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 (20 January 2017)

U.S. Housing Starts Reach 2007 High

During December alone, total starts rebounded 11.3% to 1.226 million (AR, 5.7% y/y), and recouped most a November decline to 1.102 million in November, revised from 1.090. The Action Economics Forecast Survey expected 1.184 million starts. Starts of single-family homes declined 4.0%, however, in December to 795,000 (+3.9% y/y) from 828,000. It was the lowest level of starts in three months. Starts of multi-family units jumped by more than one half m/m to 431,000 (9.1% y/y), though these starts were very erratic m/m all during 2016. Building permits in December eased 0.2% (+0.7% y/y) to 1.210 million. They reached a peak of 1.334 million in June of 2015.

By region, housing starts in the Midwest, jumped 38.4% y/y to 227,000. Starts in the West also grew roughly one-third y/y to 331,000. In the South, however, starts weakened 3.2% y/y to 572,000. In the Northeast, starts declined 38.5% y/y to 96,000 during December.

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  • But US single-family home construction permits hit the highest level since 2007. (The Daily Shot)
  • US economic data remains solid as the Citi Surprise Index hits the highest level in over two years. (The Daily Shot)

Janet Yellen Sticks to Steady Outlook on Rates Federal Reserve Chairwoman Janet Yellen said she doesn’t see the U.S. economy at risk of overheating and doesn’t expect growth to pick up much soon, comments suggesting the central bank is sticking to its plan of raising interest rates cautiously in the months ahead.

(…) “Economic growth more broadly seems unlikely to pick up markedly in the near term given the ongoing restraint from weak foreign demand,” rising interest rates, an aging population and other factors, she said.

Still, she said, the Fed doesn’t want to wait too long to raise rates and let inflation get out of control. So, it will likely be “prudent to adjust the stance of monetary policy gradually over time,” she said, repeating the language she and other Fed officials have used recently to describe their expected pace of rate increases. (…)

From the speech with my emphasis:

  • In 2016, job gains averaged about 180,000 per month, well above the pace of 75,000 to 125,000 per month that is probably consistent with keeping the unemployment rate stable over the longer run. The unemployment rate is now close to estimates of its longer-run normal level, and other measures of labor utilization have improved appreciably.
  • And some indicators, such as small businesses’ assessments of the difficulty of hiring, shown by the solid black line, as well as the average length of time it takes firms to fill vacancies and the job openings rate, even suggest that the labor market is a bit tighter than before the financial crisis. Of course, both the labor force participation rate and the employment-to-population ratio are still much lower than they were a decade ago. But the cyclical element in these declines looks to have largely disappeared, and what is left seems to mostly reflect the aging of the population and other secular trends.
  • As we look to broader trends, gross domestic product (GDP) growth has been restrained in recent years by a variety of forces depressing both supply and demand, including slow labor force and productivity growth, weak growth abroad, and lingering headwinds from the financial crisis. Although I am cautiously optimistic that some of these forces will abate over time, I anticipate that they will continue to restrain overall growth over the medium term, likely holding down the level of interest rates consistent with stable labor market conditions.
  • (…) slack in labor and product markets is no longer placing downward pressure on inflation, in contrast to the situation only a few years ago when the unemployment rate was still quite elevated. Barring future major swings in oil prices and the foreign exchange value of the dollar, inflation is likely to move up to 2 percent over the next couple of years, aided by a strong labor market.
  • (…) although core inflation is rising gradually from a low level, this increase mainly reflects the waning of the effects of earlier movements in the dollar, not upward pressure from resource utilization.
  • (…) figure 4 illustrates the relationship over the past several decades between labor market pressures and core inflation. Note that during periods when the unemployment rate fell below the Congressional Budget Office’s estimate of its normal long-run level, shown by the yellow shaded regions, core inflation, the solid red line, rose little, if at all. This stability is especially marked since inflation expectations became anchored during the mid-to-late 1990s.
  • That said, I think that allowing the economy to run markedly and persistently “hot” would be risky and unwise.
  • (…) it will likely take many years before the forces now restraining the economy dissipate to the degree envisioned in participants’ estimates of the longer-run normal level of the real federal funds rate.
  • The downward pressure on longer-term interest rates that the Fed’s asset holdings exert is expected to diminish over time–a development that amounts to a “passive” removal of monetary policy accommodation. Other things being equal, this factor argues for a more gradual approach to raising short-term rates.
 
