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: June 2020

THE DAILY EDGE: 5 JUNE 2020

NOTE: It seems that Mailchimp failed to send yesterday’s Daily Edge to subscribers. You will find it right below today’s.

  • Russia, Mexico, Brazil all see alarming jump in cases, deaths
  • Hong Kong sees another alarming cluster
  • Florida reports most new cases since April for 2nd straight day. Payback for recent beach parties?
Instagram founders launch COVID-19 spread tracker Rt.live 

Rt.live is an up-to-date tracker of how fast COVID-19 is spreading in each state. “Rt” measures the average number of people who become infected by an infectious person. The higher above the number 1, the faster COVID-19 races through a population, while a number below one shows the virus receding. For example, Rt.live displays that Georgia has the highest, most dangerous Rt score of 1.5 while New York is down to 0.54 thanks to aggressive shelter-in-place orders. (…)

Rt.live shows that as of yesterday, Texas and California are at or just under 1 and Vermont has the best score at 0.33.

Rice: Bank of America says the staple food for half of the world’s population has jumped 70% since January, on a COVID-19 labor supply chain hit and stockpiling. (Axios)

The Goldman Sachs Analyst Index (GSAI) rebounded by 5.5pt to 29.2 in May. The composition of the rebound was mixed, as the sales and orders components increased but the employment component pulled back. The levels of all three components continued to indicate widespread contraction. The inventories, output prices, material prices, and wages components rose, while the exports component declined.

1. GSAI Rebounded in May, but Still Severely Depressed. Data available on request.
Hotels: Occupancy Rate Declined 43.2% Year-over-year, Seventh Consecutive Week of Higher Demand
The next big problem for the economy: Businesses can’t pay their rent Nearly half of commercial retail rents were not paid in April and May

The problem for the broader U.S. economy is that when businesses like Ross Stores and T.J. Maxx stop paying rent, it sets off an alarming chain reaction. Landlords are now at risk of bankruptcy, too. Commercial real estate prices are falling. Jobs at property management companies and landscapers face cuts. Banks and private investors are unwilling to lend to most commercial real estate projects anymore, and cash-strapped city and local governments are realizing the property taxes they usually rely on from business properties are unlikely to be paid this summer and fall. (…)

Lawmakers are trying to figure out how to prevent businesses — as well as their landlords — from going out of business, but government leaders are struggling to figure out how to help.

Some landlords are asking local governments to delay property tax collections, but many municipalities are already financially strained as tax proceeds plunge and costs skyrocket during the pandemic. (…)

This Time, Europe Hasn’t Thrown Away Its Shot Common borrowing is a historic step that would address a critical flaw in the single currency zone’s architecture.

(…) Germany, whose determination to maintain fiscal austerity is at the center of the euro zone’s problems, is now moving ahead with a 130 billion euro stimulus program, which chancellor Angela Merkel described as “courageous and decisive.” These measures give Europe a more coherent response to the pandemic than many thought possible. (…)

Another strong case in favor comes from Anatole Kaletsky of Gavekal Economics. First, he points out, the bonds will be issued by the EU in its own name, avoiding any confusion of joint guarantees. Second, and perhaps most important, this implies tax-raising power for the EU, beyond its current income from customs duties and a small share of value added taxes. Kaletsky suggests that this will need to be raised from “economic activities which transcend national boundaries” — so maybe a tax on carbon, financial transactions or digital activities. Finally, he points out, the proposal allows the EU to leverage itself. Interest rates are at rock bottom, so this could soon become a mechanism for dealing with far more than coronavirus relief. (…)

CMHC to tighten lending standards for home buyers Canada Mortgage and Housing Corp. is toughening up its rules to make it harder to get mortgage insurance, a move that would reduce demand from riskier borrowers and keep prices in check at a time of economic uncertainty.

Trump’s Re-Election Hopes Grow Shakier With Biden Gains A shifting battlefield map is imperiling Donald Trump’s re-election.

Democrat Joe Biden has pulled further ahead in the industrial Midwestern states that Trump won in 2016, as Trump’s handling of the coronavirus and the resulting job losses prompted a precipitous slide in his support.

Trump summoned top political advisers to the White House Thursday for a meeting to reverse the decline. (…)

Biden’s average lead in national polls has inched up 2 points over the last week, and he is now ahead of Trump by almost 8 points, his largest lead since December.

