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)

Invest with smart knowledge and objective odds

THE DAILY EDGE: 11 July 2023: Howard Marks

Yesterday, Howard Marks, always a must read for me, posted a new memo: Taking the Temperature. This one discusses market calls and “how one can make useful observations regarding the status of the markets”. I reproduce part of it here but encourage you to read it in its entirety. (Howard’s emphasis)

(…) So, one key is to avoid making macro calls too often.  I wouldn’t want to try to make a living predicting the outcome of coin tosses or figuring out whether the favorite will cover the point spread in every football game over the course of a season.  You have to pick your spots – as Warren Buffett puts it, wait for a fat pitch.  Most of the time, you have nothing to lose by abstaining from trying to adroitly get in and out of the markets: you merely participate in their long-term trends, and those have been very favorable.

My readers know I don’t think consistently profitable market calls can be manufactured out of macroeconomic forecasts.  Nor do I believe you can beat the market simply by analyzing company reports. (…)

When markets are at extreme highs or lows, the essential requirement for achieving a superior view of their future performance lies in understanding what’s responsible for the current conditions.  Everyone can study economics, finance, and accounting and learn how the markets are supposed to work.  But superior investment results come from exploiting the differences between how things are supposed to work and how they actually do work in the real world. To do that, the essential inputs aren’t economic data or financial statement analysis. The key lies in understanding prevailing investor psychology.

For me, the things one must do fall under the general heading of “taking the temperature of the market.”  I’ll itemize the most essential components here:

  • Engage in pattern recognition.  Study market history in order to better understand the implications of today’s events.  Ironically, when viewed over the long term, investor psychology and thus market cycles – which seem flighty and unpredictable – fluctuate in ways that approach dependability (if you’re willing to overlook their highly variable causality, timing, and amplitude).

  • Understand that cycles stem from what I call “excesses and corrections” and that a strong movement in one direction is more likely to be followed – sooner or later – by a correction in the opposite direction than by a trend that “grows to the sky.”

  • Watch for moments when most people are so optimistic that they think things can only get better, an expression that usually serves to justify the dangerous view that “there’s no price too high.”  Likewise, recognize when people are so depressed that they conclude things can only get worse, as this often means they think a sale at any price is a good sale.  When the herd’s thinking is either Pollyannaish or apocalyptic, the odds increase that the current price level and direction are unsustainable.

  • Remember that in extreme times, because of the above, the secret to making money lies in contrarianism, not conformity.  When emotional investors take an extreme view of an asset’s future and, as a result, take the price to unjustified levels, the “easy money” is usually made by doing the opposite.  This is, however, very different from simply diverging from the consensus all the time.  Indeed, most of the time, the consensus is as close to right as most individuals can get.  So to be successful at contrarianism, you have to understand (a) what the herd is doing, (b) why it’s doing it, (c) what’s wrong with it, and (d) what should be done instead and why.

  • Bear in mind that much of what happens in economies and markets doesn’t result from a mechanical process, but from the to and fro of investors’ emotions.  Take note of the swings and capitalize whenever possible.

  • Resist your own emotionality.  Stand apart from the crowd and its psychology; don’t join in!

  • Be on the lookout for illogical propositions (such as “stocks have fallen so far that no one will be interested in them”).  When you come across a widely accepted proposition that doesn’t make sense or one you find too good to be true (or too bad to be true), take appropriate action.  See something; do something.

Obviously, there’s a lot to grapple with when taking the temperature of the market.  In my opinion, it has more to do with clear-eyed observations and assessments of the implications of what you see than with computers, financial data, or calculations.

I’ll go into additional depth on a couple of points:

On pattern recognition: You may have noticed that the first of the five calls described above was made in 2000, when I had already been working in the investment industry for more than 30 years.  Does this mean there were no highs and lows to remark on in those earlier years?  No, I think it means it took me that long to gain the insight and experience needed to detect the market’s excesses.

