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 (6 February 2017)

Higher Jobless Rate Suggests Economy Has Room to Run U.S. employers hired briskly in January and more Americans joined the workforce, suggesting the labor market still has room to grow after years of expansion.

Despite brisk hiring, the U.S. unemployment rate rose in January and wages grew modestly, evidence for the Trump administration and the Federal Reserve that the economy has room to grow before it risks overheating.

The backdrop of a steady but unspectacular labor market is likely to keep the Fed cautious about raising interest rates and could prevent the central bank from colliding with President Donald Trump as he aims for faster economic growth.

Employers added 227,000 jobs last month, the biggest gain since September, the Labor Department said Friday. Job growth over the past three months averaged 183,000, inline with the trend earlier in 2016.

Still, the jobless rate rose to 4.8% in January from 4.7% a month earlier, as more Americans came off the sidelines and actively looked for work, pushing up the count of unemployed. In one sense that is a positive development, suggesting increased optimism about the prospects of eventually finding work. (…)

The average hourly paycheck grew just 3 cents over the month—and 2.5% over the year—despite millions of workers receiving raises under minimum-wage laws across 19 states at the start of the year. (…)

A measure of underemployment—taking into account the jobless, part-time workers who can’t find full-time jobs, and Americans too discouraged to hunt for jobs—rose to 9.4% from 9.2% last month. January also saw a big increase in reluctant part-time workers.

The best of all worlds?

Good jobs growth, slow wage gains, higher participation. Perfect!

But is it really?

  • November and December jobs numbers were revised down 39k, including –40k in November, a 20% correction 2 months ago.
  • January was a warm month which helped construction (+36k).
  • Retail employment rose 46k in January. Seasonal adjustments quirks?
  • Using non-seasonally adjusted numbers, the YoY gain in payrolls was +1.5%, from +1.6% in November and + 1.8% in September.
  • The workweek was unchanged at 34.4 hours, in line with the past several years.
  • Aggregate wages rose just a little but the mix continues to put more weight on low paying jobs. Some 50% of the January increase was in temp jobs, retail, health care, and food services.
  • Minimum wages rose in 19 states in January but the timing of the survey (Jan. 12) impacted the earnings data by not including the first full 2-week paycheck of the year.
  • Still, average hourly earnings were up 3.2% YoY in January. The 6-m moving average is now +2.7% from +2.3% in March, +2.4% in June and + 2.6% in November. This chart shows the YoY change in seasonally adjusted hourly earnings. The January slowdown is clearly suspect.

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After you read Markit’s Services PMI survey report for January below, you will understand why this chart looks very suspect””:

In all, this job report gives investors and the Fed the best combination of data at the start the year. But it would be best to wait a little before celebrating Goldilocks.

In effect:

Service sector growth reaches 14-month high in January
  • The seasonally adjusted final Markit U.S. Services Business Activity Index rebounded to 55.6 in January, up from December’s three-month low of 53.9. Moreover, the latest reading was comfortably above the average for Q4 2016 (54.4) and signalled the fastest rate of business activity growth since November 2015.
  • Higher levels of business activity were mainly linked to improved sales growth and a more supportive economic backdrop.
  • January’s survey data revealed a robust and accelerated increase in new work received by service sector companies. The rate of expansion was the fastest since July 2015. Anecdotal evidence linked the rise to greater levels of business and consumer spending at the start of 2017.
  • Increased volumes of new business exerted pressure on operating capacity among service sector firms.
  • Reflecting this, backlogs of work rose for the fifth time in the past six months. Survey respondents sought to alleviate capacity constraints by taking on additional staff in January. Higher levels of employment were also linked to new project starts and improved confidence regarding the business outlook. Measured overall, the rate of
    job creation was only slightly weaker than December’s 15-month peak.
  • Some firms noted that squeezed margins had acted as a brake on employment growth at their business units in January. The latest increase in average cost burdens was close to December’s recent peak.
  • Rising input prices were attributed to higher fuel costs and greater salary payments. Meanwhile, prices charged by service sector firms increased at only a moderate pace in January.

