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

COMMERCIAL REAL EST

THE DAILY EDGE (11 April 2017): Hard vs Soft, yet again.

Conference Board Employment Trends Index Rose in March U.S. employment trends remained strong in March, according to a report, suggesting solid job growth will continue this spring.

The Conference Board Employment Trends Index came in at 131.43, up from 131.09 in February. The March reading also reflects a 4.3% gain compared with the year-prior report. (…)

The index aggregates eight labor-market indicators, which the Conference Board says helps filter out the volatility from monthly reports, to show underlying trends more clearly. Gains in the index in March were fueled by positive contributions from six of the eight components. In order from the largest contributor to the smallest last month, they were: real manufacturing and trade sales, the ratio of involuntarily part-time to all part-time workers, industrial production, the percentage of respondents who say they find “jobs hard to get,” the number of employees hired by the temporary-help industry, and job openings.

The Fed’s own Market Conditions Index is not so cheerful:

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HARD VS SOFT

Everybody has entered the ring now and it’s getting more confusing.

This is from uber-bear Zerohedge:

 

  • This is from Bloomberg whose hard data is not as soft:

Confused smile It is hard to know what’s really hard!

And even the soft side is hard to understand. The ISM’s latest data leads them to estimate Q1 GDP up 4.3% (!). Markit’s PMI data says +1.7%.

John Hussman wrote a good piece yesterday (Echo Chamber)

(…) Soft survey-based measures tend to be most informative when they uniformly surge coming out of recessions. In contrast, during late-stage economic expansions, positive disparities in soft measures tend to be false signals that are resolved in favor of harder measures. (…)

What’s striking about survey-based economic measures is that their 5-year rolling correlation with actual subsequent economic outcomes has plunged to zero in recent years (and periodically less than zero), meaning that these measures have been nearly useless or even contrary indicators of subsequent economic outcomes. (…)

Yellen Sees Monetary Policy Shifting Federal Reserve Chairwoman Janet Yellen indicated Monday that the era of extremely stimulative monetary policy was coming to an end.

(…) “Where before we had our foot pressed down on the gas pedal trying to give the economy all the oomph we possibly could, now [we’re] allowing the economy to kind of coast and remain on an even keel,” she said. “To give it some gas, but not so much that we’re pressing down hard on the accelerator.” (…)

“Evidence suggests that the population roughly expects inflation in the vicinity of 2%,” she said. “We’re focused on making sure that inflation expectations and actual inflation stay very well anchored.”

If Everyone Is So Confident, Why Aren’t They Borrowing? Economists are struggling to explain a sudden slowdown in bank lending.

Total loans and leases extended by commercial banks in the U.S. this year were up just 3.8% from a year earlier as of March 29, according to the latest Federal Reserve data. That compares with 6.4% growth in all of last year, and a 7.6% pace as of late October. (…)

Loans to businesses have slowed most sharply, with the latest data showing commercial and industrial loans up just 2.8% from a year earlier, compared with 8.9% growth in late October. (…)

Political uncertainty seems partly to blame. Consumers and businesses may express greater confidence since the election, but many might still hesitate to take out big-ticket loans to fund new projects until they have greater clarity on the outlook for tax, trade and health-care policy.

Such caution would only be rational. It also suggests the growth surge many investors are expecting may not materialize until the policy picture out of Washington becomes clearer.

Source: BMI Research (via The Daily Shot)

Pointing up The slowdown in credit growth we saw in the US is also visible on a global basis.

Source: Capital Economics

Lending for Commercial Property Falls as Investors Pull Back Commercial real estate lending by banks, insurance companies and other financial institutions is declining as sales activity slows and regulators voice concern about the sector.

Lenders closed roughly $491 billion of mortgage loans in 2016, down 3% from 2015, according to new statistics from the Mortgage Bankers Association. Most of the decline occurred in the fourth quarter, when volume was 7% lower than the same quarter in 2015, according to Jamie Woodwell, the trade group’s head of commercial property research. (…)

The slowdown is accelerating this year. Investors have purchased just $50.3 billion worth of U.S. commercial property in the first two months of 2017, compared with $80.1 billion during the same period in 2016, according to data firm Real Capital Analytics. (…)

Yet banks and insurers are getting more aggressive over deals as investment in the sector declines. A flock of new lenders also are emerging on the scene, including investment funds formed by private-equity firms that are focused on real estate debt.

