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$ (16 MARCH 2016): Retail Sails Lowered!

U.S. Retail Sales Fell in February; January, Too, It Now Turns Out U.S. retail sales fell in the opening months of the year amid lower auto and gasoline sales, highlighting consumer caution amid volatility in financial markets.

Sales at retail stores and restaurants fell 0.1% from the prior month to a seasonally adjusted $447.31 billion in February, the report said. January retail sales dropped 0.4%, versus the initially reported 0.2% increase. (…)

Excluding motor vehicles, retail sales were down 0.1% in February. Excluding gasoline, sales were up 0.2%. Excluding both categories, sales grew 0.3% last month. (…)

February sales excluding gasoline, for example, were 4.8% higher than a year earlier.

A weaker than previously thought retail sales trend so far this year puts further pressure on US policymakers to hold off hiking interest rates.

Official data showed US retail sales falling for a second successive month in February. Sales were down 0.1% last month, and a previously-reported rebound in January was revised away to show a 0.4% decline, according to official data from the Commerce Department.

After rising 1.1% and 0.3% in the third and fourth quarters, respectively, retail sales are running on average 0.2% lower so far in the first quarter compared to the final three months of last year.

More worrying was the news that core sales were flat after a mere 0.2% increase in January, which was revised down from a robust 0.6% rise. The January expansion in core sales had been cheered by the markets as a reassuring sign of consumers’ resilience in the face of worries about stock market volatility, but the state of the retail sector is now starting to look shakier. Core sales so far in the first quarter are running just 0.2% higher than in the fourth quarter, which would be the weakest rate of increase seen for a year (see chart).

* excludes gasoline, food services, building materials and auto sales.

The data will inevitably lead to a raft of downward revisions to analysts’ predictions for first quarter GDP growth. The weaker than expected picture will also add to suspicions that Fed officials, about to gather for their March policy meeting, will no doubt also err towards caution and avoid hiking interest rates again until the economy shows signs of renewed resilience.

The sales data come on the heels of business survey data showing a worrying loss of growth momentum in the economy in February. Markit’s PMI surveys showed one of the weakest expansions of business activity seen since the financial crisis, pointing to GDP growth slowing sharply towards stagnation.

Sad smile In truth, this latest retail sales report and its downward revision for January a bummer. The script looked so simple: the long awaited oil windfall spending had begun last November and was gathering steam just in time to clear inventories and set the stage for a manufacturing revival this spring. Hmmm…Not so sure it will be that straight lined…

NBF keeps the faith:

While retail data showed a second consecutive drop in nominal sales in February, the latter was largely due to falling prices. In real terms, retail spending is actually well on track to grow in Q1 at a faster pace than in the prior quarter. American consumers seem to be benefiting from a hot labour market (which is boosting household incomes), positive wealth effects for homeowners, cheap credit and low pump prices. As today’s Hot Chart shows, the share of gasoline in total retail spending fell under 7% for the first time in 14 years. Low fuel prices leave more cash in consumers’ wallets to spend on other things. So, it shouldn’t be surprising that discretionary spending, i.e. retail sales excluding gasoline, groceries and health care products, is now at an all-time high.

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There is no official stat on real retail sales which complicates the analysis now that good inflation has turned into deflation. Total nominal retail sales are up 3.6% YoY in February but prices are down some 3.5% as this Evercore ISI chart illustrates:

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U.S. Producer Prices Fall in February, Driven by Food and Energy

The headline Final Demand Producer Price Index fell 0.2% m/m (0.0% y/y) in February after an unexpected 0.1% m/m rise in January. The February reading was spot on expectations from the Action Economics Forecast Survey. The unchanged y/y reading in February was the first nonnegative monthly reading in 13 months. Final demand prices excluding food and energy prices were unchanged in February from January against an expectation of a 0.1% m/m increase; they had jumped 0.4% m/m in January. Compared to a year ago, this measure was up 1.2%, its highest reading since January 2015.

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Given the volatility and difficulty interpreting changes in prices of trade services, both the financial markets and the BLS have begun to shift their view of “core” PPI inflation to final demand prices excluding food, energy, and trade services prices from the historical “core” measure, which excluded only food and energy prices. This “new” core measure rose 0.1% m/m in February, down from +0.2% m/m in both January and December, to stand 0.9% higher than a year earlier.