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The ISM Services survey also reveals cost inflation in services industries:

Markit Final U.S. Composite PMI™

  • At 55.8 in January, up from 54.1 in December, the seasonally adjusted final Markit U.S. Composite PMI™ Output Index signalled the strongest rise in private sector business activity since November 2015. This reflected positive contributions to growth from both the manufacturing and service sectors at the start of 2017.
  • The January surveys signal annualized GDP growth of approximately 2.5%, setting the scene for a solid first quarter. With January seeing the largest inflow of new business for 18 months, there’s good reason to believe that firms will be even busier in coming months.

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Service-related industries account for 83% of total private employment in the U.S. The “tangible” economy has been pretty weak lately with few signs of a turn as this AAR chart shows.

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(…) According to research firm DAT Solutions LLC, demand for trucking services shifted downward in recent weeks, with truck loads available on the spot market declining 14% during the week ending Jan. 21.

Executives Old Dominion Freight Line Inc., one of the biggest U.S. trucking companies with more than 17,000 full-time employees, said on an earnings conference call this week they saw demand pick up in January but want to see more consistent growth before they step up hiring. “I think we’re in pretty good shape with the work force where are and the volumes we have,” said David Congdon, chief executive officer at the Thomasville, N.C.-based company. (…)

Fiscal Hole to Test President Trump’s Agenda For an economy that isn’t in recession, the U.S. is facing one of the bleakest fiscal outlooks since World War II. One question that President Donald Trump will soon have to decide: How much is he willing to embrace even wider deficits?

(…) Unlike past periods, deficits are swelling not because of an economic downturn or a short-term boost in discretionary spending, but because of the costs of caring for an aging population. Medicare and Social Security are the biggest projected drivers of spending. Ten years ago, some 6,700 Americans turned 65 every day. The number is now 9,800 Americans, and it will rise to 11,700 by 2026.

An aging population not only pushes up federal spending on health care and retirement, it also shrinks the tax base and may lead to slower rates of growth in personal income and household spending. (…)

The Congressional Budget Office expects, under current law and assuming the economy keeps expanding modestly, deficits to rise from 2.4% in the fiscal year that starts this October to 4.2% gradually over the following four years. (…)

BTW:

Source: David Stockman, h/t Anne (via The Daily Shot)

EARNINGS WATCH

From Factset:

During the month of January, analysts lowered earnings estimates for companies in the S&P 500 for the first quarter. The Q1 bottom-up EPS estimate (which is an aggregation of the EPS estimates for all the companies in the index) dropped by 1.5% (to $30.10 from $30.57) during this period.

During the past year (4 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 2.5%. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 2.3%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has also been 2.4%.

To date, 55% of the companies in the S&P 500 have reported actual results for Q4. In terms of earnings, fewer companies (65%) are reporting actual EPS above the mean estimate compared to the 5-year average. In aggregate, companies are reporting earnings that are 2.5% above the estimates. This surprise percentage is below the 1-year (+4.4%) average and below the 5-year (+4.2%) average.

In terms of sales, fewer companies (52%) are reporting actual sales above estimates compared to the 5-year average. In aggregate, companies are reporting sales that are 0.1% below the estimates, which is also below the 5-year average.

The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) year-over-year earnings growth rate for Q4 2016 is 4.6% today, which is above the estimated earnings growth rate of 3.1% on December 31.

The blended sales growth rate for Q4 2016 is 4.6%, which is below the estimated sales growth rate of 4.9% on December 31.

At this point in time, 65 companies in the index have issued EPS guidance for Q1 2017. Of these 65 companies, 44 have issued negative EPS guidance and 21 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68%, which is below the 5-year average of 74%.

