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 (26 May 2017): Recession next year?

David Rosenberg: “We Probably Will Have A Recession Next Year”

(…) So should we be prepared for another US recession in the near future? That’s the question Jonathan Roth asked Rosenberg in the enclosed interview.

“I think what people should be focused on is the shape of the yield curve,” Rosenberg said. “[Every] single inversion of the yield curve, where short-term rates go above long-term interest rates, has presaged a recession—every single time.” (…)

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OPEC, Allies to Extend Oil Cuts for Nine Months to End Glut

(…) Six months after forming an unprecedented coalition of 24 nations and delivering output reductions that exceeded all expectations, resurgent production from U.S. shale fields has meant oil inventories remain well above the level targeted by OPEC. While stockpiles are shrinking, ministers acknowledged the surplus built up during three years of overproduction won’t clear until at least the end of 2017. The group is prepared for a long game.

“We’ve said we’ll do whatever is necessary,” Saudi Oil Minister Khalid Al-Falih said Thursday after the meeting in Vienna. “That certainly includes extending the nine months further. We’ll cross that bridge when we get to it.”

Al-Falih said the cuts are working, adding that stockpile reductions will accelerate in the third quarter and inventory levels will come down to the five-year average in the first quarter of next year. While he expects a “healthy return” for U.S. shale, that won’t derail OPEC’s goals and a nine-month extension will “do the trick,” he said. (…)

The Daily Shot offers 2 important charts:

  • The current OPEC cuts, while significant, are smaller than what we saw during the previous cycles.

  • Many large non-shale production projects will be coming online over the next few years.

China Exerts More Control Over Its Currency With Tweak to Yuan Fix China’s central bank is taking greater control over the yuan by changing the way it sets its official value against the U.S. dollar, its latest effort to prevent big swings in the currency’s value as economic worries mount.

The People’s Bank of China intends to add a “countercyclical factor” in the model it uses to fix the yuan’s daily rate, according to a statement from the China Foreign Exchange Trade System, the currency-trading arm of the People’s Bank of China. The purpose of the tweak, which has been in effect on a trial basis in recent days, is to smooth out fluctuations against the dollar, the statement said. (…)

These measures mark a shift in tactics from last year, when the central bank focused on guiding the yuan lower against the dollar in an orderly fashion. Behind the current emphasis on curbing the yuan’s fluctuations is a Chinese leadership that puts priority on economic and political stability ahead of a leadership shuffle later this year. Beijing also wants to avoid increased trade friction with Washington after President Donald Trump accused China of exploiting the yuan’s value to help Chinese exporters. (…)

Source: Danske Bank, @joshdigga (via The Daily Shot)

Trump Officials Offer Differing Views on Tax Plan

White House budget director Mick Mulvaney told a Senate committee that the administration’s tax plan doesn’t bank on any revenue stemming from faster economic growth. Four floors below that hearing, Treasury Secretary Steven Mnuchin gave a contradictory answer to a different Senate panel, insisting that the administration’s tax plan will partly pay for itself with economic growth. (…)

And the apparent disagreement isn’t academic; it is central to the administration’s fiscal policy. The Trump administration’s simultaneous promises of a balanced budget, economy-boosting tax cuts and accurate accounting are proving difficult to reconcile with each other. (…)

‘Secular Stagnation’ Even Truer Today, Larry Summers Says

(…) “When I made my comments in 2013 at the IMF they were couched with very substantial doubts. Today I would have fewer. The essence of my argument then was that because of a variety of structural factors the neutral rate of interest was much lower than it had been and, therefore, getting to an adequately low rate was going to be more difficult. And that was going to act as a constraint on aggregate demand much more of the time than people thought. Relative to the prevailing forecasts at the time that I spoke, interest rates have been very substantially lower. Growth has been very substantially lower. Inflation has been very substantially lower for the industrialized world. Fiscal policy has been more expansionary. So the broad argument that I was making at that time seems more true today.” (…)

“One thing you should pay attention to is the yield on 10-year TIPS [Treasury Inflation-Protected Securities] because I think the interesting part is not the short-run dynamics but averaging over the cycle. If you look at the real interest rate decade by decade, it’s been going down for five decades.”

“I would be trying to raise R-star [another term for the neutral rate] so I would be wanting to operate with a different fiscal-monetary mix. Even though some of the things the Trump administration is doing are giving it a bad name, the basic impulse that increased business confidence that raises the propensity to invest is a good thing. So, first, more public investment I think is a good thing.” (…)

Labels Matter: What to Call the Stock Rally “Trump Trade,” “Reflation Trade” or “Liquidity Trade”?

