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

THE DAILY EDGE (19 June 2017): THE U.S. ECONOMY: OK OR NOT?

THE U.S. ECONOMY: OK OR NOT?

The Fed says the economy is ok, at least ok enough to keep tightening even though inflation has slowed down considerably in 2017. The Atlanta Fed GDPNow has slipped to +2.9% for Q2 while the NY Fed Nowcast signals +1.9%, both significantly less buoyant than in March.

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  • The Fed says the economy is performing about in line with its forecast, but everybody else is totally surprised by its weakness. (Charts below from Ed Yardeni)

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  • If the U.S. is the engine of the world, commodity prices are not suggesting the world is strong.
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  • The U.S. petroleum usage is declining:

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  • The ECRI weekly index has rolled over:

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  • The U.S. electricity consumption is peaking  again:
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  • Truck tonnage and intermodal volume are not showing any signs of strengthening final demand:
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  • Fortunately, consumer labor income remains solid, sustaining consumption and retail sales.
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  • Problem is, an ever larger part of the consumer budget goes to healthcare, education and lodging as these charts from Evergreen Gavekal demonstrate:

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  • Americans tend to focus on the ISM surveys for short term economic trends and these have been rather encouraging lately. However, IHS Markit’s PMIs have proven  to be smarter short term economic forecasters in recent years:
Weak US PMI signals confirmed by official data

Official data showed US manufacturing output missing expectations in May, adding to a flow of recent data that point to a renewed bout of industrial weakness.

PMI survey data not only accurately predicted the downturn in industrial growth, but also revealed the underlying factors behind the slowing, notably a waning of both capex and consumer spending. The numbers therefore suggest there are downside risks to the near-term outlook for the US economy.

Commerce Department data indicated that factory production fell 0.4% in May. The decline was the second in the past three months, and suggests that industry is once again starting to struggle after a strong start to the year.

It’s not just output that is falling. Official statistics also showed a drop in both factory orders and the narrower gauge of durable goods orders in April, the latest month for which data are available. Meanwhile, manufacturing payrolls numbers slipped back into decline in May, dropping for the first time since last October.

By contrast, output, orders and employment had all been growing at encouragingly solid rates earlier in the year.

Production was just 0.3% higher in the three months to May compared to the prior three months period, which is the worst performance since November. This compares with a two-and-a-half year high of 0.8% in February.

Similarly, manufacturing payroll numbers has increased by some 52,000 in the three months to February – the largest gain for over two years. That rate of job creation has since more than halved. Just 21,000 jobs were added in the three months to May. (…)

An analysis of the detailed sector data behind the PMI numbers provides further insight into the current state of demand. The data reveal that new orders for investment goods, such as plant and machinery, and consumer goods have risen at considerably reduced rates in recent months, with the latter slowing especially sharply.

While the slowing in growth of new orders for investment goods hints at a cooling of capital spending by businesses, the downturn in the new orders index for consumer goods signals a deteriorating trend in household spending. (…)

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This moderation of retail sales growth corresponds with a decline in the PMI’s consumer goods new orders index from a peak of 58.2 in the three months to January to a 17-month low of 53.2 in the three months to May.

The above chart uses the PMI new orders index from US producers of consumer goods tracked against the 3m/3m per cent change in retail sales. Actual retail sales will include imported goods, so the correlation will naturally not be perfect. However, the chart highlights how it is very unusual for the PMI series to send a misleading advance signal as to turning points in sales growth. Note also that the PMI data are available two weeks prior to the official retail sales data. (…)

Whereas the survey indices had been trending higher late last year, in recent months they have been trending down. These latest disappointing May numbers are therefore unlikely to be spurious readings, but are instead a reflection of a renewed struggle of US manufacturers in the face of waning demand.

