Edge and Odds

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Edge and Odds

Invest with smart knowledge and objective odds

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THE DAILY EDGE: 22 MAY 2019: The Front Line

A VISIT ON THE FRONT LINE
Retailers’ Sales Lag as They Gird for Tariffs Kohl’s, J.C. Penney, Home Depot fall short of analysts’ estimates, plan for impact of higher duties on Chinese merchandise

Retailers are on the front line of this trade war. They need to prepare because they get hit first.

Kohl’s Corp. KSS -12.34% , J.C. Penney Co. JCP -6.96% , and Nordstrom Inc. JWN 1.04% reported declines on Tuesday, while Home Depot Inc. HD 0.26% posted a weaker-than-expected 2.5% rise in comparable-store sales. (…)

Kohl’s, which imports about a fifth of its goods from China, said Tuesday that additional costs related to rising import tariffs prompted it to lower its guidance for the year.

Already?

Home Depot finance chief Carol Tomé said the home-improvement chain estimates it will spend about $1 billion more to buy goods with the 25% tariffs in place, coming on top of the roughly $1 billion in costs added by the 10% tariff.

The company said it plans to manage the cost increases by buying more volume at lower prices from some vendors and by spreading price increases across a wider swath of items to limit the impact on sales. (…)

$1B + $1B = $2B on $110B in revenues = 2% hit. HD’s pretax margin was 13.5% in 2018, suggesting a potential 15% profit drop. What HD says is that it will ask suppliers to take some of the hit and will spread the rest across the entire store to mitigate the impact on Chinese import prices. No doubt HD will also ask non-Chinese suppliers to participate. Collateral damage that will spread across the whole economy, hit small companies harder and hurt lower income consumers the most.

Last week Walmart executives said they will likely raise some prices in the face of tariffs, but are managing cost increases product by product.

(…) And purchases of products like auto parts that are needs, not wants, are less likely to decline because of tariff-induced price increases. (…) Around 30% to 45% of auto-parts sales originate from China, Wells Fargo said in a report. (…)

Kohl’s shares fell more than 12% on Tuesday, and Penney’s fell about 7%. Shares of Home Depot and TJX Co TJX 0.55% s, which also posted results, rose slightly. In after-hours trading, shares of Nordstrom, which reported results after the market closed, fell more than 8%. (…)

Home Depot isn’t seeing any signs of consumer weakness (…) It said sales are picking up with warming weather, and the retailer maintained its guidance for the year. (…)

Other battle lines:
  • World trade is dangerously slumping (Charles Schwab)

World Trade Volume

(…) As we’ve been opining for some time, although the impact to-date of the trade war has not been substantial in terms of either economic growth or inflation, if it continues to heat up, the impact will be increasingly felt. The indirect effect has already kicked in; with hits to “soft economic” data like business confidence and capital spending intentions. The reason we continue to believe trade will be an important determinant of the length of runway between now and the next recession is because of this confidence transmission mechanism.

The fiscal stimulus of last year helped boost animal spirits through the business confidence channels; along with hopes for a capex-led next leg to the economic expansion. Absent a comprehensive trade deal, it’s hard to imagine a scenario where those animal spirits are reignited.

(…) Apple could lose nearly a third of its profit if China retaliated by banning its products, Goldman Sachs analysts estimated this week. Dan Ives, an analyst at Wedbush Securities, said 3% to 5% of iPhone sales in China may disappear over the next 12 to 18 months because of the U.S. ban on Huawei.

Apple would face much more dire consequences if production restrictions were implemented in China, Goldman analysts led by Rod Hall wrote in a research note.

“We do not believe the company would be able to shift much iPhone volume outside of China on short notice, though actions that would push Apple production outside of China could have negative implications for the China tech ecosystem as well as for local employment,” the Goldman analysts said.

Even if China doesn’t retaliate directly, nationalist sentiment will likely hurt Apple’s sales in the country and could cause the company to miss its fiscal third-quarter forecasts, according to Lynx Equity Strategies. (…)

Keep in mind that all telcos in China are under state control…

Chinese President Xi Jinping has called for the nation to embark on a new Long March and “start all over again”, in the most dramatic sign to date that Beijing has given up hope of reaching a trade deal with the United States in the near term. (…)

Xi’s message was delivered at a time when the country’s official media outlets have adopted increasingly nationalistic tones in relation to the trade war and broader Sino-US relations. However, media reports have stopped short of directly criticising US President Donald Trump. (…)

China has officially kept the door open to future trade talks, but no new talks have been scheduled. Technical work, such as document drafting and translation, largely ceased after the two sides failed to reach a final agreement in the 11th round of talks earlier in May, according to two sources who were briefed on the situation.

