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 (12 December 2016): Earnings Watch

Oil Soars as More Producers Agree to Join Output Cuts Oil prices surged by more than 4% after more oil-producing nations agreed to slash production, a move aimed balancing the oversupplied oil market.

(…) Over the weekend, a group of heavyweight producers outside of the Organization of the Petroleum Exporting Countries, including Russia, agreed to scale back their output by 558,000 barrels a day. The move would come on top of the cut of 1.2 million barrels a dayagreed to by OPEC in late November. The total reduction represents almost 2% of the global supply. (…)

The bulk of the cuts—300,000 barrels a day—have been pledged by Russia, which produces more crude oil than any other country. Other output reductions are promised by 10 other countries, including Oman, Azerbaijan and Sudan.

Bernstein Research noted that some of the non-OPEC supply cuts would come from natural decline but that most would come from self-imposed cuts.

The market got an extra boost of confidence on reports that Saudi Arabia indicated that, if necessary, the kingdom may be willing to take a deeper cut than the 486,000-barrel cut it had agreed in the November meeting. (…)

“Last week the U.S. oil rig count rose by 21 rigs to 498 which was the biggest one week gain since July 2015”, noted SEB Markets in a recent report. (…)

(…) The Organization for the Petroleum Exporting Countries has a history of failing to enforce its own production limits, according to numerous energy analysts and former OPEC officials. The cartel’s agreements usually spell out exactly how many barrels a day each member must cut. But ensuring that everyone abides by these quotas has been supported only by a fragile honor system, with OPEC having no official mechanism for punishing members that stray from their pledges. (…)

In 17 production cuts since 1982, OPEC members have reduced output by an average of just 60% of their commitments, according to Goldman Sachs. OPEC exceeded its quota by an average of 883,000 barrels a day on average from 2000 to 2008, according to Morgan Stanley. (…)

Protectionist Impulse Poses Threat to Global Growth, Warns BIS Mounting public and political skepticism toward free trade poses a threat to economic growth, according to the Bank for International Settlements in a cautionary reminder of the risks facing the global economy.

(…) “Looking further ahead, the most worrying signs relate to the risk of greater protectionism. Those signs have been multiplying in recent years, and prospects have darkened considerably with the most recent political events,” said Claudio Borio, chief economist of the BIS, a Switzerland-based consortium of central banks.

“There would be no winners, only losers. Lower global growth, and possibly higher inflation, would benefit no one,” he said in comments accompanying the release of the BIS’s quarterly review. (…)

OTHER HEADWINDS: Housing and Autos

Next, is the big two of household spending: cars and houses. Both are obviously harmed by a significant pop in the cost of money and each is displaying signs of late-cycle fatigue. Auto lenders are already dealing with a rapid rise in dud loans (delinquencies on sub-prime loans are the highest since 2010). To keep things moving—and delay loss recognition—they are increasingly resorting to rolling the debt incurred on prior purchases into the next transaction. The result often is negative equity on the new vehicle. There is also a looming mountain of metal coming off lease over the next two years, threatening to inundate the used car market. Meanwhile, housing was looking winded even before the affects of the recent big leap by mortgage rates. (David Hay, Chief Investment Officer, Evergreen/Gavekal)

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Windy in China as well:

(…) China’s passenger-car sales rose 17% in November to another record-high. It’s made China the fastest-growing market again both for local and foreign makers. But the strong demand may be less about a love for cars, and more a love for deals. A tax cut on car purchases is set to expire in December. The impending end of the tax has brought forward months of demand and consumers aren’t taking chances, locking in deals.

The blow might be cushioned if the tax rate is raised only in stages. State media reported that the state-backed auto association, China Association of Automobile Manufacturers, submitted a proposal to raise the tax to 7.5%. Yet that may not be enough of an incentive, given the extent of buying front loaded over the past year, and sales should slow, nonetheless. (…)

The car industry accounts for 10% of China’s economic activity, according to Credit Suisse, so the stakes of keeping it going are high. But China’s car market is now inundated with cars. And the vehicle population has hit an inflection point of sorts. Car ownership is nearing 20%. Put another way, one in five people now own a car, according to Nomura analysts. Going by the fate of other large car markets, like Japan and South Korea, that is when sales see a significant shift lower. (…)

Making U.S. Stocks Great Again

Good stuff from Barron’s Randall Forsyth with my remarks:

(…) As for fundamentals, the outlook for growth and inflation isn’t likely to shift, given that fiscal policy won’t change until next year at the earliest. The most immediate—and arguably most powerful—effects are likely to be from regulatory changes, which may be effected by executive order or by different guidance from the bureaucrats’ bosses.