“It’s tougher right now,” said Craig Bender, who heads up ING Groep NV’s U.S. real estate lending business. “The banks are hungry. The life insurance companies are hungry.” (…)

Lenders and developers have gotten especially aggressive in building rental apartments. More units are under way today than in any period since the mid-1970s, experts said. (…)

Lenders also have been emboldened because loan performance is doing well. Just 0.59% of commercial mortgages held on balance sheets of banks and thrifts today are more than 90 days delinquent, the lowest rate in more than a decade, according to the Mortgage Bankers Association. By comparison the delinquency rate was 4.21% at the end of 2010.

The improving loan quality reflects steadily rising prices. A property value index compiled by Green Street Advisors more than doubled between 2009 when it hit its post-crash low point. But lately that index plateaued. In March, it declined by 0.5%.

The Dodge Momentum Index increased by 0.9% in March to 144.4 (2000=100) from its revised February reading of 143.2. The Momentum Index is a monthly measure of the first (or initial) report for nonresidential building projects in planning, which have been shown to lead construction spending for nonresidential buildings by a full year. The Momentum Index has now risen for six consecutive months, with much of the gain being driven by institutional projects entering planning while commercial projects so far in 2017 have receded slightly.

The institutional portion of the Momentum Index rose 3.7% in March, and is 23.0% higher than the end of 2016. Commercial planning meanwhile fell 1.2% in March and is down 2.9% from December 2016. However, the overall Momentum Index, as well as the commercial and institutional components, are well above their year-ago levels. This continues to signal the potential for increased construction activity in 2017 despite the short-term setbacks that are inherent in the volatile month-to-month planning data. (Chart from CalculatedRisk)

China Regulator Warns Banks Away From Speculative Activity China is taking another step to curb risk in its financial system, instructing lenders to steer clear of certain practices that has created unhealthy asset bubbles and prevented money from flowing into a weak real economy.
Surprised smile Oh Canada!
Pace of housing starts hits highest level since September 2007

The overall increase came as the annual pace of urban starts increased by 20.2 per cent to 235,674 units, boosted by an increase in multi-unit starts.

Multi-unit urban starts increased by 30.2 per cent to 160,989, while single-detached urban starts increased by 3.1 per cent to 74,685 units. Rural starts were estimated at a seasonally adjusted annual rate of 18,046.

CMHC’s trend measure, a six-month moving average of the monthly seasonally adjusted annual rate, increased to 211,342 units in March compared with 205,521 in February.

  • Irrational exuberance?

Home price inflation has become THE hot topic of discussion in Canada. Surging prices are no longer confined to greater Toronto and Vancouver. As today’s Hot Chart shows, we estimate that close to 55% of regional markets in Canada are reporting price inflation of at least 10%. This record proportion is very similar to that observed in the United States in 2005 at the peak of the market. Even if Canada continues to enjoy some of the best demographics in the OECD, home price inflation appears to be running ahead of fundamentals. When 55% of the market is on fire, the use of interest rates to cool things down is justifiable. The Bank of Canada must change its narrative and abandon its easing bias as soon as this week. (NBF)

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Stock Market Valuations and Hamburgers

The link is to John Mauldin’s latest Thoughts from the Frontline. Good stuff in there although still omitting the Rule of 20…Some comments of mine:

  • Long-term market stats and relationships that do not take into account periods of high and low inflation risk mix very different investment environments which necessarily impact the LT average and median stats.

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  • The inverse relationship between P/E ratios and inflation is evident from this chart:

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  • And the stability of the Rule of 20 is obvious from this 60-year chart covering high and low inflation eras:

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  • Hence this valuation risk map:

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Amid the debate and confusion between hard and soft data, the political and geopolitical situations and the Fed’s shifting, there remain 3 essential data sets to focus on:

  1. Equity valuations based on hard historical data have entered the “high risk” area meaning that the risk/reward ratio has completely shifted from very favorable/favorable to investors during most of the last 8 years to highly unfavorable.
  2. Trailing S&P 500 operating earnings troughed last July at $114 and have increased 3.6% since. Recent trends in estimates and corporate guidance suggest that Q1’17 earnings will rise some more. The earnings tailwind is soft but pretty steady so far.
  3. Inflation has been slowly accelerating since early 2015 offsetting all the earnings gain in the Rule of 20 “fair value” (yellow line in chart above). As a result, the S&P 500 Index is currently 11% above that “fair value” calculation (20 minus inflation x trailing EPS = 2090). This is the largest gap (overvaluation) since 2008 (black line).