China warned last Friday that there was no point in holding more talks if the US was not “sincere” in wanting to achieve a fair outcome.

“The message is clear: China is ready to fight a protracted trade war,” said one source.

The US government’s decision last week to place Chinese technology firm Huawei and its affiliates on a trading black list has strengthened a perception in Beijing that the US is pursuing a broad strategy to thwart China’s rise, leaving little room for China to compromise on any front. (…)

Sue Trinh, a strategist with Royal Bank of Canada in Hong Kong, wrote in note on Tuesday that there has been “a significant nationalist shift in Chinese rhetoric” regarding the trade war, particularly the use of militaristic imagery terminology in official media.

An opinion piece in the state-run Global Times last Friday argued that Beijing is in no hurry to end the trade war because China is more capable of withstanding the ensuing pain than the US.

“In the best scenario, China would become more adaptable and cut our reliance on the US market for good,” the editorial said.

  • American farmers are front and center in this war:

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China accounted for 14% of U.S. agricultural exports in 2017, almost $20 billion worth of soybeans, hay, dairy, poultry, pork, etc.. That was nearly triple the 2007 level highlighting the significant investments American farmers have made in land and machinery to supply China. Ag products exports to China dropped to 16.3B in 2018 and are forecast to slump to $7.3B in 2019, back to their 2007 level. The data in the above charts are up to Q4’18…

U.S. Existing-Home Sales Fell in April The U.S. housing market continued to soften in April, with the spring selling season so far proving a disappointment despite falling mortgage rates and a strong economy.

Existing-home sales fell 0.4% in April from the previous month to a seasonally adjusted annual rate of 5.19 million, the National Association of Realtors said Tuesday. Compared with a year earlier, sales in April declined 4.4%, the 14th straight month of annual declines. (…)

The median sale price for an existing home in April was $267,300, up 3.6% from a year earlier. (…)

From Haver Analytics:

Sales of existing single-family homes declined 1.1% (-4.0% y/y) to 4.620 million units, the fourth decline in the last five months. Sales of condos and co-ops rebounded 5.6% (-8.1% y/y) to 570,000 units.

The number of homes on the market increased 1.7% y/y. (…)

The South is hanging in (-1.7% YoY) but everywhere else sales are pretty weak and trending lower.

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Pending home sales for March showed similar trends:

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House prices are below their LT average but that average includes the pre-FC abnormal levels. In reality, house prices are on the high side vs income.

If you live in the Midwest, existing home sales have collapsed from 1.3 million annualized in November 2018 to 1.17 million in April 2019.

The Chemical Activity Barometer (CAB), a leading economic indicator created by the American Chemistry Council (ACC), rose 0.4 percent in May on a three-month moving average (3MMA) basis, the third monthly gain after several weak months. On a year-over-year (Y/Y) basis, the barometer is up 0.5 percent (3MMA).

The unadjusted measure of the CAB retreated 0.2 percent in May, with weakness centered in equity prices, and rose 0.7 percent in April. The diffusion index was steady at 65 percent in May. The CAB reading for April was revised upward by 0.27 points and that for March by 0.13 points.

“Year-earlier comparisons have turned positive in recent months, and while trade tensions, slowing economic growth overseas, and soft economic reports in the U.S. have created uncertainty that has weighed on business investment, the CAB signals gains in U.S. commercial and industrial activity through mid-2019, albeit at a moderate pace,” said Kevin Swift, chief economist at ACC. (…)

Production-related indicators in May were slightly positive. Trends in construction-related resins, pigments and related performance chemistry were mixed and suggest further slow gains in housing activity. Plastic resins used in packaging were positive, while those for consumer and institutional applications were mixed. Performance chemistry and U.S. exports were mixed. Equity prices dropped sharply this month, while product and input prices rose. Inventory and other indicators were positive. (…)

Hanging in there! A decline below the zero growth line would not be a good omen.

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Banks are not upbeat:

  • Banks have become less lenient on C&I loans…

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…in spite of weak and weakening demand:

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  • Banks are generally tightening standards on consumer loans, particularly credit cards…

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…in spite of weak demand:

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First on that line of thought:

St. Louis Fed Chief Says Interest Rate May Be Cut to Meet Inflation Target James Bullard is first central-bank official in recent years to lay out case for lowering rate

(…) The Fed “may want to consider ways to re-center inflation and inflation expectations at the 2% target” in a climate where it has consistently failed to achieve its price-rise goal, Mr. Bullard said in remarks prepared for a presentation that he gave in Hong Kong.