(Mohamed A. El-Erian)

(…) Under the Trump trade, you would load up on U.S. industrials, financials and the dollar, while shorting Treasuries. Under the Reflation Trade, you would take a much more global equity exposure. Under the Liquidity Trade, you would seek to gradually reduce investment dollars at risk, while rotating more of the remaining market exposure to lagging international market segments. (…)

How about the “Tech Trade” as the FT wrote yesterday:

Or the “Top 5 Trade” as Bespoke Investment points out today:

(…) how much of the market’s gain is attributable to the largest stocks?  Below we show three series. The light blue line is returns for the S&P 500 YTD.  In the dark blue line, we strip out the performance contribution of the five largest stocks in the S&P 500: Apple (AAPL), Facebook (FB), Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL).  As shown, while the overall index is up almost 8% so far in 2017, it’s up only 4.6% if you strip out the five largest stocks.  In the red series below we show the spread between the two, in other words, the cumulative performance contribution from those 5 stocks.  At the start of the year, these five stocks accounted for 11.6% of the index’s market cap, so you’d expect a non-trivial percentage of gains to come from them. That share stands at about 13.7% today.  Generating nearly half of the index’s gains with less than 15% of its market cap is an out-sized contribution and shows just how painful it can be in terms of relative performance if you’ve been underweight these mega-Tech behemoths.

052517 YTD Performance

Or the “MAGNAFicient Trade” as per my May 18 post THE SIX-HORSE HITCH

Canada’s Banks Can’t Dodge Housing Risks Forever

(…) There certainly is no reason to panic when it comes to Canada’s major banks. They lend to much higher-rated borrowers than nonbank lenders like Home Capital. Around 60% of Canada’s mortgage market also is insured, either by a government agency or two private insurers, notes Keefe, Bruyette and Woods analyst Brian Klock.

Four of Canada’s five largest banks have reported quarterly earnings in the last two days. Three of them— Royal Bank of Canada ,Canadian Imperial Bank of Commerce , andToronto-Dominion Bank —beat analyst expectations. Delinquency ratios on their mortgages are remarkably low at around 0.25%.

Nonetheless, there is cause for concern. Total exposure to mortgages is high, averaging one fifth of assets at the five largest banks. (…)

Canadian banks have enjoyed a reputation for soundness since they emerged relatively unscathed from the 2008 crisis. Now, though, they hold lower levels of capital than their counterparts south of the border. The big five Canadian banks boast an average common equity tier 1 capital ratio of 11.2%, compared to 11.9% for the four largest U.S. banks.

Canadian banks’ shares are also much more expensive. The big five trade at an average 1.79 times book value, compared to 1.15 for the U.S. big four. (…)

Two observations on this:

  • The chart below illustrates Canadian bank loss ratio since 1990. The dotted line is residential mortgages. The 1990-95 period marked a deep and long recession in Canada (chart from Scotiabank)

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  • When comparing P/BV, one needs to also compare returns on book values (ROE). U.S. banks average ROEs of 8.9% (regional banks) and 9.5% (diversified banks). Canadian banks ROEs average 15.5%, 1.7 times above the U.S. while their P/B are 1.5 times higher.
  • Low loan losses drive bank earnings
Trump Blasts ‘Very Bad’ German Carmakers Over U.S. Sales

(…) “The Germans are bad, very bad,” Trump told EU officials in a closed-door meeting, Der Spiegel reported, citing unidentified attendees. “Look at the millions of cars that they sell in the U.S. Terrible. We’re going to stop that.” (…)

CORRELATION IS NOT CAUSATION

imageSource: @jsblokland, @simonjhix, @soccerquant (via The Daily Shot)

THE DAILY EDGE (25 May 2017)

Home Sales Slip amid Housing Shortage Home sales declined in April, a tepid start to a spring selling season marked by a dearth of homes available for purchase.

Sales of previously owned U.S. homes last month fell 2.3% from March’s revised level to a seasonally adjusted annual rate of 5.57 million, the National Association of Realtors said Wednesday. (…)

The supply of homes on the market has fallen year-over-year for 23 consecutive months, according to NAR. There was a 4.2-month supply of homes on the market at the end of the month, down from 4.6 months a year ago.

Properties typically stayed on the market for 29 days in April, down from 34 days in March.