The February decline in the headline index mostly reflected a 0.6% m/m decline (-2.7 y/y) in prices of final demand goods. The index for final demand services was unchanged in February (+1.5% y/y). The decline in goods prices was led by a 3.4% m/m drop in energy prices (gasoline prices fell 15.1% m/m) with an assist from a 0.3% m/m decline in food prices. Goods prices excluding food and energy edged up 0.1% m/m (+0.2% y/y) in February.

After three consecutive monthly increases, the index for final demand services was unchanged in February, but the 1.5% y/y increase was the highest since January 2015. In February, a 0.3% m/m increase in prices of final demand services excluding trade, transportation, and warehousing (led by a 4.8% m/m jump in prices for brokerage services, the third consecutive significant monthly increase–this index is now up 25% y/y) offset a 0.4% decrease in prices for final demand trade services (usually volatile and difficult to interpret change–this index had jumped 0.9% m/m in January) and a 0.7% drop in prices of final demand transportation and warehousing services.

Final demand construction prices fell 0.1% m/m in February, the third monthly decline in the past four months, but were up 1.0% from a year earlier.

Prices of processed goods for intermediate demand slumped 0.7% m/m in February, their eighth consecutive monthly decline, and were 5.6% lower than a year earlier.

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U.S. Home Builders Index Remains Unchanged

The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo held steady m/m at 58, the lowest level in nine months. The NAHB figures are seasonally adjusted. During the last ten years, there has been an 81% correlation between the y/y change in the home builders index and the y/y change in single-family housing starts.

The index of single-family home sales was unchanged (+12.1% y/y) at 65. Offsetting this stability, however, was a 4.7% decline (+3.4% y/y) in the index of expected sales during the next six months. It was the lowest level in twelve months.

Home builders reported that their traffic index improved 10.3% following three straight months of decline.

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CEOs Plan Less Hiring and See Growth Slowing in 2016

More top corporate leaders said they expect to cut employment at their firms in the next six months than add jobs, according to the Business Roundtable’s first-quarter CEO Economic Outlook Survey, released Tuesday. The group’s members are chief executives at the country’s largest firms.

The survey found 38% of those polled expect their companies to reduce employment in the next six months, versus 29% expecting to increase employment. The fourth-quarter survey showed 34% expecting a decrease, and 35% expecting an increase over the next half year.

In the latest survey, the CEOs said the U.S. economy would grow 2.2% during 2016. That’s down from an expectation for a 2.4% advance this year recorded in the fourth-quarter poll. Gross domestic product increased 2.4% in 2015, according to the Commerce Department. (…)

The Roundtable’s Outlook Index did increase to 69.4 from 67.5 in the fourth quarter. The slight improvement reflects a better outlook for sales growth and investment plans. Still, the reading is among the lowest since the recession ended. A year ago the index was 90.8. Readings above 50 indicate economic expansion.

Eurozone Construction Jumped in January

The European Union’s statistics agency said on Wednesday that construction rose 3.6% on the month, the largest month-to-month rise since March 2012. Eurostat said output was 6% higher than in January 2015, the largest year-to-year gain since April 2014.

The January jump in construction was led by Germany. The eurozone’s largest member recorded a 7% increase, but that was bettered by France, which recorded a rise of 7.3%. Construction in Spain rose 2%, and in Portugal by 0.9%. However, there were weaker spots, with production falling 0.2% in the Netherlands and 6.2% in Slovakia.

The January surge follows a strong end to 2015, when construction was up 1.3% in the final three months after declining in each of the three previous quarters.

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Trading at Banks Turns Grim

(…) As the forecasts roll in, the reasons for the downbeat attitude are clear enough. The first quarter is typically the most active on Wall Street trading desks, as big investors like hedge funds put their money to work.

Instead, it is shaping up to be a lot more like the disappointing final months of 2015, when concerns over economic growth and commodities prices left trading activity and revenue slumping for major banks. (…)

Jefferies, a unit of Leucadia National Corp., swung to a loss during its first quarter ended Feb. 29, as trading revenue tumbled and the firm took two unusual hits to its normally solid equities-trading business.