This next chart plots the ISM (black) and IHS Markit (red) PMIs since December. The hope is that the good ISM-adjusted readings of the June Philly and NY Fed PMIs are confirmed by the national PMIs…

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We thus have a situation where the Fed is raising short term rates while long term rates, inflation and most major economic gauges are weakening. Based on the experience so far this century, the better bet has to be away from the Fed…

U.S. Import Prices Slow as Petroleum Falls, Other Prices Flat

(…) Nonpetroleum import prices were unchanged after April’s 0.3% increase, revised from 0.4%; their y/y increase was +1.0%. Among end-use categories, industrial supplies & materials prices excluding petroleum also decreased, down 0.5% (+5.8% y/y), breaking a strong six-month advance. Categories with increases included foods, feeds and beverages, which rose 1.2% (4.1% y/y) and motor vehicle & parts, up by 0.1% (0.1% y/y). Capital goods prices were flat overall (-0.4% y/y) and excluding computers, they eased 0.1% (-0.5% y/y). Consumer goods prices excluding autos were also unchanged in the month, and they were down 0.2% y/y. (…)

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SENTIMENT WATCH
Investors pour $30bn into global ETFs US equity funds reap benefits of continued market rally

Investors poured $31.6bn into ETFs globally in the week ending on Wednesday, beating a previous high for the year of $26.5bn during the week to April 26. (…)

Record level of investors fear corporate bonds are overvalued

(…) Eighty-four per cent of investors polled in the second quarter said corporate bonds are overvalued, according to a survey by the CFA Society. This is the fifth consecutive quarter of increase and the highest since the industry body began asking about valuations in 2012.

The majority of investors, 82 per cent, also think government bonds are overpriced, an increase of 4 per cent from the last two quarters. (…)

Adding to the sense of pessimism are investor concerns over developed-market equities. Sixty-nine per cent of respondents said they were overvalued, up from 40 per cent in the first quarter of 2016. Only emerging market stocks were perceived to be fairly valued, with 41 per cent of respondents saying they were undervalued and 34 per cent saying they were correctly priced.

The findings tally with a separate survey from Bank of America Merrill Lynch, which also found a record number believe stocks are overvalued. (…)

THE DAILY EDGE (15 June 2017)

U.S. Industrial Production Holds Steady While Factory Output Declines

Industrial production was unchanged last month (2.1% y/y) following a 1.1% April jump, revised from 1.0%. Manufacturing sector output declined 0.4% (+1.4% y/y) after a 1.1% increase, revised from 1.0%. Utilities output increased 0.4% (0.1% y/y). Mining output improved 1.6% (8.3% y/y), the  fourth month of strong increase this year.

Production of final products held steady (1.6% y/y) after a 1.6% jump. Consumer goods production rose 0.2% (1.2% y/y) after a 1.7% jump. Durable consumer goods output declined 0.7% (+3.8% y/y) after a 2.4% increase as motor vehicle output fell 1.0% (+5.8% y/y) following a 4.1% increase. (…)

Capacity utilization eased to 76.6% while factory sector utilization declined to 75.5%. Factory sector capacity rose a steady 0.7% y/y.

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Philadelphia Fed Factory Conditions Index Falls Sharply

The Philadelphia Federal Reserve reported that its General Factory Sector Business Conditions Index declined to 27.6 during June and reversed most of May’s jump to 38.8 in May.

The ISM-Adjusted General Business Conditions Index constructed by Haver Analytics fell slightly to 57.9 this month. This figure is comparable to the ISM Composite Index. During the last ten years, there has been a 71% correlation between the adjusted Philadelphia Fed Index and real GDP growth.

The decline in the overall index reflected a sharply lower shipments reading. That was accompanied by higher figures for new orders, unfilled orders, inventories and a higher delivery time index, which indicated the slowest delivery times since 2004.

The employment series eased to the lowest level since February. During the last ten years, there has been an 81% correlation between the jobs index and the m/m change in manufacturing sector payrolls. The average workweek reading slipped but remained near the March 2004 high.

Prices paid declined to the lowest level since October. Twenty-eight percent of respondents (NSA) reported paying higher prices, while four percent paid less. The prices received index increased to the highest level in three months.