The decline in inventory comes at a time of strengthening demand. The share of first-time buyers climbed to 34%, up from 32% in March, as young people began to re-enter the market in force. (…)

Buyers purchased more than 25% of homes on the market in April, a 13-year high, according to Mr. McLaughlin’s analysis.

The median sales price in April was $244,800, up 6% from a year earlier. Sales in April were up 1.6% compared with a year earlier,. (…)

BTW, existing home inventory fell 9.0% YoY in April!!! Sales are up 1.6%.

large image(Haver Analytics)

The headwind: (The Daily Shot)

RBC’s economists see nothing alarming from this next chart. I see what looks like changing trends. How can that be with unemployment so low?

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U.S. GDP GROWTH

The PMI data for January to March were historically consistent with GDP growing at an annualised rate of 1.7% in the first quarter, which compared with an official GDP estimate of 0.7%. For the first two months of the second quarter, the PMI data are signalling an annualised GDP growth of 1.5%.

There is an 89% correlation between Markit’s PMI and GDP:

Still on low gear. Employment growth also seems set to keep slowing down.

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Manufacturing looks particularly weak:

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Why Earnings Have Investors Feeling So Happy Earnings at U.S. companies grew at the fastest pace in the first quarter in nearly six years, the latest boon to a bull market that has stretched into its ninth year.

(…) Sales are picking up after many companies had turned to reducing costs and delaying investments in infrastructure to boost profits through the recovery from the financial crisis. Revenues are expected to grow by 7.7% from the year-earlier period, according to FactSet, the highest rate since the fourth quarter of 2011. Sixty-four percent of companies beat analysts’ expectations for revenue for the latest quarter, according to analysis from FactSet, above the five-year average of 53%.

Companies also are spending less to repurchase their own shares this year, easing some investors’ concerns that buybacks have been pumping up earnings growth. Share repurchases among firms are tracking 18% lower than a year ago and 1.4% lower than the fourth quarter of 2016, according to S&P Dow Jones Indices data as of Wednesday. (…)

Ten of the 11 sectors in the S&P 500 are on track to post quarterly earnings growth in the first quarter, with financial and technology companies reporting among the biggest improvements, according to FactSet. (…)

“When we look at how earnings came in this quarter and how they’re expected to come in the rest of the year, people’s concerns about the stock market should really be allayed,” said Jonathan Golub, chief equity strategist at RBC Capital Markets.

S&P 500 companies have now posted earnings growth for three straight quarters, after five consecutive quarters of declines, according to FactSet. The rebound is expected to continue. Analysts polled by FactSet estimate the broad index will post earnings growth of 6.8% for the second quarter and 11% for the full year.

Much of that is because a prolonged slump in commodities prices eased at the end of last year. About a third of the S&P 500’s earnings growth in the first quarter came from energy companies, according to FactSet, where results improved alongside oil prices, which sank to their lowest levels in more than a decade in early 2016. (…)

Some comments to curb your enthusiasm:

  • The better revenue growth was mainly in commodity-sensitive sectors. Revenue beat rates were average to weak in Consumer Discretionary (52%), Staples (36%), Financials (53%), Telecom (25%) and Utilities (46%). Overall, the revenue surprise factor was 1%.
  • Q1 was indeed quite strong. Q2 is shaping up like a very tilted barbell with 6 key sectors expected to show EPS growth of only 0.6%, down from +2.4% on March 31.

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Trump administration warns tax receipts are coming in slowly, government could run out of cash sooner than expected

White House Office of Management and Budget Director Mick Mulvaney on Wednesday said that tax receipts were coming in “slower than expected” and that the federal government could run out of cash sooner than it had thought. (…)

BTW (via Evergreen Gavekal):

  • Per The New York Times’ May 13th issue, 2016 tax revenue came in below budget in 25 states, the most since the Great
    Recession.
  • Renowned economist and bond manager Lacy Hunt recently wrote that 10% of banks reported tightening credit card and
    consumer loans in the opening quarter of this year, nearly identical to what was seen just prior to the recessions in 2000 and
    2008.