Morgan Stanley, meanwhile, said that first-quarter revenue this year was tracking closer to the fourth quarter of last year’s, normally a much weaker quarter for bank trading revenue than the first quarter, in various markets. (…)

Analysts from Credit Suisse Group AG predicted that the five biggest Wall Street banks would report trading revenue of $19.1 billion for the first quarter, down 16% from a year earlier. Analysts at UBS Group AG said this year is shaping up to be the worst first quarter in trading revenue in at least seven years.

Last year, the first quarter proved to be a high-water mark for 2015. Among large banks, trading revenue of $23.7 billion in the first quarter made up about 32% of the year’s annual trading revenue of $73.1 billion, said UBS analyst Brennan Hawken. By the end of last year, sentiment on trading had soured to the point that Morgan Stanley moved to lay off 25% of its debt traders and salespeople in December. (…)

Jefferies executives said Tuesday that trading conditions improved in March, after the close of the bank’s Feb. 29 quarter.

“While we are early in the quarter and one can never predict the future, it appears markets have not only stabilized, but aggressively snapped back,” Chief Executive Rich Handler and executive committee Chairman Brian Friedman wrote, pointing to improved conditions recently in bank stocks, junk-bond-fund inflows and energy prices.

Last week, Citigroup Chief Financial Officer John Gerspach said revenue from equities and fixed-income trading likely fell 15% in the first quarter. (…)

Chinese Premier Says It Is ‘Impossible’ to Miss Economic Targets

Chinese Premier Li Keqiang said it would be “impossible” for China to fall short in meeting its relatively high economic-growth targets even as it pushes ahead with structural reforms.

Speaking to reporters at the conclusion of China’s annual legislative session, Mr. Li said China won’t suffer a “hard landing,” or sharp downturn, and can achieve growth and reform simultaneously.

“Reform and development aren’t contradictory,” he said. “We should be able to stimulate market vitality and support economic development via structural reforms.” (…)

Mr. Li said capital-adequacy ratios at China’s financial institutions are sound, bad loans are well covered by reserves and the nation is making progress in cutting corporate debt using debt-for-equity swaps.

Mr. Li signaled that China will do what it takes to maintain its growth targets and that it has a “good reserve” of policy instruments in the event that growth falls outside an acceptable range, He said China will employ “innovative measures” to ensure steady economic progress. (…)

Mr. Li said restructuring and a reduction in overcapacity will be achieved without a sharp increase in layoffs or unemployment, pointing to the 13 million urban jobs the nation created last year.

Oil rises as producers announce meeting on output freeze

Oil prices firmed on Wednesday on an announcement that producers will meet next month in Qatar to discuss a proposal to freeze output and on growing signs of a decline in U.S. crude production.

Producers both from and outside the Organization of the Petroleum Exporting Countries will hold talks in the capital Doha on April 17, Qatari oil minister Mohammed Bin Saleh Al-Sada said.

Around 15 OPEC and non-OPEC producers, accounting for about 73 percent of global oil output, support the initiative, the minister said in a statement. (…)

On Monday, Russian Energy Minister Alexander Novak said a deal could be signed excluding Iran, which he said has the right to boost oil output after years of sanctions.

OPEC sources told Reuters a deal excluding Iran is not ideal, but not a deal breaker. (…)

Meanwhile, back at the wall:

S&P500200DMA

FYI, Lowry’s Research says sees weakness in the broad market with high selectivity and weak upside momentum characteristic of a weakening rally.

NEW$ & VIEW$ (4 MARCH 2016): Retail Sails!

EUROZONE RETAIL SALES EXPLODE

I have not seen this in any mainstream media. Yet it could be the most important economic news this year given that it comes along the same strong trend in U.S. retail sales between November and January. The volume of retail sales in the Euro Area rose 0.4% MoM in January following a 0.6% jump in December. Last 2 months annualized: +6.2% in real terms, during the two most important months of the year (Eurostat).

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Core retail sales were even stronger rising 0.5% and 0.7% MoM in December and January respectively, a 7.4% annualized rate, in volume.