Most notably, whereas I spent two pages above describing the profound error in “The Death of Equities,” you may have noticed that I didn’t say anything about my having called out the article when it appeared in Businessweek in 1979.  The reason is simple: I didn’t.  I had only been in this business for about a decade at that point, so (a) I didn’t have the experience needed to recognize the article’s error and (b) I had yet to develop the unemotional stance and contrarian approach needed to depart from the herd and rebel against its thesis.  The best I can say is that my eventual development of those attributes enabled me to catch the same error when it arose again 33 years later. Pattern recognition is an important part of what we do, but it seems to require time in the field – and some scars – rather than just book learning.

On cycles: In my book Mastering the Market Cycle, I defined cycles not as a series of up and down movements, each of which regularly precedes the next – which I believe is the usual definition – but as a series of events, each of which causes the next.  This causality holds the key to understanding cycles.  In particular, I think economies, investor psychology, and thus markets eventually go too far in one direction or another – they become too positive or too negative – and afterward they eventually swing back toward moderation (and then usually toward excess in the opposite direction).  Thus, in my opinion, these cycles are best understood as stemming from “excesses and corrections.”  Overlooking the details of the individual episodes, it’s clear from the descriptions of these five calls that the greatest opportunities for bargain purchases result from overly negative prevailing psychology and the greatest opportunities to sell at too-high prices arise from excessive optimism. (…)

It’s easy to say you don’t invest on the basis of macro forecasts, and I’ve been saying this for decades.  But the truth is, if you’re a bottom-up investor, you make estimates regarding future earnings and/or asset values, and those estimates have to be predicated on assumptions regarding the macro environment.  Certainly, you can’t predict a business’s results in a given period without considering what’ll be going on in the economy at that point.  So, then, what does avoiding macro forecasting mean to us?  My answer is as follows:

  • We generally assume the macro environment of the future will resemble past norms.

  • We then make allowance for the possibility that things will be worse than normal.  Ensuring our investments have a generous “margin of safety” makes it more likely they’ll do okay even if future macro developments disappoint somewhat.

  • What we never do is project that the macro environment will be distinctly better than normal in some way, making winners out of particular investments.  Doing so can lead to profits if one is right, but it’s hard to consistently make such forecasts correctly.  Further, investments reliant on favorable macro developments can expose investors to the possibility of disappointment, leading to loss.  It’s our goal to construct portfolios where the surprises will be on the upside.  Relying on optimistic underlying assumptions is rarely part of such a process.  We prefer to make assumptions I would describe as “neutral.”

So we do base our modeling on macro assumptions – by necessity – but rarely are those assumptions boldly idiosyncratic or optimistic.  We never base our investment decisions on the mistaken belief that we (or anyone else) can predict the future.  Thus, we recognize that the above average results we seek must arise from our ground-up insights and not from our ability to do a superior job of forecasting unusual macro events.

You might ask here, “What about the memo Sea Change and its assertion that we may be seeing a shift toward a wholly different environment?”  My answer is that I feel good about this memo because (a) it’s mostly a review of recent history and (b) the important observations surround the unusual nature of the 2009-21 period, its effect on investment outcomes, and the improbability of it repeating.  (I’m particularly comfortable saying interest rates aren’t going to decline by another 2,000 basis points from here.)  While it’s important to stick to guiding principles, it’s also essential to recognize and respond to real change when it happens.  Thus, I stand by Sea Change (my only expression of an opinion of this kind in my entire working life) as an acceptable deviation from my standard practice.  For me, the case for a sea change has more to do with observing and inferring than it does with predicting.

And what about market timing?  As I’ve written numerous times since developing my risk-posture framework a few years ago, every investor should operate most of the time in the context of their normal risk posture, by which I mean the balance between aggressiveness and defensiveness that’s right for them.  It makes perfect sense to try to vary that balance when circumstances dictate compellingly that you should do so and your judgments have a high probability of being correct, like in the case of the five calls I’ve discussed.  But such occasions are rare.

So, we stay in our normal balance – which in Oaktree’s case implies a bias toward defensiveness – unless compelled to do otherwise.  But we are willing to make changes in our balance between aggressiveness and defensiveness, and we have done so successfully in the past.  In fact, I consider one of my principal responsibilities to be thinking about the proper balance for Oaktree at any given time.