Not a sign of a strengthening economy. Neither is that:

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Yesterday from BMO whose U.S. activities are concentrated in the Midwest region:

Bank of Montreal set aside C$259 million ($192 million) for soured loans, up 29 percent from a year earlier and the highest since at least 2011, tied largely to U.S. personal and commercial banking and corporate services, the Toronto-based firm said Wednesday in a statement. Analysts surveyed by Bloomberg had expected provisions of about C$200 million. Bloomberg’s Doug Alexander reports. (Source: Bloomberg)

Fed Minutes Signal Officials Ready to Raise Rates Soon Federal Reserve officials expected at their meeting this month that it would “soon be appropriate” to raise rates, according to minutes of the gathering, a signal the central bank could lift its benchmark rate in June.
  • “Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the committee to take another step” in raising rates, the minutes said.
  • “Participants generally indicated their assessments of the medium term economic outlook had changed little since the March meeting,” the minutes said.
  • Officials generally believed the deceleration in price pressures would prove temporary, though some expressed uncertainty about the greater-than-expected weakness.
  • Some officials at the meeting said stronger hiring and wage gains and larger declines in the unemployment rate could warrant a faster pace of rate increases, but a few said the Fed could move more slowly than currently projected if continued declines in the unemployment rate didn’t create obvious price pressures.

The Fed also moved toward a consensus on a proposal to start gradually shrinking its $4.5 trillion in holdings of Treasury and mortgage securities later in the year, according to minutes of the gathering released Wednesday. Under the approach discussed, they would allow increasing amounts of those securities to mature over time, without reinvesting the proceeds. (…)

Officials were inclined to stick to that scenario even though the economy appeared to stumble in the first quarter, the minutes showed. Officials saw that slowdown as likely to be transitory. And while some expressed concern about recent softness in inflation, it wasn’t enough to knock them off track. (…)

Poloz Changes His Tone Amid ‘Encouraging’ Economic Data

While Governor Stephen Poloz left the benchmark interest rate at 0.5 percent Wednesday, he added new language stating “the current degree of monetary stimulus is appropriate at present.” Policy makers also said Canada’s adjustment to the oil price decline is “largely complete” and that “recent economic data have been encouraging” — with a “robust” labor market driving consumer spending and housing.

The language represents a slight change in tone for a central bank that up to now has been downplaying the recent run of strong data — pointing instead to persistent slack in the economy, especially relative to the U.S., as well as emerging geopolitical risks. Yet, it’s become a tenuous stance as economic numbers show a robust rebound. (…)

What Ten Million Simulations Tell Us about President Trump’s Chances of Achieving 3-Percent Economic Growth

President Donald Trump’s budget is premised on the projection that the United States will be able to raise its long-run economic growth rate to 3 percent a year. This rate allows the budget to assume large tax cuts and still project a balanced budget after ten years. This long-run forecast represents the largest divergence between an administration forecast and that of either the consensus forecast of the Blue Chip survey of private forecasters (2.0 percent) or that of the nonpartisan Congressional Budget Office (CBO, 1.9 percent) in many decades. (…)

Trump administration's growth disparity dwarfs those by previous administrations

Following up on THE SIX-HORSE HITCH:

BofA’s Hartnett Sees Stocks Approaching Peak Irrationality

GOLD

I don’t write much on gold since I don’t really understand its ups and downs. These charts interested me from the demand viewpoint (charts from RBC):

  • Overall demand is slowing. Only “investment” seems to be growing.

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  • Gold exchange traded products have been quite popular in the past year.

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  • Large, sustained decline in Indian demand:

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CBO’s Health-Law Report Sets Up Fight Among Senate GOP The health-overhaul bill approved by House Republicans would leave 23 million more people uninsured while reducing the cumulative federal deficit by $119 billion in the next decade compared with current law, according to an estimate from the Congressional Budget Office.

The findings provide ammunition for the two competing factions that Senate Republican leaders need to pull together to pass a bill. Centrist Republicans, concerned about the number of uninsured, hope to make the House bill less far-reaching, while conservatives want to double down on measures the CBO suggests will lower premiums on average. (…)

Some Senate Republicans say privately that their effort to forge an agreement that can attract at least 50 votes faces a tough road. A working group of 13 Republican senators is pushing to come up with a proposal by Congress’s August recess, and if they don’t make progress in coming months, that could forecast trouble. (…)

(Washington Post)

Image result for batman robin imagesWhat Donald Trump Needs to Know About Bob Mueller and Jim Comey The two men who could bring down the president have been preparing their entire lives for this moment.

(…) President Trump impulsively fired Comey in the hope that it would shut down the Russia investigation; one week later, though, he finds himself facing not just one esteemed former FBI director but two: the first a wronged martyr for the bureau, and the second a legendary investigator without a hint of politics. (…)