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

NEW$ & VIEW$ (25 APRIL 2016): Bleak PMIs; Oil?? Earnings Watch

BLEAK FLASH PMIs

Last Friday, Markit released its flash PMIs fo the U.S., the Eurozone and Japan. I have not seen any mention of them in the mainstream media, even though they were highly informative on the continued slowdown in world economies. In case you missed my earlier posts:

Department Stores Need to Close Hundred of Sites, Research Firm Says U.S. department-store chains need to close hundreds of locations if they want to regain the productivity they had a decade ago, according to real-estate research firm Green Street Advisors.

The real-estate research firm estimates that the closures could include roughly 800 department stores, or about a fifth of all anchor space in U.S. malls.

Sears Holdings Corp. alone would need to close 300, or 43%, of its Sears stores to regain the sales per square foot it had in 2006, adjusted for inflation, according to Green Street. (…)

Sales at the nation’s department stores averaged $165 a square foot last year, a 24% drop since 2006, according to company disclosures and Green Street estimates. Over the same period, the stores reduced their physical footprint by 7% in aggregate. (…)

“There’s a misperception out there that when we close a store, that business transfers online,” Ed Record, Penney’s chief financial officer, told analysts in November. “When we close a store, particularly in a small market, we see our dot-com business go down.”

A spokesman for Nordstrom said that all of its stores are profitable, and closing stores “is not our normal practice.” (…)

The store glut has important implications for the country’s weaker malls, which rely on their anchors to drive foot traffic. “If department stores were to move forward and aggressively streamline their physical presence it could result in several hundred malls no longer being relevant retail destinations,” he said.

OIL

In an about-face, companies are using hedges to lock in prices that they turned their noses up at a few months ago. (…)

Despite the uptick in activity, U.S. producers have hedged just 36% of their expected output for 2016, according to Citi Research. In past years, they hedged about half of their production. (…)

The market is so volatile, shale companies are jumping to sell their future output whenever the price pops, said Sameer Panjwani, an associate at Tudor, Pickering, Holt & Co., an energy investment bank in Houston.

“You do things when you can, not when you have to,” he said. (…)

The drop in revenues stemming from the export of oil is the direct result of the plunge in crude prices from around $115 a barrel in the middle of 2014 to below $30 at the start of the year and now above $40, the IMF said. (…)

The IMF estimates that the oil exporting countries in the Middle East will see 10 million young people being added to the workforce in the next five years. Mr. Ahmed warns that the current pace of job creation is insufficient to absorb the new labor market entrants.

“If jobs continue to be created at the same rate as in the last few years, you will end up with 3 million (additional) unemployed by the end of this five-year period,” Mr. Ahmed said. The IMF estimates average youth unemployment to be around 20% in the region. (…)

By Hubert Marleau, Palos Investment

Over the past the five days, I have read as many articles and comments as I possibly could to get in order to understand what took place in Doha last Sunday. What I have read confirms that the geopolitical scene in the Middle East is dangerous and perhaps even impossible to reverse.

(…) The 18 oil-producing countries representing about half the world’s crude output that attended the conclave, believed that a deal to freeze production would be the start of a process to stabilize oil prices. Several Saudi officials signaled on Saturday evening that the Kingdom would consider a freeze without Iran’s participation. A draft agreement was circulated. Almost everyone was under the impression that within an hour or two a deal would be signed.

Then out of nowhere, by late Sunday afternoon, the meeting that was supposed to clinch a deal that had already been agreed became a farce descending into confusion. The talks collapsed and Saudi Arabia surprised the group and even their allies by reasserting a demand that Iran must also cap its oil production.

However, Iranian officials were not about to negotiate and it was reported that on Sunday that veteran Ali al-Naimi received a call from the new kid on the block in Riyadh; the 30 year old deputy crown prince, Mohammed bin Salman, and favoured son of King Salman. Mohammed bin Salman has risen to a position of almost unrivaled power with control over sensitive portfolios like oil, defense and the economy. He scuttled all hopes of brokering the first global output deal in 15 years that could of mark a new level of cooperation between non-Opec oil producers and Opec members.

The question to ask is “How can we go from agreeing to everything on Saturday and turning everything upside down on Sunday?”. There are probably several reasons. In our opinion, the main ones are:

1. Saudi Arabia believes that in the end Russia and Venezuela, which have strong ties with Iran, should have used their influence to bring the Iranians to some kind of geopolitical terms, such as reducing military aid to Syria and Yemen and/or economic like capping oil output at a certain level. The former being more important because there is a proxy war going on between the two countries. Russia, Venezuela and Iran are at most risk. The pain of not freezing is set to deepen more with the foes than with the allies like Qatar, Kuwait and UAE. It’s like a form of punishment.