If we’re happy to vary our risk posture, then what does it mean when we say, “we’re not market timers”?  For me, it means the following:

  • We don’t sell things we consider attractive long-term holdings to raise cash in expectation of a market decline.  We usually sell because (a) a holding has reached our target price, (b) the investment case has deteriorated, or (c) we’ve found something better.  Our open-end portfolios are almost always fully invested; that way we avoid the risk of missing out on positive returns.  It also means buying usually necessitates some selling.

  • We don’t say, “It’s cheap today, but it’ll be cheaper in six months, so we’ll wait.”  If it’s cheap, we buy.  If it gets cheaper and we conclude the thesis is still intact, we buy more.  We’re much more afraid of missing a bargain-priced opportunity than we are of starting to buy a good thing too early.  No one really knows whether something will get cheaper in the days and weeks ahead – that’s a matter of predicting investor psychology, which is somewhere between challenging and impossible.  We feel we’re much more likely to correctly gauge the value of individual assets.

While on the subject of buying too soon, I want to spend a minute on an interesting question: Which is worse, buying at the top or selling at the bottom?  For me the answer is easy: the latter.  If you buy at what later turns out to have been a market top, you’ll suffer a downward fluctuation.  But that isn’t cause for concern if the long-term thesis remains intact.  And, anyway, the next top is usually higher than the last top, meaning you’re likely to be ahead eventually.  But if you sell at a market bottom, you render that downward fluctuation permanent, and, even more importantly, you get off the escalator of a rising economy and rising markets that has made so many long-term investors rich.  This is why I describe selling at the bottom as the cardinal sin in investing.

The “margin of safety”, first introduced by Ben Graham in The Intelligent Investor, is a key investment concept: risk vs reward. Assess, measure if possible, the downside risk before committing.

  • It holds for macro analysis: how solid is the economy? Are the monetary and fiscal authorities reasonably in control and investor friendly?
  • For equity markets: how cheap are equity markets, relatively and absolutely?
  • For sectors: how cheap? how solid are the growth prospects? Macro dependent or mainly self-sustainable?
  • For individual stocks: how cheap, relatively and absolutely? Management: proven, involved, personally invested? Prudent or aggressive? Indebted?

We can’t forecast the future, the potential rewards, but we can control the downside. It does not mean to only buy absolute value, it means to understand risk, assess and measure it when possible, and properly balance risk and reward.

Personally, I have often been tagged a “GARP” investor: growth at a reasonable price. In my younger days, I put more weight on the growth side of the equation (time was on my side). The relative weights have shifted as I grew older…

Fed Officials Say Higher Rates Needed to Reach 2% Inflation Goal Mester and Daly say tighter policy is needed to curb price pressures.

(…) “We’re likely to need a couple more rate hikes over the course of this year to really bring inflation back into a path that’s along a sustainable 2% path,” San Francisco Fed President Mary Daly said at the Brookings Institution in Washington.

Cleveland Fed chief Loretta Mester, speaking at an event hosted by the University of California, San Diego, said her own view also “accords with” Fed officials’ median forecast for two more rate increases.

“In order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving,” she said. (…)

Daly said the risks of doing too little to curb inflation still outweigh the risks of doing too much, though the gap between those two is narrowing. (…)

“How quickly we moved from expansionary policy to restrictive policy, and now we’ve indicated through our projections and our communications that we think we still have some ways to go to get the policy to this sufficiently restrictive stance to get inflation to 2%, all of those reflect a commitment to get price stability not in over 10 years, but over a few years,” [New York Fed President John] Williams said. (…)

Atlanta Fed President Raphael Bostic said that while the rate of inflation is too high, policymakers can be patient for now amid evidence of an economic slowdown — a stance at odds with many of his colleagues.

“I have the view that we can be patient — our policy right now is clearly in the restrictive territory,” Bostic told the Cobb County Chamber of Commerce in Atlanta. “We continue to see signs that the economy is slowing down, which tells me the restrictiveness is working.”

Fed officials will also receive new inflation data this week, with the Wednesday release of a monthly BLS report on consumer prices. Forecasters surveyed by Bloomberg expect it to show prices excluding food and energy advanced 0.3% last month, with the year-over-year rate of increase moderating to 5%, according to the median estimate.