One way the Fed could accomplish that would be to ease its monetary-policy stance, Mr. Bullard said.

“A downward policy-rate adjustment even with relatively good real economic performance may help maintain the credibility of the [Federal Open Market Committee’s] inflation target going forward,” Mr. Bullard said. “A policy rate move of this sort may become a more attractive option if inflation data continue to disappoint.” (…)

Other Fed rate-rise skeptics, like Minneapolis Fed leader Neel Kashkari, have refrained from saying a rate cut was in the cards. Most central bankers see steady rates this year, and some who had thought an increase might happen have backed away. Meanwhile, financial markets are eyeing a rate cut by year’s end. (…)

EUROPE: NOT A UNITED FRONT

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Source: @acemaxx, @FT; Read full article

THE DAILY EDGE: 16 MAY 2019

U.S. Retail Sales Ease Due to Broad-Based Weakness

Total retail sales slipped 0.2% (+3.1% y/y) during April following a 1.7% March increase, revised from 1.6%. Excluding motor vehicles and parts, retail sales improved 0.1% (3.3% y/y) after rising 1.3%. A 0.7% gain had been expected.

Last month, a 1.1% decline (+2.2% y/y) in sales of motor vehicle & parts led the overall sales weakness, after a 3.2% March rise. This compared to a 6.1% decline in unit sales of motor vehicles during April.

A measure of the underlying pace of retail spending is nonauto sales growth excluding gasoline and building materials. These sales were unchanged during April (3.4% y/y) after a 1.1% increase.

Weakness in retail sales was pervasive. Sales of building materials & garden equipment stores were off 1.9% (+1.2% y/y) following a 0.8% increase. Electronics & appliance store sales declined 1.3% (-4.3% y/y) and reversed the prior month’s rise. Clothing & accessory store sales eased 0.2% (+0.2% y/y) after a 2.1% jump. Sales via the internet also slipped 0.2% (+9.0% y/y) following three straight months of strong increase. (…) Restaurant & drinking establishment sales  increased 0.2% (5.7% y/y) after a 1.0% rise.

Extremely volatile consumer:

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Sales ex-automotive, building materials and garden equipment (which feed directly into GDP) are hanging in YoY thanks to a strong first quarter. But last 5 months, which include December 2018, control sales are up a low 1.2% annualized. Last 9 months: +1.4%. This in spite of strong employment growth, rising wages and slower inflation. The American consumer has gone in hibernation and seems happy like that.

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Perhaps this will incite consumers to buy now:

Because the economy needs an active consumer:

Weak Manufacturing Drives U.S. Industrial Production Lower

This is pretty weak. Manufacturing IP has decidedly turned down in January. It’s more than the weather.

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U.S. IP is down in 3 of the last 4 months, at a 5.0% annualized rate.

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U.S. IP is rarely that weak YoY and lower oil prices are not the cause this time:

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The weakness is widespread. All sectors are negative.

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Capacity utilization is dropping: bad for capex, bad for industrial margins.

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Is this a change in trend?image

U.S. Targets Huawei as It Seeks to Revive China Trade Talks President Trump signed an executive order that would let the U.S. ban telecommunications gear from “foreign adversaries,” underscoring tensions with China even as the U.S. said it would likely resume trade talks soon in Beijing.

(…) The executive order came hours after Treasury Secretary Steven Mnuchin said the two sides would “most likely” meet again in Beijing in an effort to salvage the trade deal after each country raised tariffs on goods from the other. (…)

Negotiators for both nations are discussing specific dates for the trip, most likely during the last week of May, said people familiar with the planning. (…)

Mr. Mnuchin also signaled progress on removing steel and aluminum tariffs against Mexico. (…)

Those developments came as the White House postponed for about six months the final decision on whether to impose broad tariffs on automobile and auto-part imports, two administration officials said Wednesday.

Mr. Trump was facing a deadline this week on whether to apply the tariffs following a report from the Commerce Department about the national-security risks of automotive imports. (…)

The Trump administration is pulling out the big guns in its push to slow China’s rise, with potentially devastating consequences for the rest of the world.