But it’s the Electoral College that chooses presidents, and Biden’s standing in battleground states has begun to repair the so-called “blue wall” of loyally Democratic states that Trump toppled in 2016. The former vice president now has consistent leads of 4 points in Pennsylvania, 4.2 points in Michigan and 3.4 points in Wisconsin.

(…) Biden’s hill to climb remains steep, with little room for error. If the rest of the map stays the same as 2016, Biden would need all three states to reach the 270 electoral votes necessary to claim the White House.

But the 2020 map so far looks significantly different in ways that could help Biden. He holds a substantial lead in Arizona, for example, a state that Trump won by more than 5 points in 2016. The former vice president believes he could be competitive or even win in Florida, North Carolina, Ohio and even Texas– all states that Trump comfortably won on his way to the White House. (…)

“If the election were held today, Donald Trump would lose,” said Republican strategist Terry Sullivan. “But the election isn’t today, it’s in five months. If we’ve learned anything over the last three-and-a-half years, it’s that five months out is a lifetime.” (…)

The president’s average approval rating in the RealClearPolitics average fell to 42.8% Thursday, its lowest point since November (…)

(…) “There’s absolutely zero chance” of reaching the purchase commitment announced in January when the deal was reached, said Joe Glauber, the U.S. Department of Agriculture’s former chief economist. “They’re just so far behind.” (…)

The U.S. Agriculture Department last week lowered its forecast for exports of farm goods to China by $1 billion, based on reduced demand. (…)

But the USDA forecast amounts to $8 billion in sales to China for the first nine months of this year, meaning another $28.5 billion would be required in the last quarter to fulfill Trump’s promise of $36.5 billion for the year. The last-quarter total would be more than double the largest exports on record for that time period, $12.4 billion in 2013.

China bought $4.65 billion in U.S. farm-related products in the first four months of the year, only slightly higher than $4.3 billion in the same period last year, which came in the middle of a trade war.

A Peterson Institute analysis concluded that U.S exports to China of agricultural products are running at only 38% of the pace set in the trade deal. (…)

Trump’s answer has been another bailout for farmers. After the president authorized back-to-back trade bailouts totaling $28 billion over two years, the administration in April announced a $19 billion rescue for farmers, using money Congress appropriated in its last coronavirus relief package. More aid is widely anticipated in the next virus spending bill Congress considers. (…)

Lawmakers in Eight Countries Form New Alliance to Counter China

A group of senior lawmakers from eight democracies including the U.S. have launched a new cross-parliamentary alliance to help counter what they say is the threat China’s growing influence poses to global trade, security and human rights.

The Inter-Parliamentary Alliance on China, which launched Friday, comes as the U.S. struggles to muster a cohesive alliance to take on China’s growing economic and diplomatic clout and as it leads foreign governments in condemning Beijing’s move to impose national security legislation on Hong Kong that threatens the city’s autonomy. (…)

The alliance said China’s economic rise is putting the global, rules-based order under pressure and that countries that have tried to stand up to Beijing have mostly done so alone — and “often at great cost.” The list of participating nations includes the U.S., Germany, U.K., Japan, Australia, Canada, Sweden, Norway, as well as members of the European parliament. (…)

“The time has come for democratic countries to unite in a common defense of our shared values,” Smith, the U.K. lawmaker, said on Twitter.

China Says It Will Take ‘Necessary Measures’ on U.S. Blacklist The Chinese government said it will take “necessary measures” to safeguard the interests of domestic companies, after fresh U.S. restrictions on a blacklist of 33 companies took effect Friday.
SENTIMENT WATCH
The Bulls Have Taken Back the Stock Market The S&P 500 is up nearly 40% in just the past 50 trading days, the largest such rally since 1957

(…) It has been a long time since anyone has called Boeing a winner, but the company’s stock staged a big rebound this week. Shares were up about 26% through Thursday, far and away the biggest move among the 30 Dow components. (…)

Boeing sits in the middle of many of the swirling issues in the markets. Its primary customers are airlines, which are under duress. They need business people and tourists to resume traveling. And for that to happen, the economy needs to recover, and progress needs to be made toward a coronavirus vaccine.