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SENTIMENT WATCH

(…)Nov. 8 [Election Day] was an extraordinarily important day, a major inflection point. It was a radical regime change. Suddenly I’m spending a lot more time writing about fiscal policy than monetary policy. This business is never dull. Before the election, I didn’t think it mattered to the market who won. The market would continue to move higher. To me it is all about P/E [stocks’ price/earnings ratio] times E [earnings estimate]. In August, Joe Abbott, our quantitative strategist, and I concluded the earnings recession was over. The picture had been dark because of the collapse in earnings and a plunge in oil prices. Now we’d have 8% to 9% earnings growth just because comparisons would be easy. In addition to energy, we saw strength in technology, industrials, and consumer discretionary.

When Trump won, he also had a majority in both houses of Congress. Suddenly we had to reread his economic policy proposals. We did some back-of-the-envelope calculations on reducing the corporate tax rate, recognizing it might go from an effective rate of about 27% after deductions to 15%. We concluded that earnings growth could be closer to 20% than 10%. We’re assuming the interest deduction disappears. We built in some cushion, in case we were too optimistic. But it still resulted in a huge increase in our Standard & Poor’s 500 earnings forecast, to $142 a share this year from $128. Frankly, I’m simply being conservative. A P/E of 17.6 gets us to 2500 by year end. If the market gets to 2500 sooner, I’ll reassess.

We are also betting tax cuts aren’t just for corporations but individuals. So economic growth will be more like 3% instead of the 2.5% we expected this year. As a result, we raised our outlook for the S&P 500 from 2300 to 2500.

I hope Trump’s protectionism is really more about moving from free trade to fair trade and bilateral agreements, rather than shutting off trade relations. But renegotiating everything on a bilateral basis can get dicey. If Trump’s America-first approach is protectionist and triggers protectionist reactions, we’re all in trouble. Certainly we’d have to worry about a global recession. But I don’t expect him to kill off globalization. Too much money is at stake.

(…) The U.S. went from an administration of—how shall I put it?—community organizers to one run by wheeler-dealers. The Trump team isn’t made up of professional politicians. But it isn’t out to destroy world trade; it is pro-growth. For example, Treasury Secretary nominee Steven Mnuchin believes sustained 3%-to-4% GDP growth is critical for the country.

The new administration is going to want to make deals. It is looking for weak points on the other side of the table and will press them. Trump changes his mind so much that it is pretty easy for him to say, “well, we got a better deal than I promised you,” and market it that way. (…)

The real risk is a resumption of the “Old Normal,” wherein booms followed busts, as opposed to the New Normal since the financial crisis. The next bear market will come, as it always has, when we have the next recession. In the old-normal business cycle, we’re at full employment and don’t need more fiscal stimulus. But if there is an economic boom, there aren’t enough workers to achieve a lot of Trump’s stated goals. Workers long for the pay they got in the good old days, but many are already employed. If wages take off and are seen as price inflation, the Fed will have no choice but to tighten more aggressively. I’m back to being an old-fashioned business-cycle economist who thinks we need to watch wage pressures. (…)

One month into the year, the balance of risks is somewhat less positive in our view, for three reasons.

First, the recent difficulty congressional Republicans have had in moving forward on Obamacare repeal does not bode well for reaching a quick agreement on tax reform or infrastructure funding, and reinforces our view that a fiscal boost, if it happens, is mostly a 2018 story.

Second, while bipartisan cooperation looked possible on some issues following the election, the political environment appears to be as polarized as ever, suggesting that issues that require bipartisan support may be difficult to address.

Third, some of the recent administrative actions by the Trump Administration serve as a reminder that the president is likely to follow through on campaign promises on trade and immigration, some of which could be disruptive for financial markets and the real economy.

