the S&P 500 have reported actual EPS above the mean EPS estimate on average. As a result, from the end of the quarter through the end of the earnings season, the earnings growth rate has typically increased by 3.7 percentage points on average (over the past 5 years) due to the number and magnitude of upside earnings surprises.

If this average increase is applied to the estimated earnings decline at the end of Q2 (June 30) of -2.7%, the actual earnings growth rate for the quarter would be 1.0% (-2.7% + 3.7% = 1.0%). (…)

SP 500 Earnings

On the eve of the Q2 earnings season, analysts are scrambling to revise their numbers, mostly down again.

image

image

Over the next two weeks, I will be much less interested in the beat rates than in the actual earnings and revenue growth rates. The 24 companies that have already reported their Q2 boast an 83% beat rate vs the 65% long term average and the 76% prior four quarter average and a +5.7% surprise factor (+3.3% long term average, +5.3% last 4 quarters). Their revenue beat rate was 75%, also well above the 60% long term average and the 63% prior four quarter average. The revenue surprise factor was +0.8% (+1.5% long term average, +1.0% last 4 quarters).

But why should we be impressed, let alone happy, with their aggregate earnings decline of 7.8% on revenues up 3.0% following –4.6% and +5.4% respectively in Q1? Earnings are not only decelerating, they are falling at an accelerating rate. And margins are seriously contracting.

At the end of the day, we don’t buy revisions or beat rates, we buy earnings.

In the table below, I have highlighted quarters when sector earnings decelerate (excluding Energy which has its own dynamic). Analysts are totally united predicting that Q2 will prove to be the trough in trends for almost each and every sector.

image

What has suddenly happened since June 30th?

If the economy has reaccelerated and business sales (volume + inflation) are now rising much faster than wages (costs), somebody should tell Chairman Powell and his FOMC colleagues. If the trade war and all the uncertainty and supply chain adjustments stemming from it have ended, somebody should tell Trump and Xi so that they move on to some other game.

image

Did you know that pre-tax corporate margins (red line) are now lower than they were prior to the Great Financial Crisis without the negative effects from collapsed oil prices like in 2015-16?

Maybe corporate America will again prove its resilience even against the current daunting challenges. A case in point:

Middle market private companies in the Golub Capital Altman Index experienced approximate year-over-year earnings growth of 12.5% and revenue growth of 10.3% during the first two months of the second quarter of 2019. This compares to approximate year-over-year earnings growth of 9.5% and revenue growth of 9.3% in the first quarter of 2019.

image

Lawrence E. Golub, CEO of Golub Capital, said, “We continue to see very strong growth in the U.S. middle market, especially among domestically focused companies. The Golub Capital Altman Index for the second quarter of 2019 posted a seventh consecutive quarter of revenue growth at or near double-digit rates, and a fifth consecutive quarter of earnings growth at or near double-digit rates. We see ample momentum in the economy to offset the potential impact of tariffs. The labor market is strong, inflation is tame, fiscal policy and monetary policy are expansionary; in short, the U.S. economy does not look to us like it currently needs additional support from the Fed.”

Dr. Edward I. Altman said, “Revenue and earnings growth remain strong in our sample of U.S. middle market companies, showing a modest acceleration from the healthy pace of the first quarter of 2019. Earnings growth outpaced revenue growth in aggregate and in most of our sector indices, suggesting that labor costs had limited impact on profit margins despite a very strong labor market. We are not surprised to see a moderate deceleration of earnings growth in our sample of Technology companies year-over-year; the second quarter of 2018 was exceptionally strong. Overall, our data highlights the fundamental strength of U.S. middle market companies focused on the domestic market.”

image

TECHNICALS WATCH

Lowry’s Research reminds us that “the formation of major market tops is a process, not an event. Specifically, the eroding strength that ends a bull market is a gradual process
occurring over a period of months, not days or weeks.” Lowry’s analysis shows that “Selling Pressure has set lower lows at each of the [recent] bull market highs – Jan. 2018, Sept. 2018 and April 2019. Although now above its April 2019 low, Selling Pressure is currently trending lower (…) At the same time, there is little sign of the steady erosion in Demand that typically occurs in the final stage of a bull market. (…) In summary, although the S&P 500, by some perspectives, shows only nominal gains since the Jan. 2018
bull market high, there is little evidence suggesting this apparent ‘consolidation pattern’ represents a major market top. To the contrary, the forces of Supply and Demand
continue to suggest an ongoing, healthy bull market.”

But it is still mainly a large cap market:

spy

mdy

sly

iwm

The S&P 500 Index has run pretty far ahead of its 200 dma:

image

And it is in rising risk territory from a valuation viewpoint, with flattening earnings and a Fed desperately trying to lift demand and inflation amid admittedly tight labor resources and generally rising corporate costs.

image

Nerd smile The Only Thing the Smart Money Is Smart About A number of recent studies show that professional investors—the, ahem, smart money—are prone to the same mistakes that individual investors make. The difference, our columnist writes, is that the pros get paid to make them.

(…) The problem, says Essentia’s head of research, Chris Woodcock, is what psychologists call the “endowment effect.” This is the automatic tendency to put a higher value on what you own than what you don’t—and to become reluctant to part with something merely because it is yours.

Therefore, he says, portfolio managers “put greater focus on positive rather than negative attributes” of the stocks they own. That leads them to minimize potential bad news and to hang on too long. (…)

Clock A bit of my own history in finance…Yes, I was using VisiCalc early on.

40 Years Later, Lessons From the First ‘Killer App’ VisiCalc, the world’s first spreadsheet, took the nascent personal computing world by storm, and just as suddenly ceased to exist—in the process, writes Christopher Mims, it transformed how companies are built and how all of us make decisions

(…) VisiCalc was unveiled on June 4, 1979, and shipped that October. Dan Bricklin first dreamed it up in a classroom at Harvard Business School—the room now bears a plaque commemorating his idea—and partnered with Bob Frankston, who coded VisiCalc and collaborated in its design.

When users opened VisiCalc, they would see a character-based grid where numbers or text could be manipulated. It was handy for budgeting, financial projections, bookkeeping and making lists. Today it’s instantly recognizable as a spreadsheet, as familiar to us as a blinking cursor, but at the time it was a novel idea that had to be experienced to be understood. (…)

VisiCalc was the first piece of software that was so popular that it drove people to buy computers just to run it. (…)

Mitch Kapor, who worked for VisiCalc’s publisher as a product manager, left the company and began working on his own spreadsheet program. Instead of creating it for the Apple II, Mr. Kapor put his money on another horse: the brand-new IBM PC. Released in 1983, his software—Lotus 1-2-3—took the world by storm on a scale that even VisiCalc’s success couldn’t have foretold. (…)

Lotus 1-2-3 had variable column widths, a macro language to allow simple programming in cells, and the ability to create charts and graphics. Plus, it was fast. (…)

After Mr. Kapor stepped down as CEO of Lotus, the company focused on porting its product to IBM’s OS/2, its attempt to beat Microsoft at PC operating systems, missing the shift to Microsoft’s Windows. That shift was driven largely by users clamoring, yet again, for the best system to run the best spreadsheet—in this case Excel, which Microsoft announced for Windows in 1987. (…)

Also showing my age…

Crying face It’s No Longer a ‘Mad’ World

It’s No Longer a ‘Mad’ World

Really?