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

RETAILING

THE DAILY EDGE (3 November 2016): November Jitters

Fed Sends New Signals About a Possible December Rate Increase Inflation is finally showing signs of behaving the way Federal Reserve officials want it to, bolstering the case for them to raise short-term interest rates next month

(…) Inflation has “increased somewhat since earlier this year,” Fed officials said in a statement released after a two-day policy meeting, noting also that some investors’ expectations of future inflation “have moved up but remain low.” (…)

The Fed’s policy committee “judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives,” it said. (…)

The word “some” is new. Given that the October manufacturing PMIs were strong almost throughout the world, the Fed needs to make sure that the U.S. consumer is active during the coming holiday period because that would clear the remaining excess inventories in the system and set the stage for a good 2017 first half. The Fed statement acknowledged the slowdown in consumer spending in Q3 vs Q2 (“Household spending has been growing strong rising moderately…”). The FOMC of Dec. 13-14 should have enough info on retail sales to assess the trend.

Everybody is focused on Friday’s payroll data but retail sales are more significant at this point. Higher employment with increased savings would not help clear excess stocks.

Retail sales will suffer in the months ahead due to rapidly rising medical and rental CPI.  Whenever rental and medical costs have risen significantly in the past, they have led to a big decline in retail sales.  You can see from the chart below that Medical CPI plus Rental CPI provides a nine month lead on Redbook Same Store Sales.  Consumers will start cutting back spending on non-essential items in order to pay for medical care and housing.

Retail stocks are highly correlated to the ups and downs of same store retail sales.  As you can see from the next chart, the S&P 500 Consumer Discretionary sector has fallen sharply when rental and medical costs have risen, notably in 2001-02 and 2008-09.

Interesting, but I am not sure Redbook sales are still a good proxy for retail sales given online sales.

BTW, Thomson Reuters’ Same Store Sales Index

(…) is expected to show a 1.1% gain for October 2016, an improvement from October 2015’s -0.4% result. An increase of 3% or more indicates a healthy retail industry. (…)

October marks the last month of the retail industry’s third quarter. Our Thomson Reuters Quarterly Same Store Sales Index, which consists of 80 retailers, is expected to post 1.1% growth for 3Q (vs. 1.4% in 3Q 2015).

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U.S. ADP Private Payroll Gain Eases

The ADP/Moody’s National Employment Report indicated a 147,000 increase (1.9% y/y) in October nonfarm private sector payroll employment following a 202,000 September addition, revised from 154,000.

The ADP report is not a solid indicator but it was pretty weak in October.

Worldwide manufacturing growth hits two-year high

The JPMorgan Global Manufacturing PMI, compiled by Markit from business surveys in over 30 countries, rose to 52.0 from 51.0 in September, its highest since October 2014. The upturn means that the latest survey data are roughly consistent with global manufacturing output rising at a reasonable 4% annual pace.

Both output and new orders grew at the strongest rates for just over two years, and the recent drag from inventory reduction continued to ease. Stocks of both finished goods and inputs showed the smallest declines for over a year.

Global exports continued to rise at only a modest rate, however, acting as a dampener on overall order book and production growth, especially in the emerging markets. While the developed world manufacturing PMI edged up to a 24-month high of 53.0, the emerging market PMI merely rose to 50.9 (albeit a 20-month high).

Key drivers of the overall global improvement were the US and China, where the PMIs hit 12- and 27-month highs respectively, the latter buoyed by output rising in China’s factories at the fastest rate for over five years (despite a renewed drop in exports).

The upturn was broad-based, however, as further support came from Europe, where the eurozone PMI hit a 33-month high and the UK continued to register solid growth. The Nikkei PMI for Japan also recorded its best performance for nine months, and the Russian PMI meanwhile lifted to a four-year peak.

However, the fastest rate of growth (as signalled by the headline PMI) continued to be reported by the Philippines, followed by the Netherlands and Germany, these two runners-up highlighting the relative strength of factory production in northern and central Europe (neighbouring Austria and the Czech Republic were also in the top eight).