Goldman Sachs expects a 0.22% increase in June core CPI, half the Cleveland Fed’s Inflation Nowcast at +0.43% in June after +0.44% in May. As of July 10, July core CPI is seen up 0.42%, still in the 5% range.

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On shelter inflation. GS

expect shelter inflation to moderate somewhat (we forecast both rent and OER to increase by 0.47%), as the gap between rents for new and continuing leases continues to close. We estimate that the gap between new- and continuing-lease rents is currently around 3¼%, down from a peak gap of 7½%. Going forward, we expect shelter inflation to slow to a +5% annualized rate by December 2023 (or +0.41% not annualized) and +3¾% (or +0.30% not annualized) by December 2024, as growing multifamily supply keeps new-lease rent growth subdued and the gap between new- and continuing-lease rents closes further.

RealPage’s June report shows that new lease growth decelerated to +4.3% while renewal lease growth experienced a slowdown to +6.2%.

Second-Quarter GDP Growth Estimate Increases On July 10, the GDPNow model estimate for real GDP growth in the second quarter of 2023 is 2.3 percent, up from 2.1 percent on July 6.

The influential Evercore ISI economist Ed Hyman just lifted his GDP estimates from +1.0% to +2.0% in Q2 and from -1.0% to +1.0% in Q3. He still believes a recession is coming and holds his Q4 GDP at -2.0%.

NFIB: Small Businesses Raising Prices Falls to Lowest Level Since March 2021

NFIB’s Small Business Optimism Index increased 1.6 points in June to 91.0, however, it is the 18th consecutive month below the 49-year average of 98. Inflation and labor quality are tied as the top small business concerns with 24% of owners reporting each as their single most important problem.

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The net percent of owners raising average selling prices decreased three points to a net 29% seasonally adjusted, still a very inflationary level but trending down. This is the lowest reading since March 2021.

Unadjusted, 12% of owners reported lower average selling prices and 43% reported higher average prices. Price hikes were the most frequent in retail (52% higher, 10% lower), construction (49% higher, 4% lower), finance (48% higher, 3% lower), and wholesale (47% higher, 19% lower). Seasonally adjusted, a net 31% of owners plan price hikes.

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China Signals More Economic Aid After Property Debt Relief

(…) Top state-run financial newspapers ran reports Tuesday flagging the likely adoption of more property supportive policies, along with measures to boost business confidence.

Earlier, financial regulators stepped up pressure on banks to ease terms for property companies by encouraging negotiations to extend outstanding loans. The People’s Bank of China and National Financial Regulatory Administration said in a joint statement Monday that the aim is to ensure the delivery of homes that are under construction.

Some outstanding loans — including trust loans due by the end of 2024 — will be given a one-year repayment extension, it said. Previously, the more-generous loan terms were to be applied only for loans that were due by late May 2023, as part of a 16-point plan unveiled late last year. (…)

Loans due by the end of 2024 account for about 30% to 40% of developers’ total debts, according to Raymond Cheng, head of China and Hong Kong research at CGS-CIMB Securities, adding the measures may help ease developers’ liquidity in the short term if implemented. (…)

China Securities Journal, the country’s flagship securities newspaper, said Tuesday that China is expected to “accelerate” policy roll-out in order to promote the stable and healthy development of its real estate market. In a separate report, it also said the government may introduce measures to boost business confidence among private, state-owned and foreign firms following officials’ recent meetings with company executives.

Meanwhile, Shanghai Securities News cited Wang Qing, chief macro analyst at Golden Credit Rating, as saying that policymakers may take further measures such as relaxing property purchase and mortgage rules as well as cutting home loan rates to achieve a soft landing of the real estate market. (…)

In the statement, the PBOC and NFRA said project-based special loans provided by commercial banks to developers before the end of 2024 would not be classified as higher risk. They also urged financial institutions to ramp up support to ensure the delivery of construction projects. (…)

Currently, developers have outstanding bonds of about 2.9 trillion yuan ($401 billion) on their balance sheet, with nearly 1 trillion yuan of the debts due within the next 12 months and a maturity wall expected in the third quarter. (…)

Chinese authorities are trying to prevent an implosion of the industry, putting flimsy band-aids on the credit side. What is needed is boosting demand for housing. Tall order when confidence has disappeared.

