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)

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China retailing

THE DAILY EDGE (15 May 2017)

U.S. Retail Sales Improve Strongest sales gain in three months came with positive revisions to earlier data

Total retail sales and spending at restaurants increased 0.4% during April (4.5% y/y) following a 0.1% March gain, revised from -0.2% reported initially. Earlier figures also were revised. It was the strongest gain in three months. A 0.6% increase had been expected in the Action Economics Forecast Survey.

Sales at motor vehicle & parts dealerships increased 0.7% (4.4% y/y) after as 0.5% decline. The increase compares to a 1.6% gain (-3.0% y/y) in unit motor vehicle sales. Retail sales excluding autos increased 0.3% (4.5%) following a like increase during March, revised from 0.2%. A 0.4% rise had been expected.

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Better but not great. Non-auto sales +0.8% in the last 3 months, +3.2% annualized vs +4.6% YoY in April. But goods inflation was negative (see below) so real sales are stronger. Real spending has been rising much faster than real earnings since October 2016 as consumer credit is increasing at a 6.0-6.5% YoY clip.

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According to the University of Michigan latest consumer survey, consumers have the most favorable real income expectations in a dozen years. The recent rise in optimism, which saw a boost after President Donald Trump’s election in November, reflects a turnaround from consumers’ attitudes in October, when sentiment had matched a two-year low.

This President sure needs to make America great again.

U.S. Consumer Prices Rose Modestly in April

The consumer-price index, which measures what Americans pay for everything from radishes to rent, advanced a seasonally adjusted 0.2% in April from the prior month, the Labor Department said Friday. Excluding the often volatile categories of food and energy, so-called core prices rose just 0.1% from March.

The annual increase in consumer prices slowed for the second straight month, with prices rising 2.2% in April from a year earlier. February’s 2.8% annual increase was the largest in five years.

Prices excluding food and energy were up 1.9% on the year. It was the first time the annual gain in core prices had been below 2% since October 2015. (…) Food prices rose 0.2% last month, and were up 0.5% from a year earlier.

Shelter costs—which account for about a third of the overall price index—increased 0.3% on the month and rose 3.5% on the year in April.

Prices for cars, apparel and prescription drugs all fell last month.

A separate Labor Department report showed average weekly earnings for private-sector workers, adjusted for inflation, rose 0.4% in April from the prior month. From a year earlier, inflation-adjusted weekly earnings were up 0.3%. (…)

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.1% (1.4% annualized rate) in April. The 16% trimmed-mean Consumer Price Index also rose 0.1% (1.0% annualized rate) during the month. Over the last 12 months, the median CPI rose 2.4%, the trimmed-mean CPI rose 2.0%, the CPI rose 2.2%, and the CPI less food and energy rose 1.9%.

There was, in effect, a big break in inflation trends after January. Core Goods prices are dropping hard: –3.0% annualized in last 2 months. Even prices of core Services are slowing, flat in last 2 months. Unless wages also slow down, margins are being squeezed.

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image(Haver Analytics)

Big break? Long break in inflation? Let’s look at some facts:

  • The inflation trends in the pipeline are mixed but still pointing to rising prices.
  • Final demand PPI was up 0.5% MoM in April (+2.5% YoY) and + 2.8% a.r. in last 3 months.
  • Core final demand PPI shows similar trends in the last 3 months.
  • That includes Trade Services PPI +0.9% in Jan., +0.4% MoM in Feb., -0.1% in March and -0.3% in April. Trade Services PPI measures profit margins at wholesale and retail ends and these are dropping fast.
  • Excluding declining margins, Core PPI rose 0.7% in April and is up +4.4% a.r. last 3 months (+2.1% YoY).
  • Core CPI-Services is flat in last 2 months but PPI-Services is +2.8% a.r. in last 3 months.
  • PPI Intermediate demand for processed goods rose 0.5% MoM in April (+5.4% YoY) and is +4.0% a.r. last 3 months.
  • Non-petroleum import prices are +3.2% a.r. last 3 months.

In all, inflation does not seem to be breaking down meaningfully. Median CPI is +2.0% a.r. last 3 months and inflation in the pipeline remains in the 2-3% range. As of May 12, the Cleveland Fed’s Inflation Nowcast shows core CPI up 0.16% from April, a 2.0% annualized rate.