India moved into fourth place, helping demote the UK to fifth place. The UK nevertheless remained a strong performer, thanks largely to the weakened pound. Only the Philippines and then Germany reported faster export sales growth than the UK in October. (…)

Brazil once again suffered the steepest downturn, despite seeing its smallest deterioration in nine months, followed by Malaysia and then South Korea, the latter two sitting in contrast to the surging growth recorded in the Philippines and highlighting the marked divergence in manufacturing trends within Asia.

(…) the survey provided scant evidence that prices were being driven up by demand rising faster than supply. Suppliers’ delivery times, for example, were largely unchanged, suggesting much of the increase in costs could be explained by higher oil prices rather than a fundamental improvement in suppliers’ pricing power.

(…) Production expanded especially sharply, growing at the fastest rate since March 2011, helped by a further rise in new orders. A renewed decline in export sales, albeit marginal, suggested that much of the uplift was driven by a welcome strengthening of domestic demand.

Part of this further improvement in manufacturing conditions therefore appears to have been due to the government’s efforts to stimulate the economy through fiscal measures. Other encouraging leading signals were busier supply chains and increased purchasing activity.

(…) Job cuts in the manufacturing sector consequently continued to be widely reported despite strong improvements in output and new orders, as companies downsized and sought cost savings. On a brighter note, there were nascent signs of stabilisation in the manufacturing workforce as the rate of decrease in employment slowed to the weakest since May 2015.

CEBM Research’s own analysis suggests that China’s manufacturing-related employment surged 28% in October.

CETERIS NON PARIBUS

Alibaba Group Holding Ltd. is using its e-commerce stronghold in China to grow beyond its online marketplace. The company reported strong results in its latest quarter, with users increasing spending and the company showing profit potential in areas that include internet and entertainment services, the WSJ’s Alyssa Abkowitz reports. The Chinese internet giant is betting big on cloud computing, and is challenging Amazon Web Services and Microsoft with growing business that could give the company a cushion against a hard landing for China’s economy. The foundation e-commerce business is still growing, however, and defying China’s downturn. It’s also changing in significant ways: mobile revenue now accounts for 78% of Alibaba’s China retail revenue, and users of mobile devices are spending more every time they log in, suggesting the market is getting more comfortable with big purchases as well as small, one-off retail buys.

SHORT-TERM PAIN FOR LONG-TERM GAIN

Ocean carriers shouldn’t expect relief from overcapacity anytime soon, or even during this decade. A new report from the Boston Consulting Group Inc. projects the imbalance between shipping supply and demand will only grow in the next few years, WSJ Logistics Report’s Erica E. Phillips writes, suggesting that this year’s plunging freight rates and shrinking carrier profits will only grow worse without a big shock to the market. BCG says in a new report that the market right now shows container shipping lines steaming straight ahead with a strategy of adding more and bigger ships even as global trade sputters. The bottom line: the cap between shipping capacity and demand that reached 7% this year will grow to between 8.2% and 13.8% in 2020, the firm says. Freight rates have ticked up this fall, but analysts say that’s just brief relief for carriers, not a trend.

43%:Share of global container shipping the top three carriers will hold next year, according to Maersk, compared to 17% twenty years ago.

OIL

Oh-Oh! Is there suddenly a demand problem in the U.S.? This is the biggest weekly crude surplus on record.

The Daily Shot adds this telling chart:

Russia continues to agree with OPEC about the need to “cut” production while sharply raising its own output.

And these two:

Gift with a bow All just in time for Thanksgiving and Christmas…

U.K. Must Hold Vote in Parliament Before Brexit: Court Ruling

The Economist: “An appeal is likely. The government insists that it conducts foreign affairs under the ancient “royal prerogative”, without lawmakers’ oversight.

Egypt Free Floats Its Currency, Devaluing It Against the Dollar Egypt’s central bank said Thursday it would freely float the local currency, a move aimed at eliminating a flourishing black market for U.S. dollars and securing a much-needed IMF loan, but devaluing the pound by almost half.
EARNINGS WATCH

Good season overall.

  • 385 companies (83.1% of the S&P 500’s market cap) have reported. Earnings are beating by 6.1% while revenues are surprising by 0.2%.
  • Expectations are for revenue, earnings, and EPS growth of 2.5%, 1.9%, and 4.1%, respectively.
  • EPS is on pace for +5.1%, assuming the current beat rate for the remainder of the season. This would be +8.6% excluding Energy.
  • If there are no further beats this season, EPS would grow 4.1% with revenues, margins and buybacks contributing 2.5%, -0.5%, and 2.1%, respectively. Excluding the drag from Energy, margins would be adding 100 bps.