2. Saudi Arabia may want to take its market share policy to the next level as it still has sufficient spare capacity to increase oil output. The Saudis could immediately increase oil output by more than 1 million barrels a day to 11.5 million if demand presented itself and a further 1 million to 12.5 million nine months later.

3. Saudi Arabia wants to calibrate its ties with the US to ensure that Washington remains a trusted and supportive ally of the Kingdom’s posture to remain the leader in the Middle East and retain its intent of asserting regional influence. Underlining Saudis’ hegemony and governorship in this delicate and dangerous region, the deputy crown prince assembled an antiterrorism coalition of more than 30 Muslim nations.

In this regard, Saudi Arabia severed ties with Iran and pursued a with-us or against-us strategy in efforts to assemble a broad anti-Teheran bloc. Gulf countries tend to blame Iran for some of the violent conflicts and disagreements in the region. Mr. Obama was in Riyadh on Wednesday and so perhaps the Saudis decided on Sunday to wait until they had a talk with Obama. The next oil meeting is in June. The Saudis could then comply with a production freeze if they clear the air with the US president.

The Saudis are not happy with the US diplomatic rapprochement with Iran and reestablishment of cordial relations. Obama wants either a “cold peace” between Iran and Saudi Arabia or a self-regulating balance of power for the region. This is not an easy policy to implement for the US footprint in the region has significantly reduced while that of Iran has increased as a result of the nuclear deal achieved last July.

The bottom line is that Obama wants to create an environment in which America’s middle-east allies rely less on the White House. Ultimately, he believes that it’s not the job of the US to solve every problem in the Middle East. In this connection, Saudi Arabia severed ties with Iran and set a coalition of allied nations. Moreover, the Saudis recently threatened to sell all or a huge portion of their US dollar holdings that they stash as official reserves, if they get blamed for 9/11. The official reserves of Saudi Arabia is around $600 billion. It’s complicated! A point has been reached where confusion exists and the Saudis are suspicious as to whether the US is still a faithful ally and partner. “Give me your trust and I will freeze output”

OPEC is facing a prisoner’s dilemma. Should be read by all who are interested in the geopolitical aspect of the global oil complex (http://www.postnewsreport.com/opec-is-facing-a-prisoners-dilemma/)

In reality, nobody can predict what will happen over the shorter term. Longer term, like all commodities, oil will self-balance supply with demand overshooting on both sides.

EARNINGS WATCH

First, Bespoke’s tally of all NYSE companies. We will get Q1 results from over 800 companies this week.

So far this earnings season, 309 companies have reported their Q1 numbers.  While that’s just 20% or so of the total amount that will report this season, it’s enough to get an early read on how the numbers are coming in.  Of the 309 companies that have reported thus far, 63% have beaten consensus analyst earnings estimates.  Below is a chart showing the historical quarterly earnings beat rate going back to 1999.  As you can see, a 63% beat rate for this season would be slightly stronger than last season’s beat rate, which itself was the strongest reading post since 2010.  (…) (Bespoke)

eps beats

Overall, 26% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 76% have reported actual EPS above the mean EPS estimate, 14% have reported actual EPS equal to the mean EPS estimate, and 10% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above both the 1-year (69%) average and the 5-year (67%) average.

The blended (combines actual results for companies that have reported and estimated results for companies yet to report) year-over-year earnings decline for Q1 2016 is -8.9% (-9.3% last week), which is below the expected earnings decline of -8.6% at the end of the quarter (March 31). Seven sectors are reporting a year-over-year decline in earnings, led by the Energy and Materials sectors. Three sectors are reporting year-over-year growth in earnings, led by the Telecom Services and Consumer Discretionary sectors.

If the Energy sector is excluded, the blended earnings decline for the S&P 500 would improve to -3.6% (-4.2% last week) from -8.9%.

In aggregate, companies are reporting sales that are 0.1% below expectations. This surprise percentage is below both the 1-year (+0.6%) average and above the 5-year (+0.7%) average.

The blended sales decline for Q1 2016 is -1.2%, which is below the estimated sales decline of -1.1% at the end of the quarter (March 31). Five sectors are reporting year-over-year growth in revenues, led by the Telecom Services and Health Care sectors. Five sectors are reporting a year-over-year decline in revenues, led by the Energy and Materials sectors.