THE DAILY EDGE (3 February 2017)

Eurozone composite PMI: job creation at nine-year high
  • The final Markit Eurozone PMI® Composite Output Index posted 54.4 in January, unchanged from December and a tick above the earlier flash estimate of 54.3.
  • Growth of manufacturing production and service sector business activity both steadied at the solid rates achieved at the end of last year.
  • imageOutput increased across the ‘big-four’ economies during January. Solid expansions were seen in Germany, Spain and France. Growth slowed slightly in Germany and Spain, however, to four- and three-month lows respectively.
  • The rate of job creation in the euro area was the fastest since February 2008. Employment rose at quicker rates in Germany (three-month high), France (19-month high) and Italy (six-month high), but slowed slightly in Spain and Ireland.
  • Growth of new business remained solid with the rate of increase accelerating to a 14-month high, leading to a further accumulation of backlogs of work. Moreover, the Future Output Index – which tracks companies’ expectations about levels of output in one year’s time – rose to its highest level since the series began in July 2012.
    Inflationary pressures intensified further in January.
  • Input costs increased at the fastest rate in over five-and-a-half years, reflecting higher global commodity prices, increased import costs due to the weak euro
    and supplier price hikes. Meanwhile, improved pricing power led to a further increase in average output charges. Selling prices rose at a rate matching December’s 65-month record.
  • The latest reading is comparable to GDP rising at a quarterly rate of 0.4%, indicating that the economy is starting 2017 on a solid footing. Meanwhile, faster growth of new business and an upturn in confidence about the year ahead to the highest since the region’s debt crisis bodes well for the robust pace of growth to be sustained in coming
    months.
  • At 53.7 in January, unchanged from December, the final Markit Eurozone PMI® Services Business Activity Index signalled an expansion of output for the forty-second successive month. The final reading was slightly above the earlier flash estimate of 53.6.
  • Eurozone services employment rose for the twenty-seventh successive month in January, with the rate of growth rising to a six-month high.

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China Manufacturing PMI: Operating conditions improve at slower pace in January
  • The seasonally adjusted Purchasing Managers’ Index™ (PMI™) posted 51.0 in January, down from December’s 47-month record of 51.9, consistent with only a marginal rate of improvement.
  • Manufacturers reported a further rise in client demand during January, as highlighted by a sustained increase in new orders. That said, the
    rate of expansion slowed since December’s recent peak and was moderate overall. This was despite a renewed upturn in new export
    business, which increased at a solid pace that was the fastest since September 2014.
  • Efforts to cut down on costs contributed to a further decline in overall manufacturing employment during January. The rate of job shedding
    quickened slightly to its strongest for three months, but remained moderate overall. A lack of personnel and higher new orders led to a
    further increase in the amount of backlogged work.
  • With production rising at a softer pace, growth in purchasing activity also slowed in January. However, vendor performance continued to
    deteriorate     amid reports of issues with transportation. Furthermore, average lead times increased at the quickest pace since February 2011.
  • Stocks of finished goods declined for the first time since June 2016.
  • Chinese manufacturers faced a further steep increase in input costs, with the rate of inflation easing only slightly from
    December’s recent peak. As a result, companies raised their prices charged for the eleventh successive month. Though solid, the rate of
    increase was the slowest seen in the past four months.
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U.S. Productivity Gain Moderates; Unit Labor Costs Pick Up

Growth in nonfarm output per hour during Q4’16 increased at a 1.3% rate (1.0% y/y) following a 3.5% rise in Q3, revised from 3.1%. These latest two increases followed three consecutive quarters of decline. During all of 2016, productivity increased 0.2%, the weakest rise since 2011. Output rose at a 2.2% rate (2.2% y/y) while hours-worked improved 0.9% (1.1% y/y).

The gain in productivity was accompanied by a 3.0% increase in compensation, which was weaker than the 3.7% gain during Q3. The 2.9% y/y increase left it roughly equal to the gains during all of 2015 and 2014. Adjusted for price inflation, compensation fell 0.4% (+1.1% y/y).