So margins are back on the uptrend! Recent PMI surveys reveal that manufacturers are seeing some pricing power finally while wages are not (yet) threatening.

Thomson Reuters’ tally sees EPS up 3.3% in Q3 but Q4 estimates are being trimmed from +8.3% on Oct. 1 to +6.8% yesterday.

NOVEMBER JITTERS

September and October have historically been the worst months for equities. Lance Roberts shows that early November can also be nasty, even more so during election years:

First, if we look at the month of November going back to 1960, we find that there is a bias for the month to end positively 61% of the time. In other words, 3 out of every 5 months finished in positive territory which is why it is included in the seasonally strong period of the entire year. Furthermore, the average and median returns for the month top 1% over the course of that time. (…)


A look at daily price movements during the month, on average, reveal the 5th through the 8th trading days of the month are the weakest followed by mid-month. (…)

However, during election years, we see the same periods remaining weak, but more dramatically so as the volatility of election years skews the average of all years. In other words, regardless of who is elected on the 8th, look for a relief rally on the 9th, followed by a sell-off over the next few days. The traditional post-Thanksgiving rally tends to be stronger performance wise as the “inmates run the asylum” during exceptionally light volume trading days.

THE DAILY EDGE (1 November 2016)

U.S. Consumer Spending Rose 0.5% in September Consumer spending climbed 0.5% in September, a sign of resilience among households amid signs of flagging confidence in the economy.

Incomes gained 0.3%.

Economists surveyed by The Wall Street Journal had expected personal spending and income both to increase 0.4% in September. (…)

Monday’s figures showed purchases of autos and other big-ticket items surged in September—spending on durable goods climbed 1.3%.

Americans also saved a little less. The personal saving rate fell to 5.7% from 5.8% the prior month. (…)

The personal-consumption expenditures price index, the Federal Reserve’s preferred inflation measure, rose 0.2% in September from the prior month. From a year earlier, the index was up 1.2%. That was the firmest year-over-year reading since November 2014.

So-called core prices, which exclude the volatile categories of food and energy, advanced 0.1% from the prior month and were up 1.7% from a year earlier. (…)

When adjusting for inflation, consumer spending climbed 0.3% in September from the prior month. Inflation-adjusted disposable personal income—income after taxes—was flat.

Q3 slowed sequentially as this Haver Analytics table shows. Real PDI and spending: +1.6% SAAR.

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This is not a healthy trend:image

Plate The Commerce Dept.’s data include a 1.2% rebound (3.5% YoY) in restaurant & accommodations spending (3.5% YoY) in September which was confirmed by the National Restaurant Association’s own stats:

Driven by an overall increase in operators’ current situation, the National Restaurant Association’s Restaurant Performance Index (RPI) advanced in September. The RPI stood at 100.8, up 1.2 percent from August.

“September’s RPI uptick was aided by gains in the current situation indicators, which have been soft in recent months,” said Hudson Riehle, senior vice president of research for the National Restaurant Association. “Meanwhile, the forward-looking indicators are becoming more muted. Operators are decreasingly optimistic looking toward the months ahead. In fact, three in 10 operators say they expect economic conditions to worsen in the next six months.”

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The Current Situation Index stood at 101.0 in September – up 2.5 percent from a level of 98.6 in August. September’s reading of the current situation indicators was the highest level since April, and lifted the index back into expansion territory above 100. Restaurant operators showed the strongest same-store sales results since April; 49 percent reported a same-store sales increase between September 2015 and September 2016. Similarly, they also reported stronger customer traffic levels, though results were still mixed overall. Forty percent of restaurant operators reported an increase in customer traffic and 39 percent reported a traffic decline.