If those things don’t happen, it is hard to see how Boeing grows. (…)

Streetwise: Why Mr. Market Ignores a World in Turmoil

(…) Today’s question for the audience is: Why is the market rising even as U.S. cities burn, Hong Kong becomes a flashpoint in China relations with the West and the prospect of a second round of coronavirus infections remains real? (…)

The bullish story is that none of these problems matter nearly as much for stock prices as the good news for investors. Businesses are reopening while the Fed is providing unprecedented support and governments are subsidizing the economy to the tune of 11% of GDP in developed countries, Fitch Ratings calculates. (…)

The unrest and Donald Trump’s response have increased the chance of Joe Biden winning the presidency in November according to betting odds. But it is too early to be sure whether a message of “law and order” will help or hinder Mr. Trump in the polls. Aside from specific sectors, it’s also hard to know if the market as a whole would do worse from a president (Trump) threatening more tariffs, or a president (Biden) threatening more taxes. Higher taxes hurt more, but since they depend on Congress, investors might prefer to bet on gridlock. (…)

Meanwhile, there has been mixed news on the risks of a second round of infections as lockdowns end. Sporadic coronavirus outbreaks continue in South Korea despite a well-run test-and-trace system, while Israel has closed some schools again after infections spread; in many other countries the reopening has gone smoothly. Big rallies and widespread arrests raise the risk of a surge of infections in the U.S. both among protesters and police, but it will be weeks before we know. (…)

The market is probably ignoring incremental bad news because momentum has control. All those who missed the rally are buying in now that lockdown is easing, pushing up prices. The S&P 500 had its best-ever 50-day gain from the March lows to Wednesday. The prospect of a new high helps too: the Nasdaq-100 index dominated by big technology stocks briefly broke to a new high on Wednesday, while the S&P 500 is down only 3% this year (and less than 8% below its high).

(…) Easy money makes up for a lot of lost earnings. But market momentum always breaks eventually.

A big difference between this market and that of 2009 is that this one is trading on hope(s) whereas the 2009 upturn was fighting widespread despair and disbelief. Both trends were fueled by central bank easing and momentum. In 2009, “normalized” earnings were anathema. In 2020, the “V” recovery is expected to take care of everything. Like if nothing really happened…

Moody’s illustrates this Victory mentality with this next chart:

Core profits apply to all U.S. corporation s, as opposed to just the member companies of the S&P 500.Core profits exclude extraordinary gains and losses and changes in inventory valuations, while also employing economic depreciation instead of accounting depreciation.

Ordinarily, deep year-over-year declines by core after-tax profits are accompanied by year-to-year declines for the market value of U.S. common stock. For example, when calendar-year 2008’s core aftertax profits sank by 9.8% annually, year-end 2008’s market value of U.S. common stock closed 38.7%
under its year-end 2007 mark.

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Surprised smile Next Twelve Months P/E: Mega-Cap Growth Stocks vs. S&P 500 ex Mega-Cap Growth

Next Twelve Months P/E: Mega-Cap Growth Stocks vs. S&P 500 ex Mega-Cap Growth

The Institutional Investor Fear Index: No Business-as-Usual Anytime Soon

Investors pump record $22.5bn into US bond funds Cash infusion over past week is the highest since 2007, when EPFR started tracking

THE DAILY EDGE: 4 JUNE 2020

  • Brazil reported a record number of daily deaths from Covid-19 as the pandemic continued to spread in Latin America’s largest nation. It had 1,349 new fatalities on Wednesday, bringing the total to 32,548. Brazil also recorded 28,633 new cases, pushing the total to 584,016, behind only the U.S. The nation of 210 million people has become an epicenter of the virus, and health experts say the peak of the outbreak is still to come.
  • Mexico also registered a record daily rise of 1,092 deaths as President Andres Manuel Lopez Obrador resumed traveling across the country. Total deaths reached 11,729, according to data released by the Health Ministry on Wednesday night. The country now has the seventh-deadliest outbreak worldwide.
  • Swedish citizens’ confidence in the government’s handling of the pandemic fell to less than half the population, as the scientist behind the strategy acknowledged having made mistakes. A poll showed an 18 percentage point slump in support for the authorities’ response, including the controversial decision to leave much of society open even as swaths of the world shut down.