Unit labor costs increased 1.7% (1.9% y/y) following a 0.2% increase in Q3, revised from 0.7%. During all of last year, unit labor costs increased 2.6%, the strongest gain since 2007.

In the manufacturing sector, productivity increased 0.7% (0.4% y/y) following no change in Q3, revised from 0.4%. During all of last year, productivity increased 0.6% after a 0.3% rise in 2015. Factory output rose 0.8% (0.2% y/y) and hours-worked remained steady (-0.2% y/y). Compensation improved at a 4.1% rate (2.6% y/y) following a downwardly revised 3.4% increase. The gain in compensation lifted unit labor costs by a steady 3.3% (2.2% y/y). During all of last year, unit labor costs increased 2.6%, up from the 2.2% gain in 2015.

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Factory Skills Gap Could Spell Trouble for Trump’s Jobs Plan

(…) The firm [ADP] surveyed 400-plus global HR executives and found that companies expect to hire extensively in the coming year to address anticipated growth — 41 percent will add workers, compared to 32 percent who did so last year. But an even greater number see the skills gap impacting their businesses in the future. (…)

Four-fifths of executives surveyed said that a shortage of sufficiently skilled workers will affect their companies in the next 12 months. The most-represented sector in the survey is manufacturing, which the Trump White House calls the “backbone of our economy.”

Complaints of hard-to-fill factory jobs are backed up by Bureau of Labor Statistics data: 324,000 manufacturing spots were open in November, up from 238,000 a year earlier. (…)

Demand vs Supply: what happens next?

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EARNINGS WATCH
  • 268 companies (70.4% of the S&P 500’s market cap) have reported. Earnings are beating by 3.3% (2.8% ex-Financials) while revenues are surprising by 0.1%.
  • Expectations are for revenue, earnings, and EPS growth of 4.1%, 5.8%, and 7.9%, respectively (5.7% ex-Financials).
  • EPS is on pace for 8.9%, assuming the current beat rate for the remainder of the season. This would be 7.4% excluding the benefit of easy comps at AIG and GS.
Jason Furman slideshow: Border adjustment as tax policy and as macroeconomic policy.
How Trump’s immigration ban threatens health care, in 3 charts
Peter L Bernstein on Risk

Click on the link for 13 minutes about risk from the master.

Computer outbluffs world’s top poker players Texas Hold ’em tournament set men against AI program

(…) An artificial intelligence system developed at Carnegie Mellon University has just racked up $1,766,250 worth of chips against four of the world’s top professional players after a marathon 20-day poker binge.

Among the claimed breakthroughs was the computer’s success in outbluffing its human opponents — a new milestone in the ongoing contest between man and machine. (…)

“This is not just about poker. The algorithms we have developed . . . can take any imperfect information situation and output a good strategy for that setting,” said Mr Sandholm, who developed the system with Noam Brown, a PhD student.

The technology could be used to compete against humans in business negotiations, military strategy, and the high-frequency trading systems used by the biggest banks, he said. (…)

“Half-way through the challenge even, we really thought we were going to win,” said Daniel McAulay, one of the professional players. “We really got a beat-down.”

The CMU team used a supercomputer each night to analyse the day’s games and improve the software. Rather than try to study its opponents’ winning tactics, the system examined the weaknesses in its own game and patched up the three most obvious failures each day.

That eventually enabled it to outflank most of its opponents’ tactics, which Mr Sandholm called “the most psychologically devastating” aspect of the system for the humans playing against it. (…)

“We tried everything we could, it was just too strong,” said Jason Les, another of the poker professionals. “It became very demoralising showing up every day and losing this hard. I thought it would be a lot closer.”

The technology behind Libratus will almost certainly be spun off into a new start-up company and developed for commercial use, said Mr Sandholm, who has studied negotiating strategy for 27 years. One of his earlier programmes is used by two-thirds of US transplant centres to decide which patients should receive new kidneys.