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It seems that consumers are finally reacting to the oil windfall. If this continues, we’re in for many surprises…

U.S. Productivity Fell in Fourth Quarter of 2015 The U.S. economy experienced one of its worst productivity declines in more than two decades at the end of last year, extending a sluggish trend that threatens to constrain worker pay and economic growth in the coming years.

(…) The productivity of nonfarm workers, measured as output per hour worked, decreased at a 2.2% seasonally adjusted annual rate in the fourth quarter, the Labor Department said Thursday. Output rose at a 1% pace and hours worked rose at a 3.2% pace.

That was an upgrade from the agency’s initial estimate last month that productivitydeclined at a 3% annual rate in the final three months of the year. (…)

Still, it was the weakest productivity reading since the first quarter of 2014. Since the end of 1994, only four quarters have seen a larger decline. (…)

Unit labor costs at nonfarm businesses rose at a 3.3% pace in the fourth quarter, the agency said, revised down from an earlier estimate of 4.5% growth. (…)

Productivity in the fourth quarter rose a mere 0.5% from a year earlier. For all of 2015, productivity growth averaged 0.7% compared with 0.8% in 2014. Since 2007, productivity growth has averaged 1.2%.

Quarterly productivity data are volatile and undergo frequent revisions. Still, a broad and persistent slowdown in productivity gains has haunted the U.S. and other advanced economies for years. (…) (Charts from Haver Analytics)

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Moody’s:

The narrowing of margins stems from the more rapid climb of labor costs relative to labor productivity. This is important because recessions occurred each time unit labor costs outpaced corporate gross value added over a yearlong span.

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In 2015’s third quarter, unit labor costs accelerated to a 2.7% yearly increase that outran the accompanying 2.4% rise by net revenues, or corporate gross value added. Whether or not unit labor costs grew more rapidly than net revenues in 2015’s final quarter is problematic.

Mostly because the yearly increase of hourly compensation slowed from the 3.4% of the previous two quarters to Q4-2015’s 2.6%, the annual increase of unit labor costs slowed from the 2.6% of 2015’s middle two quarters to the 2.1% of 2015’s final quarter. Though it may now be easier for Q4-2015’s net revenues to at least match the growth of unit labor costs, the yearly increase of core revenues (which exclude energy product sales) slowed from Q3-2015’s 2.5% to Q4-2015’s 1.4%.

Thus, the unexpected slowing of Q4-2015’s unit labor costs offers no assurance that unit labor costs did not outpace net revenues for a second straight quarter.
However, an incomplete and preliminary estimate suggests that the yearly increase of core revenues may have improved to 2.5% in January. But, even that may not be enough to offset the possibly relentless acceleration of labor costs in a tightening labor market.

RECESSION WATCH

(…) Nerves have calmed considerably since. Blue chip indexes are up nicely from their Feb. 11 low. Junk bond yield spreads have narrowed. Oil has stopped going down and the dollar has stopped going up, so expected inflation has risen. Especially important for everyone’s blood pressure, volatility has receded. Vix, the options price-based stock market fear gauge, is back down to December levels. A model developed by Cornerstone Macro put the odds of recession, as signaled by the markets, at 64% on Feb. 11. That has since fallen to 47%.

But no one, including the Fed, should take much comfort from this.  The risk of recession hasn’t declined. In fact, it may have edged up. (…)

However, unlike the odds based on financial indicators, those macro probabilities have not since declined. Some indicators, such as surveys of factory purchasing managers, remain in recession territory. (…)

The dollar is still much stronger, stock prices lower and corporate bond yields higher than just a few months ago. Indeed, over the last year and a half, these have collectively tightened financial conditions by the equivalent of 0.75 to one percentage point in the federal-funds rate, notes Lael Brainard, a Fed governor, on top of the actual 0.25 point increase the Fed delivered in December.

Tighter financial conditions always operate with a lag, so it could be a few more months before it’s clear what toll the latest tightening in financial conditions has had on growth. It may turn out to be zero, as with last August’s bout of turmoil.

While a recession is still not the economy’s base case, it’s too soon to sound the all clear.

  • Recovery by Base Metals Price Index improves outlook

Moody’s industrial metals price index has been recovering since bottoming on January 12, 2016. Since year-end 2015, the +5.6% climb by the base metals price index differs considerably from the accompanying -6.4% slide by the price of oil.