This chart from Goldman Sachs shows that positive test rates are trending down nationwide,including in the most open states:7. Positive Test Rates Are Trending Down Nationwide, Including in the Most Open States. Data available on request.

https://www.google.com/covid19/mobility/ Accessed: June 3, 2020. Source: The COVID Tracking Project, Google LLC “Google COVID-19 Community Mobility Reports”, Goldman Sachs Global Investment Research

  • Wuhan declared free of virus after blanket testing of 10 million
  • Researchers at Scripps Research Translational Institute reviewed studies of 16 different populations infected with the new coronavirus and examined how many showed no signs of illness. They concluded that asymptomatic people may account for 40% to 45% of infections. They also found that those individuals can transmit the virus to others for an extended period, perhaps longer than 14 days.
PANDENOMICS

Axios: ISM’s stronger-than-expected reading of U.S. services sector data grabbed headlines, but IHS Markit’s index told a different story.

We have learned over the years to put more weight on Markit surveys. Speaking of services:

Next Wave of U.S. Job Cuts Targets Millions of Higher-Paid Workers

Close to 6 million jobs are potentially on the line, according to Bloomberg Economics. That includes higher-paid supervisors in sectors where frontline workers were hit first, such as restaurants and hotels. It also includes the knock on-effects to connected industries such as professional services, finance and real estate. (…)

For the analysis, Shulyatyeva and colleagues looked at job losses by sector in March and April—with affected industries dominated by blue-collar, hospitality and production workers—and determined how those layoffs would move to supervisory positions, since management cuts tend to lag the frontline workers. (…)

The Bloomberg Economics analysis underscores how financial pain is extending beyond the retail, travel, leisure and restaurant industries immediately impacted by the shutdowns. (…)

More than one-third of households making $100,000 per year have lost some employment income since mid-March, according to a Census Bureau weekly survey. And more than 25% expect to lose income in the next four weeks. Even among this higher-paid group, 7% are only slightly confident or not at all about making next month’s rent, while 5% of homeowners are just as concerned about making their mortgage payment. (…)

Axios adds that the expectation for white-collar job losses tracks with surveys of top executives from accounting firm PwC which found 31% of CFOs thought layoffs would occur in the next month, double the percentage who expected to lay off employees at the end of March.

As a case in point, Bloomberg today reveals that “Evercore told its incoming investment banking analysts that it would offer them $25,000 if they delayed their start date by a year, or $15,000 for deferring until January, a person familiar said. While Evercore committed to avoiding job cuts during the outbreak, it said it will reduce about 6% of its workforce after it conducted an operations review earlier this year. 

  • Consumer spending measures rose by 0.3pp to 88.3% of the pre-virus level over the last week, up from an April bottom of 73%. Of the highly-impacted consumer services industries, the retail sector has recovered the most, with foot traffic now back to 74% of the pre-virus level, while the entertainment industry remains the most depressed, now only back to 51% of the pre-virus level. (GS)
  • The GS Exports Tracker indicates that manufacturing exports (ex-aircraft) worsened further in April but began to stabilize in May. Over the last 4 weeks, our tracker declined 9% year-on-year to 86% of the pre-virus level. (GS)
  • Business bankruptcy measures continued to increase, as the Survey of Credit Managers’ bankruptcy measure surged to a post-GFC high. (GS)
  • With Stadiums Closed, Municipalities Struggle With Billions in Debt Two decades of using borrowed money to pay for new stadiums is coming back to haunt many cities across the country. The Covid-19 pandemic has turned sports venues into a strain on budgets when cities are already hemorrhaging revenue from shutdowns.
  • Amid Coronavirus Shutdowns, Landlords Often Determine Fate of Small Businesses On Brooklyn’s Fifth Avenue, business owners are frantically seeking rent cuts so they can ride out the pandemic. But some landlords are also under financial pressure.
  • U.S. Jobless Claims Understate Reality With Gaps in Federal Data The weekly report has yet to reflect at least half a million filings for a federal pandemic program.
  • The ECB just added to the Eurozone policy fireworks of recent days, increasing the size of its pandemic emergency purchase programme (PEPP) by 600bn euro to a total of 1350bn euro. The purchases will last at least until the end of June 2021. Also, the ECB will reinvest the proceeds from the PEPP purchases until at least 2022. After the announcement of the European Recovery Plan and last night’s powerful German fiscal stimulus package, the ECB has added to real stimulus fireworks. Today’s decision should dent any future speculation about whether or not the ECB is willing to play its role of lender of last resort for the Eurozone. It is. (ING)
  • Beijing to Give $1.7 Billion in Vouchers to Boost Shopping