Pointing up While on banking, the last 4 weeks show declining total bank loans, particularly at large banks (black). Smaller bank loans are still rising. This while deposits keep rising across the board. Lagged SVB effect?

fredgraph - 2023-07-11T073141.857

THE DAILY EDGE: 10 July 2023: Too Hot!

Payrolls Data Showing Solid Wage Growth Keeps Fed on Track to Hike Rates
  • Payrolls climbed by 209,000 in June, below economists’ forecasts but still rising at a healthy clip. The unemployment rate fell to 3.6%. Average hourly earnings rose 4.4% on a year-over-year basis, up from a 4.3% pace in May.
  • The relatively strong job gains, coupled with the re-acceleration of wages and the drop in unemployment cements the case for a Fed hike this month and will add to the conversation about more tightening being needed later this year. This is a labor market that’s still very tight.
  • Most industries added jobs, with health care and government driving gains. The leisure and hospitality industry added a meager 21,000 jobs, while construction employment rose by 23,000.
  • Services accounted for more than half of new hiring in June with 120,000 new jobs. Manufacturing added about 7,000 new jobs. Government jobs made up more than a quarter of new hiring in June, up from 18% between January and May.

Last week, I wondered how long can the manufacturing recession last before it begins to also meaningfully impact services, noting that, in 2007-08, aggregate hours worked in manufacturing declined 3.6% before services peaked.

June data and revisions to previous months show that manufacturing hours worked have stabilized since April and are down only 1.0% since their January peak.

Aggregate Hours Worked, Manufacturing & Services

fredgraph - 2023-07-07T134713.796

The chart below covers the 15 months of Fed tightening. The monthly growth in goods-producing jobs (black), which include construction and manufacturing, dropped from +68k on average during the first 5 months on the chart to +15k during the last 5. During the 5 months prior to each of the last 3 recessions, including the mild 1990 recession, goods-producing jobs declined an average of 50k per month before dragging service-producing jobs down.

fredgraph - 2023-07-08T072921.279

The lags are still lagging. It’s getting very late for a second half recession, even for one in 1H’24.

Seeking to tame demand, 500bps of tightening have yet to show any meaningful effect.

From the FOMC’s viewpoint, the June labor data were the strongest since January. Jobs growth slowed to 1.6% a.r. but hours worked rose and wages are not decelerating. In fact, Q2 wages rose at a 4.3% annualized rate, up from 3.9% in Q1.

fredgraph - 2023-07-07T104301.325

Aggregate weekly payrolls (employment x hours x wages) rose 6.3% YoY in June, in line with the average of the previous 3 months. Real payroll income keeps rising given PCE inflation averaging 4.0% YoY in April and May.

fredgraph - 2023-07-07T123905.406

On a MoM basis, aggregate payrolls jumped 0.8% in June after +0.3% in May and 0.5% in April. For Q2: +1.1% or 4.5% annualized, down from 1.6% or 6.5% annualized. Personal expenditures should grow similarly per the chart above.

Given headline inflation at +2.3% annualized in the last 3 months, thanks to surprisingly weak energy prices, real expenditures should keep growing, sustaining overall demand and core inflation.

Since March 2022, while the Fed funds rate skyrocketed 500bps, oil and natural gas prices cratered 35% and 48% respectively, freeing up a lot of discretionary income, unusually counteracting the Fed’s monetary policy.

For the FOMC, the unexpected result is that real consumer demand is sustained by rapidly slowing headline inflation, counteracting its very restrictive policy, and keeping the targeted core inflation rates much higher than what the normal playbook dictated.

While headline inflation is receding (+2.3% a.r. in the last 3 months), the Cleveland Fed’s Inflation Nowcasting model, through July 7, is forecasting core CPI up 0.42% (+5.1% a.r.) in July and core PCE up 0.36% (+4.4% a.r.), same pace as June’s.