If the Energy sector is excluded, the estimated revenue growth rate for the S&P 500 would jump to 1.6% from -1.2%.

So, a pretty big hit on margins. Factset’s tally shows that Q1 estimates have actually improved a little last week with and without energy. Thomson Reuters’ data also improved a little and TR is now showing –7.1% for Q1, back to where it was on April 1.

Fingers crossed While still very early in the season, corporate guidance is pretty good so far.

At this point in time, 20 companies in the index have issued EPS guidance for Q2 2016. Of these 20 companies, 10 have issued negative EPS guidance and 10 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 50% (10 out of 20), which is below the 5-year average of 73%.

FYI, guidance for Q1’16 was 33 negative and 6 positive on Jan.29. The big difference is from IT companies with a 6/4 pos/neg ratio for Q2 vs a 3/17 ratio for Q1. TR sees IT earnings down 0.6% in Q2 after -4.9% in Q1 and +2.5% in Q4’15.

Corporate guidance is important as we get into the middle month of Q2 as the economy is not providing much positive guidance so far:

  • retail sales have been pretty slow;
  • car sales seem to have past their cyclical peak;
  • housing is far from vibrant;
  • manufacturing keeps weakening with Markit’s April flash PMI slipping to 50.8 as “US factories reported their worst month for just over six-and-a-half years in April, dashing hopes that first quarter weakness will prove temporary.”
  • wages are rising faster than revenues.

Other non-official data confirm the lack of momentum in the economy: in the U.S., the AAR railcar loadings keep declining at a fast clip and Evercore ISI company surveys continue to weaken, including the important retailers survey which just dropped to a 3-year low. Abroad, Markit’s April flash PMIs showed a sinking Japanese manufacturing…

Both production and new orders declined markedly, with total new work contracting at the fastest rate in over three years. The sharp drop in total new work was underpinned by the fastest fall in international demand since December 2012 (…)

…and a stagnant Eurozone economy:

The eurozone economy remains stuck in a slow growth rut in April, with the PMI once again signalling GDP growth of just 0.3% at the start of the second quarter, broadly in line with the meagre pace of expansion seen now for a full year.

Markit has discontinued its Chinese flash PMI but we can infer from the others that new orders from China are not strengthening. From the March China PMI:

Manufacturing production in China increased for the first time in a year during March, albeit at a marginal pace. Higher output was supported by a renewed rise in total new work. As was the case for output, however, the rate of expansion was marginal. Some companies commented on an improvement in underlying client demand. Weak foreign demand remained a drag on new order growth, however, with new export business falling for the fourth month in a row.

In all, there is an obvious lack of momentum in world economies which is why central bankers keep looking for ways and means to rev the engines. Their bag of tricks now seems offering essentially untested tools with totally “unknown unknowns”.

At 2091, the S&P 500 Index is 0.8% above its “Rule of 20” fair value of 2074 using trailing EPS of $117.46 (per TR) and core inflation of 2.2%.

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There really seem to be very few positive catalysts around the corner that could boost investors mood such that they would be willing to bid equities much above their current elevated levels. In fact, Citigroup’s Economic Surprise Index failed again to move into positive territory as Ed Yardeni (next 3 charts) illustrates. Note that the ESI has not been positive for over one year now, indicative of how weak the economy has been given economists’ natural moodiness.

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Yet, the bull/bear ratio is back to neutral…

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…while equities rose 3.8% above their still falling 200-d m.a.:

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And here come May, June, July, August, September…

DoubleLine’s Gundlach says negative interest rates are a ‘horror’

(…) Gundlach, who oversees $95 billion for Los Angeles-based DoubleLine, said negative rates would not help fight deflation but withdraw liquidity from the market because people would rather hoard cash than invest or deposit it in a bank account.

Negative interest rates “are the stupidest idea I have ever experienced,” the newspaper Finanz und Wirtschaft quoted Gundlach as saying on its website on Saturday.