For the markets, that means further mediocre global growth, subdued inflation, tamped-down volatility, and continued accommodative monetary policies from central banks around the globe. In other words, more of the same in the near term, much as if Hillary Clinton had won.

Hmmm…for now, markets are betting more on “less subdued” inflation. The Fed is clearly becoming hawkish while the ECB has announced its own tapering.

To be sure, what has changed is psychology. “Animal spirits,” to use Keynes’ hoary cliché, have been aroused, not the least in the stock market, where industrials and financials have gotten the biggest spring in their step. (…)

In another departure from the consensus orthodoxy, Berezin provocatively writes in BCA’s Global Investment Strategy report that, while rising protectionism could have a big negative impact on the global economy, the effects on the U.S. economy would probably be modest. The U.S. remains a relatively closed economy, with exports accounting for only about 12% of gross domestic product. Much of those exports are intermediate goods that are processed or reshipped back to the U.S. or another market. So, Berezin contends, it wouldn’t make sense for China or Mexico to put up barriers to American exports, since it would hurt their jobs.

Moreover, conventional wisdom is wrong that foreign producers can pass on U.S. tariffs to consumers, he continues. And while tariffs are a tax by another name, Trump’s tax cuts would offset the fiscal drag. In any case, tariffs would probably shift sales to domestic producers, with a boost to U.S. employment. Neither would tariffs hurt capital investment; indeed, domestic industries might have to boost spending to move production back onshore.

So, why even bother thinking and talking about that since protectionism seems to be a net positive for the U.S.. But wait, it’s not, after all:

But these short-term economic gains miss the big picture. “Trade agreements are also about politics—they help form the geopolitical glue that holds the global community together,” he writes. “The real reason the 1930 Smoot-Hawley Tariff Act was so disastrous was not because it contributed to the Great Depression, but because it led to a breakdown of international relations among democratic governments at a time fascism was on the rise.”

That protectionism could actually benefit the U.S. at the expense of other countries would likely stoke anger abroad, Berezin continues. China is especially vulnerable, but tariffs would probably also spread to South Korea and Vietnam, leading to a wholesale breakdown in global trade.

Even if Trump’s threats of tariffs on Mexico and China turn out to be negotiating ploys, some increase in trade barriers seems inevitable, even if they’re not explicit. “Trump’s success in browbeating Carrier into keeping its plant open in Indiana is an example of things to come. Corporate America does a lot of business with the government, and the subtle threat of canceled government contracts will make any CEO take notice. Good news for Main Street, perhaps, but definitely bad news for Wall Street,” Berezin concludes.

Meanwhile, S&P 500 profits might not benefit nearly as much as investors expect from promised corporate tax cuts, he adds, given that the effective U.S. rate is about 25% already, well under the statutory 35% rate. As for infrastructure spending, he doubts that there are enough “shovel ready” projects around.

Some even doubt there would be enough people to actually manoeuver the shovels…

THE STOCK RALLY ISN’T JUSTIFIED by faith alone, to be sure. What impresses Doug Ramsey, chief market analyst at the Leuthold Group, has been the uniformity of the market’s positive action, from the overall breadth of the advance to the action of various subgroups. About the only nonparticipant has been utility stocks, the most prominent of the bond proxies, which have trailed with the upsurge in intermediate- and long-term interest rates.

Seasonal tendencies also are on the side of the bulls at this time of year, he adds.

On that, David Rosenberg says that “from the two days prior to Christmas through to the opening week of January, the stock market in the past rallied 80% of the time. That compares to less than 60% the rest of the year.” Since tax rates are widely expected to decline markedly in 2017, taxable sellers are likely to take trading time off till year-end. That is for those who have profitable trades on their books. Losers would be well advised to book their losses this year.

And then there are those animal spirits, which are indicated in the CNN Fear & Greed Index, which has swung from extreme negativity at election time to giddy euphoria in a month, notes Peter Boockvar, chief investment officer at the Lindsey Group. (…) To which it might be added that laggard hedge funds and other money managers probably are lobbing Hail Mary passes in the rally to make their 2016 numbers.