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The “good news” is that this unlucky (!) Fed, juggling with so many erratic balls, is not slowing demand enough to bring core inflation down to its target.

The “bad news” is that this totally focused Fed could well keep hiking until the bite is strong enough. Hopefully, it won’t get unlucky again and see those volatile energy prices “unexpectedly” spike back up…

And there’s this other known unknown explained by the Fed staff on June 23::

In Figure 2, we present our estimates for the accumulated stock of excess savings. Broadly speaking, advanced economies have followed a similar hump-shaped path so far, with a large increase in excess savings in 2020 and parts of 2021, followed by a decrease in the stock of excess savings which reflects a period of below-trend savings rates as households use their accumulated buffer to fuel consumption.

That said, we note that the United States’ path differs slightly from other countries, as its stock of excess savings increased more rapidly, peaking in 2021Q3, and then decreased more quickly.

As a result, its excess savings stock, at least computed according to our method, is currently completely depleted, which contrasts with other advanced economies where households still hold a buffer of excess savings of about 3 to 5 percent of GDP. Given the more rapid drawdown of excess savings, aggregate demand in the United States is likely to have been supported more than in other countries over the past year. (…)

Figure 2. Evolution of savings rates during the COVID-19 pandemic. See accessible link for data.

Absent any further shocks to disposable income or savings behavior, our analysis suggests that the accumulated average AFE [Advanced Foreign Economies] excess savings should be unwound by the end of the year.

Also, this known known: Student loan cliff ahead

The Supreme Court’s decision to overturn the Biden plan on student loan forgiveness complicates an already tricky situation for the U.S. economy.

The coming student loan cliff is the latest in a string of withdrawals of pandemic-era supports. These include the end of both stimulus checks and child care tax credits, as well as the pullback on SNAP benefits and Medicaid supports.

Overall, the resumption of student loan payments will pull $70 billion a year out of the economy, according to an estimate from Moody’s Analytics. The spending reduction will be about 0.4%, Moody’s estimates. (Axios)

Canada: Job Growth Remains Firm

  • Employment increased by 60k in June, above expectations (+21k) and largely driven by job gains in the services-producing sector.
  • Employment increased by 50k in the services-producing sector and by 10k in the goods-producing sector.
  • The unemployment rate ticked up to 5.4%, above consensus expectations.
  • Year-over-year wage growth ticked down 1.2pp to +3.9% in June and sequential wage growth was also soft. Three-month annualized wage growth declined to +2.4% (+3.4% in May) and MoM wage growth was essentially flat.
  • GS:

The improved data raises some risk of a hold at this week’s July meeting, but we expect the BoC will deliver another 25bp hike. The accumulated evidence from 2023H1 suggests that activity remains too firm, progress on the BoC’s preferred sequential core inflation measures has stalled out, and the continued rebound in house prices raises the risk of a pickup in shelter inflation. We therefore expect that the BoC will decide further tightening is necessary.

Beyond July, we expect that the BoC will follow a meeting-by-meeting approach to policy and maintain our forecast that the cycle will end this week with a 5% terminal rate. However, we see policy risks as skewed toward further tightening. Despite having made more inflation progress than other DMs, the BoC seems relatively more determined to return inflation to 2%. Firmer than expected activity or inflation data—particularly if the shelter inflation outlook continues to worsen or the disinflationary core goods impulse fades sooner than expected—could therefore easily push the BoC to hike again before end-2023.

Progress on the BoC’s Preferred Sequential Core Measures Has Stalled Since the End of Last Year

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China on brink of consumer deflation Latest signs of economic weakness likely to spur calls for government stimulus measures

(…) Consumer prices didn’t budge in June from a year earlier, after growing 0.2% in May and 0.1% in April. The reading is the weakest since February 2021 and undershot a 0.2% increase anticipated by economists surveyed by The Wall Street Journal.

Stripping out the more volatile food and energy prices, core inflation in China decelerated from 0.6% in May to 0.4% in June, reflecting sluggish demand for goods and services.