“The next major event (for financial markets) will be the moment when central banks in Japan and in Europe give up and cancel the experiment.” (…)

I don't know smile He also thinks Trump would be the best candidate for the US economy (via Zerohedge)

In the short term, Trump winning would be probably very positive for the economy. He says a lot of contradictory things and things that are not very specific. But he does say that he will build up the military and that he will build a wall at the border to Mexiko. If he wins he’s got at least to try those things. Also, he might initiate a big infrastructure program. What’s his campaign slogan? Make America great again. What that means is let’s go back to the past, let’s go back to the 1960s economy. So he might spend a lot of money on airports, roads and weapons. I think Trump would run up a huge deficit. Trump is very comfortable with debt. He’s a debt guy. His whole business has had a lot of debt over time and he has gone bankrupt with several enterprises. So I think you could have a debt-fuelled boom. But the overall debt level is already so high that you start to wonder what would happen after that.

Tech Shares Fail to Join the Party Technology shares​ are struggling to regain favor with investors, even as the rest of the U.S. stock market is back near record heights.

Business conditions for old-line tech stalwarts like International Business Machines Corp. and Intel Corp. have grown tougher, while Microsoft Corp. and Google parent Alphabet Inc.​disappointed investors with their results this week. In addition, one of the sector’s key sources of support—successful stock-market debuts by highly anticipated tech companies—also has dried up.

The result has been a selloff. Technology companies in the S&P 500 fell 1.9% Friday, nearly erasing the sector’s gains for 2016. Alphabet’s 5.4% fall Friday was its biggest since October 2012 and wiped out $29 billion from its market capitalization.

Investors have pulled a net $4.5 billion from technology mutual funds and exchange-traded funds in 2016 through the end of March, according to Morningstar. That follows three years of net inflows. (…)

NEW$ & VIEW$ (14 APRIL 2016)

Weak Retail Sales in March Augur Ill for First-Quarter Growth The U.S. economy is again off to a poor start to the year, clouding the outlook and validating the Federal Reserve’s wait-and-see posture on raising interest rates.

(…) A 0.3% drop for retail sales in March, according to Commerce Department figures out Wednesday, marked the third straight month in which sales have been flat or falling. (…)

GDP forecasts for the first quarter of 2016 echo the pattern of the past two years: Macroeconomic Advisers is tracking a growth rate of 0.9%, Nomura expects 0.7%, J.P. Morgan Chase 0.2% and Wells Fargo 0.1%.

That apparent slowdown—following a muted 1.4% advance in the closing quarter of 2015—and weakening prospects for global growth are leaving Fed officials on a cautious path as they weigh the next move for interest rates. (…)

Auto sales set a record in 2015 but have been disappointing so far this year, tumbling last month. Americans also cut back on discretionary spending at restaurants and bars, clothing stores and department stores in March. (…)

U.S. Consumer Prices Rose Slightly in March U.S. consumer prices rose in March for the first time in four months, but the mild gain underscores only modest inflation pressures exist in the economy.

The consumer-price index, a gauge of what Americans pay for everything from tuna to televisions, rose a seasonally adjusted 0.1% from a month earlier, the Labor Department said Thursday. Overall prices last increased in November.

Prices for gasoline, medical care and shelter all increased last month, but those gains were partially offset by a decline in prices for food and clothing.

A measure known as core prices—which excludes often volatile food and energy prices—also advanced 0.1%.

From a year earlier, overall prices increased 0.9% in March, the slowest annual gain so far this year. Core prices rose 2.2% from a year earlier. (…)

Shelter costs—reflecting home rent and mortgage payments—increased 0.2% over the month and 3.2% over the year. Rents are rising at an even faster pace. Housing expenses reflect about a third of the consumer-price index.

The cost of medical care services rose 0.1% last month, a slowdown from the prior two months’ gains, but prices are still up 3.6% from a year earlier.

Meanwhile, food prices fell 0.2% last month. The “food at home” category, a proxy for groceries, fell 0.5%, the largest decrease since April 2009. Apparel prices fell 1.1% and new vehicles prices were unchanged. (…)

Fed Beige Book: Strong Job Market Delivers Higher Wages Most regions of the U.S. saw their economies expand, supported by firming labor markets, rising wage pressures and modest increases in consumer spending, the Federal Reserve said in its “beige book” report.