David Rosenberg argues that “there is no room for inflation to be sustained – Amazon is doing to the retail industry writ large what Wal-Mart started to do two decades ago.” To prove his point, David refers us to the battered consumer-sensitive stocks as proof that there is no pricing power.

But pipeline inflation is real.

Pointing up What should worry investors though is the recent compression in wholesale/retail margins as labor costs increase faster than inflation on sales. Core Goods PPI is +3.2% a.r. last 3 months, +2.3% YoY in April while core Goods CPI is –2.0% a.r. last 3 months, –0.6% YoY in April.

Winking smile In the May 8 Daily Edge, I wrote””

In all, the writing is on the wall: unless the economy really cools off, the labor market is tight enough for wage pressures to intensify in 2017. The Employment Cost Index is now rising at a 3.5% annual rate in Q1 and the number of anecdotes about wage increases are mushrooming by the day.

I hope you appreciate when you read it here first…This was in Saturday’s WSJ, 5 days later.

(…) To try to solve the labor shortage, growers have been increasing wages. Yeatman & Sons in January raised piece rates at one of its farms to $1 for every five-pound box of mushrooms from 82 cents for large mushrooms and 80 cents for medium.

Phillips Mushroom Farms recently upped the bonus harvesters get after picking 55 pounds in an hour from 11 cents a pound to 16 cents, said general manager Jim Angelucci. Good pickers, who start at $8.75 an hour, can collect 100 pounds an hour, he said, so the extra nickel can yield a $2.25 bump to $15.95 an hour. The change helped Phillips fill five jobs and resume full production, he said. (…)

Mushroom production (…) is year-round and indoors. Growers offer employees health and retirement benefits as well as paid vacation.

Even so, the pool of workers is tight—and has shrunk in recent months. Growers attribute this partly to the strong economy in Chester County, where unemployment fell to 3.5% in March. Another factor is fears over the Trump administration’s crackdown on illegal immigration, which growers say has prompted some workers to leave the U.S.

The labor woes are dragging on production, which dropped 9% to 395 million pounds between the 2013-14 and 2015-16 growing seasons. Chester County’s share of the U.S. market for Agaricus mushrooms, which include white button and Portobello varieties, fell to 43% from 49% over the same period, according to U.S. Department of Agriculture figures. (…)

China’s retail sales up 10.7% in April

China’s retail sales, a key indicator of consumption, grew 10.7 percent year on year in April, 0.2 percentage points slower than the March level, official data showed Monday.

In the first four months, total retail sales of consumer goods rose 10.2 percent year on year, 0.2 percentage points faster than the growth in the first quarter, according to Xing Zhihong, a spokesperson with the NBS.

Consumption activities were relatively stronger in rural areas, with retail sales expanding 12.6 percent in April, outpacing urban areas, where retail sales climbed 10.4 percent year on year. (…)

China's retail sales up 10.7% in April

China’s industrial output rose 6.5% YoY last month, compared to 7.6% in March. Fixed-asset investment excluding rural areas expanded 8.9% for the first four months.

Home Capital’s Troubles Are Contained, Poloz Says
Global Oil Prices Jump on Talk of Extending Production Cuts Oil futures rose sharply after energy ministers from Russia and Saudi Arabia said they would back an extension to global production cuts.

…to the end of March 2018. (…)

The latest data showed that while participants have been compliant with quotas, stockpiles have remained elevated.

Crude stockpiles in the most industrialized nations increased from the fourth quarter of 2016 by 31 million barrels to just over 3 billion—276 million barrels above the five-year average, said OPEC last week. (…)

Even if the production cuts are extended at next week’s meeting, more oil is coming online from Canada, Brazil, Russia Kazakhstan and the U.S., notes Commerzbank. (…)

American drilling activity has risen for 17 weeks in a row, according to rig-count data from Baker Hughes . And last week, the U.S. government raised its domestic-production estimates for this year and next. (…)

Profit Growth Will Come From Overseas Foreign operations for U.S. companies will benefit from buoyant economies and with little wage pressure, boosting profit growth.

(…) But the U.S. accounts for only about 44% of the sales at the companies that comprise the S&P 500, according to S&P Dow Jones Indices. The rest comes from overseas, and the profits outlook there is stronger.

Growth outside the U.S. appears to be picking up, there is still plenty of labor-market slack in many countries, and central banks are still a while off from raising rates.