China’s producer prices index, a gauge of prices charged by manufacturers, fell 5.4% from a year earlier in June, the weakest reading since December 2015 and marks the ninth straight month of year-over-year declines. (…)

In truth, China’s headline CPI stalled from a high base last year. On a MoM basis, total CPI rose 1.4% annualized in June after +2.6% in May.

But China continues to suffer from stalled goods consumption in the U.S.. Per Goldman numbers, core goods inflation was -0.8% YoY in June after -0.2% in May. Inflation in services fell to +0.7% YoY in June after +0.9% in May. On a MoM basis, services CPI inflation edged up from 0.1% a.r. in May to 0.3% in June.

China’s shipments to the U.S. dropped 8.5% YoY in the first five months of 2023, down 12.2% in May (-18% in USD terms).

Axios says that “Both as a percentage of total imports and as a percentage of GDP, Chinese imports are now at the lowest they’ve been in 20 years.

  • Mind The Gap! Shein’s tariff arbitrage (Axios)

Not all Chinese imports get registered as imports. Specifically, if a shipment falls beneath a certain “de minimis” value, it neither gets inspected nor taxed by U.S. Customs. That de minimis value is $800 — high enough to cover effectively all of the shipments from Chinese fast-fashion giants Shein and Temu.

“The de minimis provision is foundational to Shein and Temu’s business models,” finds a House of Representatives report into the companies. Shein and Temu between them ship about 600,000 packages per day to the U.S. under the de minimis exception.

The Gap, a company that sources clothing in China and ships it in bulk, paid about $700 million in import duties in 2022. Shein and Temu, by contrast, paid nothing.

If Shein does decide to go public in the U.S., possible changes to the de minimis rule will be very high up on its list of risk factors.

Meanwhile, compounding the problem(s), the Chinese real estate dominos are finally crumbling as ADG explains:

(…) June residential property sales tumbled by 18% sequentially and 42% from their year-ago levels, according to estimates from Raymond Cheng, managing director of CGS-CIMB Securities in Hong Kong. “The numbers are really bad,” Cheng told the South China Morning Post, noting that June typically represents one of the busier months of the year.  Nationwide transactions will decline 5% across the full year per guesstimates from S&P Global, following the 28% drop logged in 2022.

Bourgeoning inventories complement that slowdown, as home listings across 13 major cities expanded by 25% over the first five months of the year, according to E-house China Research and Development Institutions, with supply in Shanghai and Wuhan vaulting by 82% and 72%, respectively. “The real situation is a bit worse than what was expected,” China Vanke, the Middle Kingdom’s second largest property firm by sales, warned at a shareholder meeting Friday.

A busted land auction in China’s tech hub underscores the grim backdrop for real estate developers.  Shimao Group Holdings came up empty in efforts to find a buyer for a $1.8 billion Shenzhen, Guangdong Province project today, despite offering the portfolio at a 20% discount to its appraised value, Bloomberg reports, citing data from JD.com. Shimao, which defaulted on $1 billion worth of dollar bonds last year, shelled out $3.3 billion for the gargantuan lot back in 2017, initially planning to erect a 500-meter skyscraper before the project went pear shaped. (…)

As the property market remains in the dumps, financial breathing room is in short supply. Thus, off-balance sheet borrowings among the LGFV [local government financing vehicles] category topped $9 trillion as of Dec. 31, estimates the International Monetary Fund, up 65% from three years earlier and equivalent to more than half the nation’s nominal GDP for 2022.  For context, total U.S. state and local government debt stands at about $3.2 trillion. Meanwhile, cash positions among a sample of 2,892 LGFVs collected by the Rhodium Group last month collectively fell 10.3% on an annual basis, marking the first such decline in five years.

State owned banks are turning to a time-worn remedy in response. Bloomberg relays that lenders such as China Construction Bank and Industrial & Commercial Bank of China are increasingly opting to amend and extend (or is that extend and pretend?), offering financing to “qualified” LGFV’s with 25-year maturity schedules, rather than the decade long borrowing terms typically extended to high quality corporate borrowers.  What’s more, some of those loans include waivers on interest or principal repayments during the first four years, reportedly reflecting lenders’ confidence “that local authorities will not let any of [the LGFV’s] fail.”