The Fed found 11 of its 12 regions reported wage growth in the period between late February and early April, according to its survey of economic conditions known as the beige book. (…)

Wages grew in areas with labor shortages, such as skilled manufacturing, construction, and information technology, as well as in low-skilled entry-level work, the latest beige book report said. Businesses in Philadelphia said they were raising starting wages to attract better workers, and a chemical company in Boston’s district said it was boosting pay by 15% at a facility in the South just to keep trained workers from leaving. Cleveland retailers said a shrinking labor pool was driving up pay. (…)

The survey paints a brighter overall picture of the economy compared with earlier in the year, with vast swaths of the country reporting job growth, wage increases and modestly rising consumer spending. Most districts said their business contacts expected a similar pace of growth going forward. (…)

Jobless Claims in U.S. Decline to Match Lowest Since 1973
Rising Wages A Mixed Bag for U.S. Investors

(…) In March, average hourly earnings climbed by 2.3% from a year earlier, according to the Labor Department, suggesting to many that wages are finally in the midst of a sustained pickup. That’s a welcome sign for central bankers and economists, who see worker earnings as a key part of returning the economy to full health.

For U.S. companies, the picture is a little murkier. Higher wage costs could pose a risk to profits–and thus stock prices–particularly for low-margin industries like restaurants and retail. Goldman Sachs Group analysts, led by Ben Snider, calculate that for every one percentage point rise in labor costs beyond 3%, earnings per share on the S&P 500 Index would drop by about 0.7%. (…)

Eventually, wage pressures, which have been historically low and now are on the rise, will “have a differentiating effect on the profits and performance of U.S. equities,” the Goldman analysts write.

They see companies with low labor costs outperforming relative to those with industrials and consumer discretionary sectors, which would respectively trim 1.2% and 1.1% off earnings per share for every 1 percentage point rise beyond 3%. (…)

Fed Banks Spar Over GDP Data The race to provide credible real-time data on U.S. economic growth is pitting the Federal Reserve Bank of New York against its sibling in Atlanta, to the puzzlement of some traders.

The New York Fed said Tuesday that on Friday it will begin issuing a new report tracking U.S. gross-domestic-product growth. In doing so, the bank is indirectly facing off with the Federal Reserve Bank of Atlanta, which has published its own regularly updated GDP estimate, GDPNow, since July 2014.

Adding to the intrigue, the rival measures offer vastly diverging views of how the economy is doing. The New York Fed’s FRBNY Staff Nowcast is estimating tepid first-quarter growth at 1.1% and the Atlanta Fed measure is showing a near stall at 0.1%, according to the banks’ websites. Final official figures won’t be released until late June. (…)

GDP trackers are rapidly becoming a preferred tool for measuring the health of the economy among everyone from bond and currency traders to global economists. The demand for speedy data has led private companies to offer their own GDP estimates, although those have had a harder time getting traction with traders since the Fed issued its own. Most Wall Street banks, and firms including Moody’s Analytics, have GDP models. (…)

That said, some caution not to read too much into GDP trackers because of their large swings. Since they push out an estimate before all of the inputs are finalized, the trackers warn that there is less accuracy at the beginning of the tracking period than the end. (…)

GDPNow takes 13 subcomponents that go into GDP and constantly recalculates the forecast as new data are supplied. The use of the subcomponents is crucial; many models don’t take this “bottom-up” approach and develop estimates for those subcomponents and so can miss granular changes in the economy, researchers said.

The New York Fed’s models seek to capture the most important macroeconomic data and digest it as news headlines, “mimicking the way markets work,” according to the New York Fed.

Both seek to take the mix of past results, newly reported data and forecast data and through their models produce an overall rate of change, expressed as a percentage.

The Atlanta Fed’s tracker is updated the same day that major new data arrive, often within hours. The New York Fed will release its new estimates every Friday, with the exception of Fridays during its blackout periods around Fed policy meetings.…

New York’s Nowcasting tool was in the works for more than a year and is based on a similar methodology to Atlanta’s, a person familiar with the matter said.

Mr. Slok said he told clients to take an average of the two Fed numbers until both have longer track records. “Over time, we will figure out which one is better,” he said.

Meanwhile, the average of the two for Q1 is the middle of +0.1% and +1.1%! Talk about “uncertainty.

Stock Rally Stalls as Earnings Draw Focus

(…) In Europe, shares of Burberry Group PLC fell around 6% following disappointing earnings and a profit warning for the coming year.

In the U.S., Bank of America Corp. announced a fall in first-quarter profit Thursday, amid declining trading revenue and low interest rates. Wells Fargo & Co. also said its first-quarter profit fell as it dealt with a slump in oil prices, but both banks’ results came in above analyst expectations.

Better-than-expected results from J.P. Morgan Chase & Co. had sparked a rally in bank shares Wednesday, leaving the Dow Jones Industrial Average roughly 2% away from its record-close set in May. (…)