The White House on Wednesday initiated a two-pronged assault on China: barring companies deemed a national security threat from selling to the U.S., and threatening to blacklist Huawei Technologies Co. from buying essential components. If it follows through, the move could cripple China’s largest technology company, depress the business of American chip giants from Qualcomm Inc. to Micron Technology Inc., and potentially disrupt the rollout of critical 5G wireless networks around the world. (…)

The threat is likely to elevate fears in Beijing that President Donald Trump’s broader goal is to contain China, leading to a protracted cold war between the world’s biggest economies. In addition to a trade fight that has rattled global markets for months, the U.S. has pressured both allies and foes to avoid using Huawei for 5G networks that will form the backbone of the modern economy. (…)

The Commerce Department said Wednesday it will soon put Huawei on an “Entity List” — meaning any U.S. company will need a special license to sell products to the world’s largest networking gear maker. Since American companies dominate semiconductors, that could smother Huawei’s production of everything from 5G base stations to mobile phones. It may not even be able to use Google’s Android, the most popular operating system globally for smartphones. A similar move last year against ZTE Corp. — China’s second-biggest telecom equipment company — nearly forced the company out of business.

“This could potentially lead to Huawei’s destruction,” said Scott Kennedy, a China expert at the Center for Strategic and International Studies. “You can’t underestimate the significance. It’s their most important company and threatening it in this way will generate a massive public response as well as from the Chinese government. The bilateral trade talks were on thin ice and this could derail them entirely.” (…)

The lack of alternatives is one reason that it’s far from certain the U.S. will make good on its threat to cut off Huawei. Observers for months had been dismissing the possibility, in part because it would hurt some of America’s largest tech corporations. The Trump administration has also been pressuring allies to bar Huawei equipment from their communications networks for security reasons. But the U.S. effort had largely failed, as even the U.K. declined to join the American call for a boycott. (…)

ZTE provides a roadmap for what may happen next. Huawei’s much smaller rival in 2017 ran afoul of the Commerce Department for violating the same Iranian sanctions, and then lying about it. The subsequent ban on American exports pushed the company to the brink of extinction, before Trump intervened as part of trade negotiations with Beijing.

A blanket ban would hurt not just U.S. companies, but also alienateAmerican allies around the world. Many have resisted Washington’s attempts to steer them away from Huawei, for reasons ranging from economics to just the simple fact that the Shenzhen-based company’s 5G technology is for now considered superior. (…)

That’s why some observers, including the Eurasia Group, argue that the White House is unlikely to bring the full force of a blacklist to bear. Instead, it argued, the Trump administration is likely to issue export licenses to all of its American companies while retaining the option in future to pull them if needed. (…)

Alien The problem here is that Huawei has the critical world patents for 5G, particularly on polar coding, as the WSJ explained last February:

Huawei, and its crosstown rival ZTE Corp. ZTCOY 3.29% , have put forth vastly more proposals—and are among the biggest owners of key patents—underpinning the coming wave of 5G technology. That is in contrast to Western firms, which played a comparatively smaller role in the blueprint and design of 5G than in previous generations of wireless technology.

Huawei’s clout in the design of 5G stems from its massive research and development budget, and from its aggressive contributions to the round-the-world meetings where engineers cobbled together the underlying architecture of 5G.

As a result, the Chinese tech juggernaut as of early February owned 1,529 “standard-essential” 5G patents, the most of any company. Together with patents owned by ZTE, the state-owned China Academy of Telecommunications Technology, and Guangdong Oppo Mobile Telecommunications Corp., companies from China own 36% of all 5G standard-essential patents, more than double their share of comparable 4G patents, according to data-analytics firm IPlytics.

The Chinese 5G patents cover technology associated with everything from 5G handset componentry to base stations and driverless-car technology. And telecom companies around the world—including those operating in places where Huawei gear might be off-limits—will have to pay royalties to Huawei to license that technology when it comes time to put 5G networks on the ground, experts say.

U.S. firms, by contrast, including Qualcomm Inc. QCOM 0.15% and Intel Corp. INTC 1.00% , hold just 14% of critical 5G patents, according to IPlytics. Huawei’s clout in 5G sets it apart from previous generations of wireless networks, which saw significantly fewer contributions from Chinese mobile companies compared with U.S. and European firms. (…)

Huawei’s prowess in next-generation technology stems partly from the fact that it now regularly outspends its rivals in research and development, a fact that has alarmed some policy makers in Washington. In 2017, the company spent $13 billion on R&D, more than any other Chinese tech company, and more than its chief rivals, Ericsson ERIC 0.88% and NokiaCorp. , combined. (…)

Some of Huawei’s proposals are now fundamental building blocks of 5G. They include one highly prized technique called “polar coding,” a method for correcting errors in data transmission. Huawei poured resources into developing it, and polar coding became a rallying cry for Huawei and its Chinese peers at standards meetings. (…)

China slams U.S. blacklisting of Huawei as trade tensions rise  China on Thursday slammed a decision by the U.S. government to put telecom equipment giant Huawei on a blacklist and said it will take steps to protect its companies, in a further test of ties as the economic heavyweights clash over trade.