Ramsey thinks the momentum and positive sentiment could carry the advance for another four to six months. And even such a confirmed contrarian says he has to admit that sometimes the crowd can be on the right side. (…)

This last Barron’s was indeed well laid out:

(…) In the stock market, it is already the most wonderful time of the year. While stocks look overbought in the short term, with three of four stocks already stretching above their 50-day averages, the bullish throng won’t thin now—not when selling after Jan. 1 lets you put off paying capital-gains tax until April 2018, when the tax rate just might be lower. Even recent laggards are catching up, a sign that brokers are getting calls to hoover up anything that hasn’t yet shimmied higher. That helped swell to 18.6% the crop of S&P 500 stocks pushing 52-week highs, the highest in two years, notes Bespoke Investment Group. (…)

But here’s the useful part:

Morgan Stanley ’s bull case pegs S&P 500 per-share earnings at $147.30 next year, and the index pushing to 3050, but its bear case puts earnings at $114.40 and the index at 1625. Bank of America Merrill Lynch likens 2017, the Chinese year of the rooster, to “an erratic bird with fat tails.” Its bull case puts the S&P 500 at 2700, its bear case at 1600. (…)

And this warning for those few who might care:

Unlike households, corporations have binged on cheap rates, and net debt to earnings before interest, taxes, depreciation, and amortization among Russell 2000 companies (excluding financials and cash-rich technology names) are near the highest in at least 30 years, notes Merrill Lynch. The percentage of S&P 500 companies using buybacks to shrink outstanding shares year over year recently peaked near 65%, just as it did in 2007, and is starting to slip. Rallying stocks ratchet up expectations for the new administration to deliver and avoid policy missteps. (…)

(…) Stock repurchase authorizations by U.S. companies totaled $83.8 billion in value for the month, according to Birinyi Associates Inc., a 76% rise from November 2015, when they totaled $47.6 billion.

It was the most robust November for share buyback authorizations since 2005, when companies set buyback plans of $88.5 billion, according to Birinyi. (…)

A couple of exceptionally large buybacks contributed to the November spike. (…) CVS Health Corp.’s board, for example, approved a new $15 billion plan while Facebook Inc.’s directors authorized one for $6 billion of its class A common stock. (…)

Even including the robust November figures, though, authorizations for the first 11 months of 2016 trail those for the corresponding period last year by a wide margin, $628.5 billion versus $783.2 billion. The number of buyback authorizations was also lower, 902 versus 1,158.

Last year was an exceptionally robust year for buyback executions, with companies making repurchases of $696.4 billion. That was the highest number since the year before the financial crisis, 2007, when companies executed $761.8 billion in buybacks.

Year-to-date through November the financial sector notched the biggest number of buyback authorizations at 281, or 31% of the total, according to Birinyi. It also authorized the largest amount by value at $141.2 billion, or 23% of the total.

EARNINGS WATCH

From Factset:

In terms of estimate revisions for companies in the S&P 500, analysts have made smaller cuts than average to earnings estimates for Q4 2016 to date. On a per-share basis, estimated earnings for the fourth quarter have fallen by 2.2% since September 30. This percentage decline is smaller than the trailing 5-year average (-3.4%) and the trailing 10-year average (-3.9%) for the first two months of a quarter.

In addition, a smaller percentage of S&P 500 companies have lowered the bar for earnings for Q4 2016 relative to recent averages. Of the 110 companies that have issued EPS guidance for the fourth quarter, 75 have issued negative EPS guidance and 35 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68%, which is below the 5-year average of 74%.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings growth rate for Q4 2016 is 3.0% today. On September 30, the expected earnings growth rate was 5.2%.

As a result of downward revisions to sales estimates, the estimated sales growth rate for Q4 2016 is 5.0%. On September 30, the expected revenue growth rate was 5.3%.

Pre-announcements are indeed positive so far:

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But estimates have really improved in only 3 sectors. Eight sectors are seeing a fairly significant degrading in their Q4 outlook, including the currently popular Industrials. To be closely monitored.image

THE DAILY EDGE (9 December 2016)

Economists See Fed Moving Faster on Rate Increases

(…) Some expect inflation to pick up on its own. Some say President-elect Donald Trump’s tax and spending plans could boost price pressures. Others see Mr. Trump’s Fed nominees advocating a more hawkish path for interest rates.