Consider the euro area in particular, which according to the Commerce Department accounts for about 40% of the income generated by U.S. multinationals’ overseas operations. Europe is  growing more rapidly than the U.S., but its unemployment rate, at 9.5% in March, is much higher. Put simply, says Bank of America Merrill Lynch economist Ethan Harris, “the U.S. is running up against labor-supply constraints and Europe isn’t.”

That ought to translate into substantially stronger profits growth for U.S. multinationals’ European operations. Workers aren’t in a position to ask for raises and companies, which aren’t running close to capacity, don’t need to add new workers quickly to meet rising demand. An added bonus: The euro has been strengthening in recent months, which translates into higher dollar profits. (…)

The upshot is that the more business a company does overseas, the better its profit growth ought to be in the year ahead. So larger companies, which tend to have greater overseas exposure, might shine. The same is true of more globally exposed areas of the market, such as the technology sector. More U.S.-focused companies, such as retailers, and more broadly, small companies, could get left out.

Actually happening as this RBC chart shows:

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But many of these companies are commodity sensitive…

And note that Eurozone growth is actually not picking up all that much, is it?

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EARNINGS WATCH

Factset’s weekly summary:

To date, 91% of the companies in the S&P 500 have reported actual results for Q1 2017. Of these companies, 75% have reported actual EPS above the mean EPS estimate, 7% have reported actual EPS equal to the mean EPS estimate, and 18% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (70%) average and above the 5-year (68%) average.

In aggregate, companies are reporting earnings that are 6.0% above the estimates. This surprise percentage is above the 1-year (+4.3%) average and above the 5-year (+4.1%) average.

In terms of revenues, 64% of companies have reported actual sales above estimated sales and 36% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the 1- year average (53%) and above the 5-year average (53%).

In aggregate, companies are reporting sales that are 1.0% above expectations. This surprise percentage is above the 1-year (0.0%) average and above the 5-year (+0.1%) average.

The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) year-over-year earnings growth rate for Q1 2017 is 13.6% today [13.5% last week]. If the Energy sector is excluded, the blended earnings growth rate for the remaining ten sectors would fall to 9.4% from 13.6%

The blended sales growth rate for Q1 2017 is 7.8%. If the Energy sector is excluded, the
blended revenue growth rate for the index would fall to 5.9% from 7.8%.

At this point in time, 90 companies in the index have issued EPS guidance for Q2 2017. Of these 90 companies, 61 have issued negative EPS guidance and 29 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68%, which is below the 5-year average of 74%.

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Recent guidance is heavily influenced by IT and HC. The other 9 sectors show 38 negative and 7 positive. Three months ago for Q1, it was 32-8. Twelve months ago for Q2’16: 35-9.

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Guidance being slightly more negative, Q2 estimates are being revised downward. While total S&P 500 EPS have been ratcheted down from 8.6% to 6.8% growth, 8 of the 11 sectors have seen their average estimated growth rate cut by more than half from +3.8% to +1.8%. But who believe these anymore when beats exceed 6%?

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Still, 3 sectors are now forecast to show negative growth in Q2. Even the dependable HC and CS sectors are only expected to grow EPS by +0.8% and +2.9% respectively.

Trailing 12-month EPS are now $122.85, up 3.6% from their level after Q4’16 and up 7.8% from their mid-2016 low. Inflation has declined from +2.2% to +1.9%. As a result fair value per the Rule of 20 is now 2224, up 6% from earlier this year, about in line with the actual S&P 500 Index.

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Economic surprises are not helping sentiment…

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…even though…image

But, under the radars, some people seem to care. The bulls keep running but are increasingly out of breadth as David Rosenberg’s chart reveals. This is not a robust market.

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UNPAID MARKETING Winking smile

The equal-weighted S&P 500 Index happens to support my equity stances largely based on the Rule of 20:

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Deflating Equities in February 2015 was not a bad call on a risk/reward basis.

NEW$ & VIEW$ (17 MARCH 2016): Inflation; Missing Barrels; Chinese Consumers.

Fed Dials Back Pace of Rate Hikes Federal Reserve officials reduced estimates of how much they expect to raise short-term interest rates in 2016 and beyond, nodding to lingering risks to the economic outlook posed by soft global growth and financial-market volatility.