Beijing has joined dozens of other Chinese cities and will issue consumption vouchers to citizens, in an effort to encourage spending after retail sales collapsed following the coronavirus outbreak. (…) At least 50 cities across China have distributed vouchers amounting to more than 6 billion yuan via e-payment systems, according to data compiled by Bloomberg, including Wuhan, Hangzhou, Nanjing and Shenzhen.

Bank of Canada pares back some emergency supports, offers slightly more upbeat tone

(…) “Decisive and targeted fiscal actions, combined with lower interest rates, are buffering the impact of the shutdown on disposable income and helping to lay the foundation for economic recovery,” it said. “While the outlook for the second half of 2020 and beyond remains heavily clouded, the Bank expects the economy to resume growth in the third quarter.” (…)

The central bank said that the “severe” impact of the crisis on the global economy “appears to have peaked, although uncertainty about how the recovery will unfold remains high.”

(…) the bank forecast that the second quarter “will likely show a further decline of 10 to 20 per cent, as continued shutdowns and sharply lower investment in the energy sector will take a further toll.”

While that is a deep contraction, it is nevertheless more upbeat than the April MPR outlook, which warned that second-quarter GDP could be “15 to 30 per cent lower” than it was in the 2019 fourth quarter.

(…) the bank hinted it may be considering refocusing its asset purchases on influencing interest rates in order to stimulate the economy, rather than the current stated goal of facilitating smooth-functioning markets. (…)

EARNINGS WATCH

We now have 490 Q1 reports in and the blended growth rate for earnings is -12.6% on a -1.4% decline in revenues. Q2 estimates: -43.0%. Q3: -25.1%. Q4: -13.3% which would take 2020 earnings down 23.1% to $125.23.

Current consensus for 2021 is $163.67, down a little from $164.48 in mid-May.

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Supply Chains, Safety Protocols Hobble U.S. Factories Manufacturers are reopening, but delayed orders, less efficient plants and new procedures weigh on output

Interesting article laying out challenges facing manufacturers. A few excerpts:

  • ( …) he expects some suppliers to go out of business this year because they won’t be viable at lower production rates anticipated across the auto industry. “Any one failure is going to impact everybody,” Mr. Pin said. “We’re all co-dependent on each other.”
  • As production accelerates, Littlestown is stockpiling more aluminum ingots than usual because deliveries have been less reliable. “I used to play inventories a lot closer than I am right now,” he said.
  • O-I Glass Inc., the biggest domestic producer of glass bottles, said it is using more expensive raw materials to make glass because of a shortage of recycled glass.
  • overhead costs have climbed. (…) distribution center is less efficient now because operations have been reconfigured to separate employees. “The container takes twice as long to unload,”

SENTIMENT WATCH

Hedge funds brace for second stock market plunge Managers say asset prices have become too detached from bleak fundamentals

But, but, maybe we can justify current high valuations. From Bloomberg:

Throwing CAPE over S&P 500 is seen justifying valuation

But, but, you took out 100 years of data to prove your point! Nerd smile The red line is the last 30 years average, heavily influenced by the dot.com era…

Shiller PE Ratioimage

The big debate on equity valuation is the “E” component. The Rule of 20 uses trailing EPS to avoid forecasting. We know earnings are about to crater, starting in about 5 weeks. We can attempt to normalize earnings (THE DAY AFTER…) but even this exercise necessitates many fragile assumptions.

Dividends and dividend yields could offer another avenue. Based on today’s pre-opening of 3100, the S&P 500 dividend yield is 1.92%. The last 3 lows in dividend yield averaged 1.75% which, on the current dividend rate of $59.70 would mean 3400 on the SP 500, +9.6% from today.

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Taking into account the YtD dividend cuts from 56 companies, S&P 500 dividends are currently $57.28 annualized, bringing the dividend yield to 1.85%. This rate would limit the upside to 3275 at 1.75% (+5.6%).