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The latest firming of base metals prices is important because it hints of an improving world economy despite the still relatively depressed price of crude oil. In fact, compared to the price of oil, the base metals price index has been a more powerful coincident indicator of world economic activity.

Regarding the annual percent changes of calendar-year averages, the IMF’s measure of the world economy shows a much stronger correlation of 0.74 with Moody’s industrial metals price index than to the world economy’s 0.40 correlation with the price of crude oil. The correlations were obtained from a 37-year sample that began with 1979 and ended in 2015. For a 30-year sample that begins in 1986 and ends in 2015, world economic growth generates correlations of 0.82 with the industrial metals price index and 0.59 with the price of crude oil.

By the way, the correlations between world growth and US real GDP growth are 0.59 and 0.52 for the 37- and 30-years-ended 2015, respectively. Thus, in terms of calendar-year percent changes, the correlation between the industrial metals price index and world economic growth is stronger than the correlation between US real GDP growth and world economic growth.

RecessionALERT WLI

  • Credit: Aging Business Cycle to Limit Rally

Since peaking at February 11’s 10.17%, the composite speculative-grade bond yield plunged by a stunning -129 bp to a recent 8.88%, where the latter was its lowest reading since the 8.88% of December 31, 2015. Coincidentally, March 2’s close for the market value of US common equity was the highest since January 6. If spec-grade yields ease further, the market value of common stock may recover all of its 2016-to-date losses.

The combination of a sharply lower spec-grade bond yield and a significantly higher benchmark Treasury yield slashed the high-yield bond spread by -150 bp from February 11’s six and a half-year high of 899 bp to a recent 749 bp. The latter was its narrowest band since the 744 bp of January 11.

A further narrowing by the high-yield spread is possible according to recent readings on the average high-yield EDFTM (Expected Default Frequency) metric, the Chicago Fed’s national activity index, and the VIX index. In fact, these three variables now suggest a range of 625 bp to 650 bp for the high-yield spread. Apparently, high-yield bonds have priced in both a deterioration of the economy and another frightening sell-off of equities.

(…) if business activity firms and equities stabilize, a -100 bp narrowing of the high-yield bond spread is well within reach.

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Why Markets Shrug Off Prospect of a President Trump

(…) The reasons traders are unruffled about a possible President Trump tell us a lot about how markets assess political risk.

Start with the odds of Mr. Trump upgrading from what rival Marco Rubio has called “Hair Force One” to the real presidential jet: According to online bookies Betfair, Mr. Trump has a 24% chance of securing the White House. That is close to the 27% likelihood punters put on Britain voting to leave the European Union in June, so-called Brexit.

While the U.K. referendum has electrified markets and hammered sterling, similar odds of a Trump victory have had no effect at all.

Why not? A simplistic answer is that few big fund managers—international types who mainly live in coastal cities or abroad—believe Mr. Trump has any chance. The problem is these are the same type of people who play on political-betting sites in their spare time, while Betfair’s odds come exclusively from people outside America because of U.S. gambling rules.

A better answer is that the U.S. election isn’t until November, while Britain’s vote is in June. Traders tend to focus on the next thing in the calendar, and there is plenty else to worry about before American voters head to the polls. This may sound like a cynical comment about short-termism in markets, but hard-to-assess political risks are frequently ignored entirely by traders until they become so obvious they can no longer be avoided. (…)

The risk itself is also hard to assess. While many both in the Republican party and the wider world are horrified at the idea of a president who promises to wall off Mexico and ban foreign Muslims from visiting the U.S., Mr. Trump has committed to few economic policies.

Stephen Jen, founder of hedge fund SLJ Macro Partners LLP, says the market has reacted to Brexit and not Mr. Trump in part because they are the “difference between personalities and institutions.” Brexit is about changing the legal and governmental framework for the U.K. Mr. Trump has put personality way above policies, but would sit in the same Oval Office as any other president, and like them be limited by Congress and the Supreme Court.

“In developed markets you have very strong institutions and the personalities matter less,” he said. “In emerging markets it’s the other way round.” (…)