There are only 3 ways this gap can softly close back to “fair value”:

  • earnings rise strongly to $135 in fairly short order;
  • inflation declines to 1.5% in fairly short order;
  • or a combination of the above…

Fingers crossed …unless the market hardly corrects the gap itself for reasons which only get obvious after the fact…

SENTIMENT WATCH

Here’s another valuation risk chart: as good as it gets:

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(via The Daily Shot)

A change in trend?

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Source: Credit Suisse (via The Daily Shot)

A different kind of sentiment measure:

Source: John Burns Real Estate Consulting


  • Today in bad incentives: “One hundred days is the marker, and we’ve got essentially 2 1/2 weeks to turn everything around,” said one White House official. “This is going to be a monumental task.”

This show will eventually come near all of us and it will be hard to swallow:

California Taxpayers Expected To Nearly Double Public Pension Contributions Over Next 5 Years

Despite the strong economy and a buoyant stock market, pension cost burdens faced by California local governments have continued to grow – with many now devoting more than 10% of revenue to retirement contributions. With the Great Recession now eight years behind us, the risk of a new downturn is increasing. The result would be a further spike in pension burdens on local governments. Unless the state enables more aggressive pension reforms than those allowed under the 2013 PEPRA legislation, several California cities and counties will find themselves forced to slash other spending. The less fortunate will simply be unable to pay the bills they receive from CalPERS or their local retirement system.

THE DAILY EDGE (28 March 2017)

POLITICS, POLITICS!

Too much of it. Sorry but it’s everywhere now:

(…) The failed health bill would have made tax reform easier because it created budgetary offsets that made it easier to cut corporate taxes without adding to the deficit. The border tax Republicans have proposed to help pay for tax cuts might also fall by the wayside. (…)

Consider, too, that there are about 15.9 million retail employees versus 12.3 million manufacturing employees. And when it comes to the number of businesses in each industry, the gap is even wider: The Census counts about 910,000 retailing firms in the U.S. versus 227,000 manufacturing firms.

If taxing imports is a no go then paying for the corporate tax cut gets harder. And, while optimists sometimes argue otherwise, cutting taxes without paying for them would be difficult. Fiscally conservative Republicans may balk at voting for a higher budget deficit and demand entitlement cuts instead. Those cuts, in turn, could be a hard sell with swing-district moderates.

If the Republicans can’t agree on what to tax to pay for the cuts then the lower corporate taxes that investors have been betting on may be more modest than expected. To get the win they desperately need, Mr. Trump and Mr. Ryan may decide to set their sights a lot lower. Investors should follow suit.

  • According to the next chart, the markets seem to be giving up on US corporate tax cuts. It shows that a broad basket of companies paying the highest tax rates has reversed all of its post-election outperformance and then some. The stock market doesn’t see these firms in a lower-tax regime anytime soon. (The Daily Shot)

Source: @tracyalloway

(…) Investors, according to Marko Papic, geopolitical strategist with BCA Research, are making too much of the Obamacare issue. Regardless of its failure to be repealed, tax reform is on its way. On Friday, Treasury Secretary Steven Mnuchin reassured Americans that we could still expect “comprehensive” tax reform by August. It’s also worth recalling that, even though he failed to reform health care during his eight years in office, President Bill Clinton still managed to tackle tax reform with the Omnibus Budget Reconciliation Act of 1993.

Does President Trump Lack Political CapitalIncreasing the likelihood that tax reform and infrastructure spending can be brought to light is, paradoxically, President Trump’s historically low approval rating. As you can see, he significantly trails the average rating of nine previous presidents during their same weeks in office. Congress’ job approval fares even worse at 28 percent, as of February.

What this means is the sound of the clock ticking is deafening. Midterm elections are less than 20 months away, and Trump could very well be a one-term president. According to Marko, this gives Trump tremendous political capital among those who share his vision and urgently wish to pass legislation toward that end.

Trump is seeking high growth now, not in 2020 or 2024, and I think it’s a mistake for investors to dismiss him,” Marko said, adding that the president’s goal of 4 percent GDP growth is more than attainable. But how?

Nerd smile In the end, it will all come down to earnings, inflation and interest rates…Q1 earnings season begins soon.

‘Project Scalpel’: Behind Big Banks’ Plan to Save $2 Billion After cutting more than $40 billion of costs since the financial crisis, big banks are considering ways to slash still more from their back-office budgets.