(…) Huawei, which denies its products pose a security threat, said it was “ready and willing to engage with the U.S. government and come up with effective measures to ensure product security.”

It said restricting Huawei from doing business in the United States would “limit the U.S. to inferior yet more expensive alternatives, leaving the U.S. lagging behind in 5G deployment and eventually harming the interests of U.S. companies and consumers.” (…)

The sanctions on Huawei were also likely to have ramifications beyond the company itself, rattling the global tech supply chain, analysts said. (…)

China dumps US Treasuries at fastest pace in two years March government bond sales by China came to $20.5bn ahead of fractious trade talks
What Will Trump’s Latest Tariffs Mean for Inflation? The latest tariff increases on Chinese imports will likely deliver a modest and temporary boost to U.S. inflation, in part reflecting the relatively small portion of American spending that goes to goods rather than services.

President Trump’s decision last week to raise tariffs on roughly $200 billion of goods, to 25% from 10%, represents the single biggest escalation of his yearlong confrontation with China. The new duties could amount to as much as $30 billion of annual revenues for the government—and additional costs for U.S. consumers. Mr. Trump’s threat to impose 25% duties on an additional $300 billion of imports from China, if carried out, would have a larger impact at up to $75 billion a year in revenue to the U.S. government.

Though recent studies have shown U.S. consumers have borne the brunt of such costs in the past, economists point out that they amount to a drop in the bucket of the U.S.’s $21 trillion economy. Since 1970, American households have spent more on services—such as housing, health care and education—than goods, many of which have become cheaper over the decades thanks to trade and technological innovation. (…)

Booming Buybacks Aren’t Likely to Slow Down Repurchases of blockbuster stock amounts during two recent pullbacks signal firms didn’t see market declines as worrying

The more than 80% of firms in the S&P 500 that have reported results for the first quarter repurchased $180 billion worth of their own stock during that time, according to S&P Dow Jones Indices, on pace to be the second-highest amount on record based on data going back to 1998. While data isn’t yet available for the second quarter, companies ramped up buying during the two previous market pullbacks.

Every quarter in 2018 marked a new high, as companies were bolstered with money they saved because of corporate tax cuts. The most buybacks in one quarter, a staggering $223 billion, came in the last three months of last year when broader markets spiraled. Buybacks also hit a record in the first quarter of 2018 when markets sold off. (…)

Last year, the top 20 companies repurchasing stock in the S&P 500—many of which were tech firms—accounted for 42% of all buybacks, compared with a 32% share in 2017, data from S&P Dow Jones Indices showed.

Buybacks are helping companies boost their earnings per share significantly. In the first quarter, 25% of S&P 500 companies added a tailwind of at least 4% to their earnings per share because of buybacks, according to S&P Dow Jones Indices. That is up from 14% of companies that boosted their earnings per share by at least 4% a year ago. (…)

I updated this yardeni.com chart for Q1’19 data.

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This next chart shows the YoY change in the S&P 500 divisor (buybacks minus new issues). The Index per share profits are currently boosted by 2.4% (Q1’19) after +1.9% in Q4’18. It should be about +2.0% in Q2, +2.4% in Q3 and Q4 based on current trends. Mid and small caps are benefitting somewhat more.

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Since 2009, IT companies have made 26% of total S&P 500 buybacks. Last 4 quarters: 35% per Ed Yardeni’s numbers.

Trump Pardons Ex-Media Baron Conrad Black, a Former Business Partner President Trump pardoned former media baron and one-time business partner Conrad Black, who was convicted of fraud and obstruction of justice charges, as well as a former Republican leader in the California Legislature.

(…) In granting a pardon Wednesday to Lord Conrad Black, Mr. Trump cited “broad support from many high-profile individuals who have vigorously vouched for his exceptional character,” the White House said in a statement. (…)

Mr. Black has been a conservative commentator and political biographer, and last year wrote a book about Mr. Trump entitled “Donald J. Trump: A President Like No Other.” In it, he describes Mr. Trump as “a good deal more ethical and honest than many other businessmen and corporate directors I have known.” (…)

Allow me a personal hmmm..here.