The economists’ predictions for the benchmark federal-funds rate averaged 1.26% by December 2017, which implies four rate increases of 0.25 percentage point each between now and the end of next year. The economists overwhelmingly said the Fed will raise rates at its Dec. 13-14 meeting, which suggests they expect three moves in 2017.

In the November survey, the economists’ estimates averaged 1.17%.

Fed officials, in their September economic projections, penciled in one quarter-percentage-point rate increase this year and two in 2017. (…)

Other economists surveyed see inflation picking up steam in the coming years, which would could lead to more Fed rate increases than currently anticipated. (…)

Why Odds May Be Fading for a Near-Term U.S. Recession

(…) the odds are gradually declining, having dropped to 17% in The Wall Street Journal’s latest monthly survey. That’s still about one-in-six odds over the next year, which is somewhat higher than we’ve seen in recent years. But it’s accurate to say that many economists are slowly lowering their warning flags.

(…) economists are now forecasting higher rates and inflation than they were before the election. But many share the assessment that inflation, in particular, has been too low in recent years, and that somewhat higher inflation would be a welcome development. (…)

Typically, the wealth effect of rising stock prices provides some lift to consumption and should provide some pep for the economy. (…)

CEOs and CFOs See Greater 2017 Risks Than Other Executives

(…) Nearly three quarters of 735 executives surveyed, or 72%, said developments around the world had created a riskier business environment than in previous years.Of those surveyed, 78 were CEOs and 100 were CFOs. (…)

Protiviti and the university surveyed executives and board members in a variety of industries globally this fall, before the U.S. presidential election. (…)

Respondents cited economic conditions most frequently as constituting a risk for 2017—with 72% of executives saying they expected conditions to have a “significant impact” on their businesses in the new year. (…)

In last year’s survey, by contrast, executives most frequently cited regulatory changes as a risk that they would face in 2016.

This year, regulatory changes are the second most frequently cited risk: 66% of the executives cited such changes as likely to have a “significant impact”  on their businesses in 2017.(…)

OECD LEIs Tick Ever So Slightly Higher as the OECD Trumpets Gaining Momentum

The OECD itself reports the following analytical assessment of its release this month:
* Signs of growth gaining momentum have emerged in the CLIs for the United States, Canada, Germany, and France. In the United Kingdom, there are also signs of improvement in the short term, although uncertainty persists about the nature of the agreement the U.K. will eventually conclude with the EU.
* Growth is expected to gain momentum in China and India, in particular, and also in Brazil and Russia, albeit from low levels.
* In the OECD area as a whole, Japan, and the euro area as a whole, the CLIs point to stable growth momentum.
* In Italy, the CLI show signs of easing growth.

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High five But Haver Analytics’ Robert Brusca is less enthused:

On balance, the OECD CLI indicators can be construed to be showing some improvement or gain in momentum as the OECD has chosen to do, but when placed of a scale of truth the real story is how meager and nascent this improvement is and that weak the growth continues to be in train. In the case of the U.S., the CLI has ticked up by a net of 0.2 points in the course of two months after being stuck at a reading of 99.1. The ratio of the current U.S. CLI to its value of six months ago is higher by just 0.1 and that is a very sour note on which to hang a song of improvement.

The OECD is a membership organization. I very much get the impression that members are trying to put the best spin possible on the interpretation of these readings. I do not find the OECD report encouraging in the least and find the ‘improvements’ posted this month as in the range of normal variation and unconvincing as yet as to the ongoing nature of improvement.

Household Net Worth Hit Record $90.2 Trillion

Stockholdings—both directly and through retirement accounts like 401(k)s—climbed by $494 billion last quarter while real estate, which is primarily people’s homes, rose in value by $554 billion, according to a Federal Reserve report released Thursday.

The report shows that U.S. households, in aggregate, had tremendous assets at their disposal, about $105 trillion against about $15 trillion of debt. That wealth has likely grown since the report was released because the stock market has rallied dramatically over the past month. (…)

OPEC’s Historic Deal Won’t Be Enough to Drain Oil Stockpiles

(…) Bloomberg News calculations based on OPEC data show that across the whole of 2017 there will be little overall reduction in record oil inventories — even if the group convinces non-members to join supply curbs at a meeting on Saturday.