(…) While prospects for revenue growth at banks have brightened since the election, a handful of the biggest firms are considering ways to slash still more from their back-office budgets. One effort, dubbed “Project Scalpel,” is aimed at cutting the administrative and operational costs involved with processing stock and bond transactions after a trade is struck, according to people familiar with the discussions.

Talks around this effort are at an early stage but so far have included a number of banks, such as Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp., the people said. If the idea materializes, it could create a joint venture that allows banks to share trade processes and technology. (…)

Now, the processes and systems around these functions have become commoditized. Competing banks have redundant systems handling the same functions. (…)

The six biggest U.S. banks have eliminated more than 100,000 jobs since 2009, while shedding less-profitable business lines and trimming compensation. (…)

European banks including Barclays PLC and Société Générale SA have said they are working with technology providers to outsource and share some trading back-office operations in Europe. (…)

Banks better work on their costs rapidly because their huge commercial real estate loan books are not looking good:

(…) Tenant-improvement allowances haven’t been typical in the Manhattan retail market. But now the concessions, which can pay for anything from lighting and displays to a complete overhaul, are becoming a key component in some new leases, particularly for large, flagship stores in high-profile areas, such as Madison Avenue and Fifth Avenue, according to Steve Soutendijk, an executive director at brokerage Cushman & Wakefield Inc.

“We’re seeing tenant-improvement and concession packages that retail landlords never, ever contemplated before,” he said. (…)

The rise in costs for retail landlords mirrors trends in other corners of the commercial-property market. Manhattan officelandlords, facing falling rents and heightened competition, took on a record 12 percent of the expense of converting raw space last year, according to Savills Studley. Apartment landlords are offering concessions and paying broker’s fees — a burden typically shouldered by the tenant in New York — to better compete as a glut of new towers gives renters more choices. (…)

China Drifts Into a U.S. Vacuum in Asia

(…) China’s advance is being enabled by a factor that few countries in Asia could have foreseen, not even China itself: an American retreat.

With no obvious alternatives, Beijing is filling a vacuum that is rapidly expanding in the early days of the Trump presidency.

But while China dominates its region with the sheer size of its economy, it struggles to lead—or inspire.

Years in the making, the 12-nation Trans-Pacific Partnership was the core of the Obama administration’s “pivot” to Asia, the product of compromises hammered out in capitals from Tokyo to Canberra, an ambitious—perhaps the last—U.S. effort to shape the destiny of a region that stands at the crossroads of every global trend from fashion to “fintech” and clean energy.

In repudiating that deal, Mr. Trump has empowered China. (…)

Instead of a U.S.-inspired free-trade deal focused on the digital economy, intellectual property, the environment and labor standards—what Hillary Clinton called the “gold standard,” before turning against it as presidential candidate—China is pushing a lower-grade alternative.

Yet, despite the shortcomings of this incremental effort, known as the Regional Comprehensive Economic Partnership, Asian economies are aligning around it because there’s no better deal on the table. (…)

For now, the main danger is that Mr. Obama’s Trans-Pacific Partnership will morph into Mr. Trump’s Trans-Pacific trade war.

Mr. Trump has threatened to impose 45% import tariffs on Chinese imports. If he triggers such an action, the effects will ricochet around the entire Asia-Pacific manufacturing supply chain.

A common view in Asia is that the success that the U.S. did so much to encourage is now feeding a backlash. (…)

Evercore’s Hyman Says China a Mess, Will ‘Blow Up’ at Some Point

(…) “The issue is that debt keeps growing faster than the economy,” in China, Hyman said. “So the economy continues to lever up. Same is true for here. We continue to have debt grow faster than gross domestic product.” (…)

Auto Mexico Autos Output Soars as Trump Administration Settles In Mexico gains considerable regional share as production in the U.S. and Canada sags

(…) Mexico’s vehicle output rose 10% over the first two months of the year compared with January and February 2016, while Canada slipped 9% and the U.S. fell 2.9%, WardsAuto.com said. That tally doesn’t include production of heavier-duty trucks.

Fiat Chrysler’s decision to move production of the Jeep Compass sport-utility vehicle to a Mexican factory from one in the U.S., and Volkswagen’s plans to start output of Audi Q5 luxury SUVs in Mexico, helped fuel the shift. Both auto makers are boosting jobs and investments at American plants amid a focus on building more trucks, but those plans are unlikely to lighten the companies’ dependence on Mexican factories for U.S. sales. (…)

Contact: edgeandodds [at] gmail.com