Goldman Sachs, using long-dated S&P 500 dividend swaps and futures:

Market prices suggest S&P 500 DPS will equal $47.44 in 2023, 16% below our top-down estimate and 19% below 2019 levels. While liquidity is thin further out the curve, prices imply that dividends will not recover to 2019 levels during the coming decade. The only precedent for a decline of this magnitude and longevity since the start of the 20th century is the Great Depression. DPS fell by 33% from peak-to-trough and took 18 years to recover to its prior high between 1931 and 1949. In contrast, after the Global Financial Crisis dividends took just 15 quarters to recover their prior high. We expect S&P 500 dividends will decline by 25% this year but recover to their 2019 peak by 2024, and be more than 40% greater than 2019 levels by the end of the decade.

Were dividends to decline 25% this year (-25.9% in 2008-09), they would end the year at $43 annualized. At 1.75%, that would be 2450 on the S&P 500 (-21%). The dividend yield was as low as 1.56% in 2004 when dividends were recovering. That would be 2750 (-11.3%).

If you care, the other side of the equation is for dividend yields to return above 2% which would require 2150 or less (-30%).

Goldman’s analysis adds that the 3-year forward implied S&P 500 dividend yield currently equals 1.5%, nearly the lowest level since at least 2006.

TECHNICALS WATCH
  • 13/34–Week EMA Trend

The process measures the intermediate-term trend in the S&P 500 Index.  A bullish trend is identified when the blue 13-week smoothed moving average (“MA”) trend line rises above the 34-week smoothed MA trend line.  A bearish trend is signaled when the blue line drops below the red line.  You can see that this trend process has done a pretty good job at identifying the major cyclical (short-term) bull and bear market trends (note small red and blue arrows). (CMG Wealth)

  • Volume Demand vs. Volume Supply (Ned Davis Research)

  

  • Lowry’s Research:

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PANDEMONIUM
China Cancels Some U.S. Farm Shipments, Maritime Executives Say

Chinese state-controlled companies have canceled some shipments from U.S. farm exporters, according to maritime officials, as tensions between Washington and Beijing rise over China’s handling of pro-democracy protests in Hong Kong and the coronavirus pandemic.

“A handful of shipments of livestock feed, corn, pork, cotton and some meat imports are pushed back,” said a senior Chinese shipping executive involved in China farm imports who asked not to be identified and who has been briefed on Beijing’s move.

“Private Chinese exporters are not part of this, but it could escalate, depending on how the relationship between the U.S. and China goes forward,” this executive said. (…)

A second Chinese shipping executive said China state importers have canceled between 15,000 and 20,000 metric tons of U.S. pork shipments, about 10 days’ worth of orders. Beijing is also holding back some U.S. shipments of corn and cotton, he said, and further actions would depend on Washington’s response to China’s tightening grip on Hong Kong. (…)

China Revives London Stock-Listing Program
The U.K. Is On a Collision Course With China

Prime Minister Boris Johnson’s government has criticized Beijing’s planned imposition of a security law on the former British territory of Hong Kong, and is taking steps to exclude Huawei from its fifth-generation mobile networks by lining up potential replacements.

The upshot is that China has become an overriding foreign policy priority of the Johnson government just as it attempts to reach a deal with the European Union on future relations. It’s a challenge that risks leaving the U.K. out in front on its own, having left the shelter of the bloc of some 450 million people on Jan. 31 to pursue its Brexit ambitions. (…)

“Hong Kong affairs brook no external interference,” China’s Ambassador to the U.K. Liu Xiaoming said on Twitter, warning U.K. politicians to “stop interfering in China’s internal affairs.”

Jeremy Hunt, a Conservative lawmaker and former foreign minister, opened a new front on Thursday with an op-ed in the Times of London warning that Taiwan, the separately ruled island that China regards as part of its territory, “should worry us more.”

“In its willingness to abandon Hong Kong’s ‘one country, two systems’, China may also be signalling that it has given up hope of a peaceful reunification with Taiwan in favour of a military solution,” Hunt wrote. “Were that to be the case the implications for western democracies would be extraordinarily dangerous.” (…)

Contact: edgeandodds [at] gmail.com