“Even with 100 percent compliance from both OPEC and non-OPEC producers global stocks are unlikely to fall in the first half of 2017,” said Tamas Varga, analyst at brokerage PVM Oil Associates Ltd. in London. “That should keep oil prices in check.” (…)

OPEC’s track record shows the group only delivers 80 percent of promised cuts. While Russia has pledged to come to the party and lower output by 300,000 barrels a day in the first half of 2017, other non-OPEC producers, such as Mexico, Azerbaijan and Colombia, are likely to dress up involuntary production declines, already factored in by traders, as cuts. That scenario would leave largely unchanged the 300 million-barrel global stockpile surplus Del Pino and his colleagues are targeting. (…)

The Dream Stock Market

It’s the season when Wall Street strategists dust off their crystal balls and predict what markets will do for the year ahead, while conveniently forgetting what they said 12 months ago. (…)

History suggests investors should ignore these year-ahead guesses. The average strategist hasn’t started a year predicting a stock-market drop in any of the surveys carried out by Bloomberg since 2000, while shares fell one year in three. (…) Strong gains were forecast in 2008, when the market had its worst year in generations. Strategists then became cautious, making their lowest forecast in 2009 since the survey began, only for the market to rebound 23%. (…)

Insiders Send Wrong Signal on Bank Stocks The rally in bank shares has coincided with insider selling that is on pace to set a record.

Bank and industrial stocks have been among the biggest winners in the postelection stock rally, but some are swimming against the tide.

Corporate insiders in these industries have been selling into the rally at an unusually strong pace, according to research firm InsiderScore. At first glance, it is easy to view this as bearish. If high-ranking executives are unloading stock, perhaps investors should consider doing the same. (…)

High five But insiders might choose to sell their stock for reasons that don’t necessarily match the incentives of the typical individual investor.

Some insiders could be locking in profits or exercising options that are close to expiration. Many banking executives in particular have held underwater options in the years following the financial crisis. Bank of America Corp. and Morgan Stanley, for example, have rallied back to mid-2008 levels. If this postelection rally was the first chance to sell, it is hard to argue against doing so no matter how they feel about the future. (…)

The recent banking rally might be overdone for a number of reasons. Insider selling isn’t one of them.

If you missed the Dec. 5 Edge and Odds, you missed this:

(…) A total of 3,500 insiders at Russell 3000 companies have unloaded their own stock in the last three weeks, while 467 purchased shares, according to data from The Washington Service, a Bethesda, Maryland-based provider of insider trading data and news. The number of sellers was higher than the monthly average of 1,832 sellers this year through October. Sellers have also increased from the comparable year-ago period, and buyers have decreased. (…)

Insider buying and selling doesn’t necessarily presage gains or declines in a given firm’s shares, of course. But Wall Street watches the data because insiders are understood to have the best information about their companies’ prospects, and are also typically veterans of their industries with longer-term horizons.

While they have historically tended to sell more than buy, their behavior since the election diverges from investors, who have exhibited a rapid shift in sentiment and poured money into equities. (…)

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“The big increase in insider selling makes sense because we’ve been making all-time market highs,” said Aaron Jett, the Los Angeles-based vice president of global equity research at Bel Air Investment Advisors, which oversees about $8 billion. “A huge portion of their wealth could be tied up with that one stock so they could want to sell to diversify.”

It is normal for executives to sell into market strength, according to Mr. Jett. That said, a prolonged period of outsize selling by insiders would be concerning, he noted.

(…) in the last month, 891 insiders of U.S. financial companies sold shares, compared with 425 executives who added, data from The Washington Service show.

Both Mr. Clissold and Mr. Jett said it is more valuable to pay attention to a pickup in executive buying rather than selling, since sales can occur for personal, idiosyncratic reasons, while stock purchases tend to indicate confidence in the company. (…)

Punch Where the big increase in insider selling makes much less sense is that it is occurring at the end of 2016:

  1. why not wait just a few weeks to defer tax payments by 12 months to April 2018?
  2. why not wait just a few weeks to potentially avoid the 3.8% Obamacare’s net investment income tax which the Trump camp wants to eliminate?
  3. why not wait just a few weeks to potentially benefit from lower capital gains tax rates promised by Republicans?

Insiders’ use of the trading window following quarterly earnings reports has been rising as the year progressed. Sellers steadily increased while buyers became fewer and fewer. Note that the November data on the chart only includes trades after the election.