The 25% jump in listings suggests that many Chinese owners are moving off the sidelines and capitulating. That could be ugly.

EARNINGS WATCH

The Q2 earnings season starts this week but we already got 18 early reporters in with a beat rate of 78% and a surprise factor of +5.5%, even though their earnings dropped 21.4% YoY on flat revenues.

Corporate America must also be positively impacted by lower energy costs. In Q2, average WTI and natural gas prices are down 32% and 71% YoY respectively.

Q2 earnings are seen down 6.4%, slightly worse than on July 1.

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Earnings pre-announcements have ben much better than at the same time after Q1:

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Trailing EPS are now $215.07. Full year 2023: $219.14e. 12-m forward: $230.26. Full year 2024: $244.88.

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The Rule of 20 P/E is behaving like in 2001 when the R20 P/E uncharacteristically did not fall back to the “20” fair value area but bounced back up. That was not because of a rising market, rather earnings falling faster than equities, right in the recession and an aggressively easing Fed.

The conventional P/E ratio is 19.1x forward EPS. We’ve been there before but not very often…

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  • NDR: “Additional rate hikes would reemphasize a challenge the market has not faced since before the financial crisis: cash is a reasonable alternative to equities. The S&P 500 GAAP earnings yield is below the T-bill yield for the first time since 2001 (chart, left). Earnings growth may need to accelerate more than analysts are suggesting for investors to justify reallocating into equities.”

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Stock Market Short Sellers That Helped Fuel This Year’s Rally Are Finally Giving Up

(…) Shifting sentiment can be seen in data showing bearish positions in exchange-traded funds slipped to three-year lows while shorts in S&P 500 futures were unwound at the fastest pace since 2020. Meanwhile, the population of optimists is exploding, with bullish newsletter writers in Investors Intelligence survey outstripping bearish ones by 3-to-1, the highest level since late 2022. (…)

Bears Unwinding Equity Bets | Large speculators cut short positions in S&P 500 at fastest pace in three years

Large speculators, mostly hedge funds that saw their net short positions in S&P 500 swell to a record at the end of May, were busy unwinding bets in the following four weeks. Their bearish holdings fell by 226,000 contracts over the stretch, the largest drop since mid-2020, according to data from the Commodity Futures Trading Commission compiled by Bloomberg.

Among newsletter writers tracked by Investors Intelligence, those classified as bullish rose to 54.9% while the proportion of bears fell to 18.3%. That’s in stark contrast from the end of last year, when bears exceeded bulls. (…)

relates to Stock Market Short Sellers That Helped Fuel This Year’s Rally Are Finally Giving Up

Source: Yardeni Research

In ETFs, short interest is near a three-year low based on its percentage of market value, according to Markit data compiled by Morgan Stanley’s sales and trading team. Short interest in individual companies — while not dissipating completely — has sunk back toward median levels across most industries. (…)

relates to Stock Market Short Sellers That Helped Fuel This Year’s Rally Are Finally Giving Up

  • Retail Flows:

Source:  Daily Chartbook

  • How much are you willing to pay for tech? Great chart via Soc Gen’s Edwards showing the latest tech PE expansion vs trailing EPS. AI is great, but what price are you willing to pay to own the hype? (The Market Ear)

Soc Gen

El Nino! Sea temp headed for record

Data: Climate Reanalyzer. (Average reflects 1982-2011 mean). Chart: Rahul Mukherjee and Simran Parwani/Axios

The globe set or tied four daily heat records last week (Monday-Thursday), and had six straight days (and counting!) with global average surface temperatures exceeding 17°C (62.6°F). That hasn’t happened since such data began in 1940 — and likely not for many centuries before that, Axios’ Andrew Freedman reports.

The seas take in about 90% of the excess heat trapped by greenhouse gasses. So global water temperatures are also hitting all-time milestones. A strengthening El Niño in the Pacific Ocean is adding extra heat — and is likely to yield a record warmest year in 2023 and 2024.

The U.S. this week will endure an intensifying, long-duration heat wave extending from Arizona and New Mexico to southwestern Texas. A heat wave will also keep going in Florida. Numerous daily — plus some monthly, and even all-time records — may be broken.