Policy makers left short-term interest rates steady and said they expect to raise their benchmark rate just twice this year, after an initial increase in December, down from the four they previously predicted. (…)

“Caution is appropriate,” Fed Chairwoman Janet Yellen said at a press conference after the rate decision was announced, summing up her approach in handling a vulnerable economy, weak global growth and a central bank with few tools to respond if new threats derail the expansion.

(…) without committing to a timetable for rate increases, officials said the next move would depend on “realized and expected economic conditions” and reiterated that they plan to move gradually. (…)

She made clear the central bank is juggling mixed economic signals: a strengthening job market but surprisingly weak wage growth, and a resilient U.S. expansion amid global weakness.

Fed officials still expect the economy to grow briskly enough to cause unemployment to fall and inflation to rise toward their 2% target over time, Ms. Yellen said. If things unfold as forecast, they would likely continue raising interest rates gradually, she said. (…)

“Inflation picked up in recent months,” the Fed’s statement said, however Ms. Yellen cautioned that she is wary about the sustainability of the uptick since it was mostly driven by volatile categories. (…)

After the Fed’s Wednesday announcement, futures market participants put a 42% probability on just one quarter-point Fed rate increase this year and a 22% probability on two. (…)

U.S. Consumer Prices Fell in February U.S. consumer prices fell in February due largely to a slide in gasoline prices, but other evidence pointed to steadily building inflation pressures that could reassure the Fed as it considers raising rates.

The consumer-price index declined 0.2% over the month, the Labor Department said Wednesday. Overall prices haven’t risen since November and are up just 1% over the past year.

Outside of energy and food, so-called core prices rose 0.3% last month, as items like rent, medical care and apparel became more expensive. Over the past year core prices rose 2.3%, the strongest 12-month gain since May 2012. (…)

Shelter costs, reflecting home rent and mortgage payments, increased 0.3% over the month and 3.3% over the year. The cost of medical-care services climbed 0.5% over the month and 3.9% over the year.

Look at this Haver Analytics table: inflation is accelerating: last 3 and 2 months at annual rates:

  • Core +3.2%/+3.7%.
  • Core Goods: +2.4%/+3.0%
  • Core Services: +3.2%/+3.7%

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Now that Core Goods prices have joined Core Services on an accelerating trend, the last thing the Fed needs is rising oil prices.

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BTW:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.8% annualized rate) in February. The 16% trimmed-mean Consumer Price Index also rose 0.2% (2.6% annualized rate) during the month. The CPI less food and energy rose 0.3% (3.4% annualized rate) on a seasonally adjusted basis.

Over the last 12 months, the median CPI rose 2.4%, the trimmed-mean CPI rose 2.0%, the CPI rose 1.0%, and the CPI less food and energy rose 2.3%.

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Speaking crudely, the Fed is not alone in the dark:

Crude Mystery: Where Did 800,000 Barrels of Oil Go? There is mystery at the heart of the oversupplied global oil market: missing barrels of crude. Where these barrels ended up, or if they even existed, is key to an oil market that remains under pressure from the glut in crude.

Last year, there were 800,000 barrels of oil a day unaccounted for by the International Energy Agency, the energy monitor that puts together data on crude supply and demand. Where these barrels ended up, or if they even existed, is key to an oil market that remains under pressure from the glut in crude.

Some analysts say the barrels may be in China. Others believe the barrels were created by flawed accounting and they don’t actually exist. If they don’t exist then the oversupply that has driven crude prices to decade lows could be much smaller than estimated and prices could rebound faster. (…)

Barrels have gone missing before, but last year the tally of unaccounted for oil grew to its highest level in 17 years. At a time when the issue of oversupply dominates the oil industry, this matters. (…)

In the fourth quarter, the number of missing barrels reached as high as 1.1 million barrels a day, or 43% of the estimated oversupply. (…)

Demand data is derived from models rather than from real measured consumption and is often substantially revised, investment bank DNB Markets said in a research note. More than half of global oil demand also now comes from non-OECD nations where statistical gathering isn’t as well developed, the bank said.

“We hence suspect that demand in non-OECD in reality is meaningfully larger than what is reported by the IEA,” they said. (…)

U.S. Housing Starts Rose 5.2% in February

Housing starts rose 5.2% from a month earlier to a seasonally adjusted annual rate of 1.178 million in February, the Commerce Department said Wednesday.