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U.S. Housing Starts Fall for Third Consecutive Month in May U.S. housing starts decreased for the third consecutive month in May, a sign home builders are struggling to meet buyer demand.

Housing starts dropped 5.5% in May from the prior month to a seasonally adjusted annual rate of 1.092 million, the Commerce Department said Friday. This figure carries a margin of error of 11.9%.

Residential building permits, an indication of how much construction is in the pipeline, fell 4.9% to an annual pace of 1.168 million last month, the agency said. (…)

Starts fell in May for single-family and multifamily construction. Permits last month were down 10.4% for buildings with multiple units and down 1.9% for single-family homes.

Data on housing starts tend to be volatile from month to month and can be subject to sharp revisions. Looking past month-to-month fluctuations, starts in the first five months of the year were up 3.2%. Permits during this period increased 5.5%.

FED UP?

The Fed’s credibility is under assault from a lot of pretty smart people. This is from Robert Kessler:

Yesterday, the Federal Reserve’s statement added another contrary indicator suggesting the end of the expansionary cycle; their avoidance of economic weakness. Going back 10 years, in June of 2007, US Treasury yields had begun to drop precipitously after 100 bonds were downgraded by S&P; the latest sign of the burgeoning sub-prime crisis. In the midst of this, the Fed’s 6/28/2007 statement characterized the economy this way,

“Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters. Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures. In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

No sense of any trouble, just worries about inflation. And yesterday, the Fed’s statement read (in-part),

“Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending has picked up in recent months, and business fixed investment has continued to expand.”

No acknowledgement of the weakness we have seen in a whole bevy of indicators missing their expectations (Citi Surprise Index). A lot of us could see the storm coming in 2007 just as we do today. Don’t mistake the Fed’s statement for an all-clear on the economy. It is likely just the opposite. Echoing this sentiment are three articles in the newspapers today with a similar topic:

  1. Wall Street Journal Fed Moves One Way, Inflation Another
  2. Financial Times The Fed can only ignore the lack of inflation for so long
  3. Financial Times Investors wary of Fed’s newfound assertiveness

ECB next?

Eurozone employment rises to record high as economic recovery gains strength

Employment rose 0.4% in the first quarter, according to Eurostat, in line with survey evidence which also suggests the rate of job creation has accelerated further in the second quarter. PMI data showed private sector employment growing at one of the fastest rates for a decade in May, with manufacturing jobs being created at a pace not previously seen in the 20-year survey history.

The surveys show jobs are being created across all major euro member states, albeit led by Germany.

Industrial production meanwhile rose 0.5% in April, indicating a strong start to the second quarter. The upturn in official production data also tallies with PMI data, which have indicated a strengthening recovery of eurozone manufacturing in recent months. The IHS Markit Eurozone Manufacturing PMI rose to a 73-month high of 57.0 in May, up from 56.7 in April.

Eurozone industrial production

Official data now show the single currency area growing 0.6% in the first quarter, up from a prior estimate of 0.5%. The faster growth is in line with the signals from the PMI surveys, which had been indicating a 0.6% expansion as far back as February.

The first quarter expansion is no aberration. In fact, running at six-year highs, the PMI readingsfor April and May suggest that the rate of GDP growth will have picked up further in the second quarter, rising to 0.7%.

Money The weak euro appears to be providing a major stimulus to the manufacturing sector.

The Eurozone Manufacturing PMI survey’s new export orders index has been hitting six-year highs in recent months. A ranking of PMI export orders growth in May showed euro member nations dominating the global leader board, holding seven of the top eight places.

European PMI sector data meanwhile add to signs that business investment is rising strongly in the second quarter. Output growth in capex bellwethers such as machinery & equipment, technology equipment and construction & engineering have all seen marked upturns in recent months, with growth accelerating especially sharply in the tech sector to a near-record pace in May. The latter was also the fastest growing sector covered by the PMI, with machinery & equipment manufacturing in third place.

Employment, exports, investment and economic output all therefore appear to be growing at increased rates in the second quarter, representing an encouragingly sustainable-looking upturn.