German Retail Sales Drop Is Largest in Two Years

large imageGerman retail sales (excluding autos) fell off sharply in September as the largest drop in two years was logged. (…)

The year-on-year gain in nominal German retail sales is at 0.4% while real sales ex-autos show a drop of 0.2% over 12 months. Both real and nominal sales show sequential growth rates that are getting progressively weaker on shorter horizons. (…)

However, car registrations in Germany have been holding up. They expanded by 2% in September (month-on-month) and are up by 9.1% over 12 months. Registrations, however, are still contracting on balance over three months. (…)

Other early European retail sales reporters include the U.K., France, Spain and Portugal. Sales are weak or lower in September of each of these countries except Spain where real sales rose by 0.6% in September (but after a 0.9% drop in August). Still, the sequential growth rates of real retail sales in these countries generally shows growth and firming with the exception of Spain and Portugal. In Spain sales slowed on balance over three months while in Portugal sales dropped over three months. Still, sales are growing year-over-year in each of these countries with the slowest annual growth in France at just 1.2% over 12 months.

In the quarter-to-date, sales are generally strong as well. In the U.K. sales are up at a 7.3% pace in Q3 compared to an 11% pace for Portugal and a 3.9% pace for Spain. Sales in France, however, are the exception; they are falling in Q3 at a -0.2% annualized rate.

German retail sales have declined MoM in 8 of the last 12 months (chart from The Daily Shot)

  • South Korea’s retail sales see the largest monthly decline in years. (The Daily Shot)
Asset Bubbles Threaten China’s Economy Easy credit and fiscal stimulus are inflating prices and volatility across Chinese financial markets. Some Chinese leaders worry the investing binge has gone too far, producing hazardous economic side effects.

(…) The biggest apparent bubble is in housing, but prices have surged for niche assets, too, such as calligraphy, antiques and art. In May, futures prices for soybean meal, used as pig feed, jumped 40%. The trading volume of 600 million tons was nine times higher than China’s annual consumption. The pipe-making material PVC is up 40% so far this year on the Dalian Commodity Exchange. (…)

Apartment prices in Shenzhen rose 47.5% last year, according to real-estate firm Knight Frank. That was the largest increase in the world and almost twice the 25% jump in the second-place city, Auckland, New Zealand. (…)

Jiangsu Shagang Co., a publicly traded steelmaker that posted a loss for 2015, swung back to profitability in the first half of this year partly because the steel-futures jump made Shagang’s rebar worth more.

Even Shagang is a speculator. To offset a difficult business climate, Shagang has diversified into “financial futures…venture/risk investment, real estate, etc.,” according to its website. Shagang declined to comment. (…)

Xiao Chaojiang, who runs Shenzhen Ruike Investment, a fund with $30 million in assets, said he has profited by jumping from stocks to steel rebar futures to iron ore to soybean meal to cotton. He is now considering other agricultural sectors. (…)

Deflating the asset bubbles poses risks for China. Some unprofitable state businesses need easy money to roll over other debts that they can’t pay. At least for now, officials are trying to control each bubble as it arises. (…)

A few charts from The Daily Shot:

  

  

Money Over Half A Trillion In M&A: October Mergers Smash All Records With $500.1 Billion In Deals

BlackRock: A Consequential Election. Impact of 2016 US election on investing

Tks Freddie:

• Washington decision making is likely to become more fractious regardless of the Nov. 8 election result. Divisions between and within the Republican and Democratic Parties have been growing, and an outcome whereby neither party would have a significant majority in the House of Representatives is a possibility. This could make it harder to reach consensus on legislation, potentially heralding a return to dramatic showdowns over budget issues.

• Yet corporate tax reform and increased spending on infrastructure appear to have some bipartisan support — and would be a ripe area for negotiation in a divided Congress. Infrastructure spending should boost growth more than usual amid rock-bottom rates, in our view. We offer some of our own policy thoughts, including steps to address a looming retirement crisis and to entice private capital to finance infrastructure.

• A growing backlash against free trade and immigration threatens to make economies more insular — at a time when economic growth and productivity in many countries are barely above stall speed. Emerging markets have the most to lose, especially under a victory by Republican nominee Donald Trump. Mexico is a clear potential loser given its heavy reliance on exports to the US.

• The US election campaign suggests rising populist sentiment is likely here to stay. We also see potential changes to income taxes, with ripple effects on US municipal bonds. We focus on two sectors that could be most affected by the election: financials and health care. Mergers and acquisitions are set to face increased scrutiny if Democratic nominee Hillary Clinton prevails, as her party appears to view anti-trust enforcement as a tool to boost competition and address inequality.