Starts on single-family homes, which account for roughly two-thirds of the market, rose 7.2% in February to 822,000, their highest level since November 2007. Permits for single-family homes rose 0.4% to 731,000, the second-highest level since the end of December 2007. (…)

Multifamily units, which include apartments and condominiums, rose 0.8% to 356,000. (…)

But new applications for building permits fell 3.1% to 1.167 million, from a revised January rate of 1.204 million, driven by a 8.4% fall in multifamily units. Some of that slowdown could be due to rising prices for land; home builders have been reporting shortages of land and labor for months.

Brian Johnston, chief operating officer of Mattamy Homes, which operates in four U.S. states and Canada, said his company has slowed the pace of land purchasing because prices have gotten so high.

”There are more builders out there and everyone is feeling more positive,” Mr. Johnston said. “They see their land supply diminishing, and they’re getting into the market to replace it.” (…)

Home-starts figures are volatile and often revised. Wednesday’s report showed new-home starts revised up to 1.120 million in January, compared with an initial estimate of 1.099 million. (…) (Charts from Haver Analytics)

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U.S. Industrial Production Slips in February

Industrial production decreased a seasonally adjusted 0.5% in February from the prior month after surging a revised 0.8% in January, the Federal Reserve said Wednesday. Total production fell 1.0% in February from a year earlier, the fourth consecutive annual decline. (…)

The Fed said overall capacity utilization, a measure of industrial slack, slipped by 0.4 percentage point to 76.7% in February. It averaged 80% from 1972 to 2015. (…)

Last month’s weakness was concentrated in the mining sector and in utilities, where the Fed said in a statement that “unseasonably warm weather curbed the demand for heating.”

Manufacturing production rose by 0.2% in February after climbing 0.5% the prior month. It was up by 1.8% from February 2015, led by a 9.1% year-over-year increase in motor-vehicle production. (Charts from Haver Analytics)

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(…) When combined with the mere 0.2% rise signalled for recent core retail sales data, the industrial malaise adds to suggestions that the pace of economic growth could disappoint in the first quarter compared to widespread expectations among analysts of 2-2.5% annualised growth.

Markit’s PMI surveys, which provide a reliable advance indication of economic growth, have also indicated a poor start to the year. Growth weakened further in February after having already slowed in January as problems spread from manufacturing to services, raising the possibility of a stalling of the economy.

Markit US PMI surveys v GDP

 
Pointing up China’s consumers tighten belts while retailers cut jobs, offer discounts

Retailers in China are shedding staff, slowing expansion plans and seeing stocks pile up in warehouses as shoppers tighten their belts – a major headache for a country that has pinned its hopes on consumers to drive economic growth.

With that growth running at its slowest in a quarter of a century, China’s consumption patterns are changing, with wealthy middle-class households trading down to more affordable brands, and poorer families paring back on basic purchases.

China’s top 50 retailers saw sales fall 6 per cent at the start of the year, and sales of basic goods from noodles to detergent grew just 1.8 per cent at the end of last year, down from more than 9 per cent just three years ago, according to Kantar Worldpanel data. (…)

This is a problem for sectors from retail to luxury and even fast food, where many international names have banked on continued growth.

Procter & Gamble Co., whose China products include Pampers diapers and Tide laundry detergent, said in January its sales were “significantly down” compared with 2014. Infant formula maker Mead Johnson Nutrition Co. said price competition and a shift to smaller shops and online hit sales. (…)

Westpac Bank’s most recent consumer survey showed sentiment at its lowest since October. “The February update points to continued weak conditions and elevated job-loss fears again weighing on the consumer mood,” said senior economist Matthew Hassan, adding that any loss of momentum for consumer demand could raise the risk that growth stays weaker for longer.

Some firms are bucking the downturn.

International brands offering “affordable luxury,” such as coffee chain Starbucks Corp. and high-end sporting goods giants Nike Inc. and Adidas AG have still grown. Adidas says it has not seen an impact on its business and plans to open about 3,000 stores in China by the end of 2020.

But retail executives and consumer goods makers said China’s slow growth is punishing the sector and forcing many to cut back, focus on smaller, faster-growing cities and offer more discounts.

“We are struggling to adapt as sales move online or to small mom-and-pop stores,” said a senior sales executive at a major Western consumer goods firm. “At the moment, it’s carnage.”

He said inventory levels at some clients had jumped to as much as nine months, from a normal average of around two weeks. (…)

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