REALITY CHECK

Gluskin Sheff’s excellent economist David Rosenberg asserts that the U.S. economy, contrary to what many surveys suggest, is not accelerating:

There is such a gap now between spin and reality it is incredible.

Since the election, roughly 80% of the survey data have exceeded expectations (though we did see the National Association of Home Builders’ housing market index dip two points to 67 in January from its cycle-high of 69 to close 2016).

In contrast, less than half of the hard economic data have topped consensus views (strip out autos and utilities, and industrial production stagnated in both November and December —in fact, manufacturing output is no higher today than it was in 2005). (…)

Don’t be fooled — the U.S. economy is soft, not strong. (…)

Cass Information Systems offers some real world data for our consideration:

As is often true of a change in trend, it is neither smooth nor linear. The October Cass Freight Shipments Index was up 2.7%, breaking a string of 20 months in negative territory, then November fell back into negative territory, albeit ever so slightly (down 0.5%). Now December—coming in up 3.5%—suggests that the October data was not a false positive but instead the beginning of a more positive trend. We have seen a wide range of results in the different modes, from continued volume growth in parcel and airfreight driven by e-commerce; to a sequential improvement in truck tonnage; to less bad rail and barge volume overall. (…)

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What specifically drove November volumes? Parcel volumes associated with e-commerce continue to show outstanding rates of growth, with both FedEx and UPS reporting strong U.S. domestic volumes. According to the proprietary Avondale Partner’s index in the most recent month available (November), airfreight has also been showing some improving strength with the Europe Atlantic lane jumping 13.4% and the Asia Pacific lane growing 7.8%. This was a solid follow-on from October and September, in which the Asia Pacific lane grew 10.5% and 7.5% (respectively) and the Europe Atlantic lane grew 3.6% and 4.7% (respectively). This also highlights that this resurgence began before the election.

Rail volumes have been part of the weakness, but have become increasingly less bad, and in recent weeks have turned slightly positive. The Association of American Railroads (AAR) reported that December YoY overall commodity carloads originated by U.S. Class 1 railroads grew by 2.7%, and intermodal units increased an impressive 11.2%. Rails have seen persistent weakness for almost two years, with overall volumes being negative 92 out of the last 100 weeks. However, the most recent week of data suggests that the higher price of crude (WTI over $52 as we write this) is driving increased activity in oil and gas exploration, as companies with DUCs (Drilled Uncompleted Wells) are choosing to proceed with fracking operations. Just as the dramatic drop in fracking led us into the industrial recession in March 2015, it now appears to be in the early stages of leading us out. Bottom line, rails may not serve as a drag to the overall Cass Freight Shipments Index in coming months, but may instead start to be a positive.

  • More on rail from RBC Capital:
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U.S. Oil Producers Ramp Up Spending U.S. oil producers, optimistic that higher crude prices are here to stay, have issued 2017 budgets that call for dramatically greater spending to tap new wells. Early indications are that energy firms expect to spend more, as well as pump more oil and natural gas this year.

Preliminary capital-spending plans released in recent weeks by more than a dozen American shale drillers, including  Hess Corp. and  Noble Energy Inc., show an average 60% budget increase for the group. (…)

Several U.S. oil producers, including Pioneer Natural Resources Co. and EOG Resources Inc., have said that advanced technology and efficiency gains implemented during the oil-price downturn will allow them to not just survive but thrive at $55 a barrel.

Spending by oil and gas producers world-wide is expected to jump 7% in 2017, according to Barclays PLC, a British bank which recently surveyed 215 energy companies about their plans.

U.S. onshore oil and gas producers will lead the way, particularly as larger shale drillers ramp back up, said J. David Anderson, a Barclays analyst. He estimates that spending among American exploration and production companies will rise more than 50%, setting off a wave of activity that may surprise OPEC and other foreign competitors. “They’re about to find out how efficient the U.S. producers have become,” Mr. Anderson said. (…)

Mark Erickson, Extraction’s chief executive, said $45 oil has proven to be a sweet spot for the company, and any improvement in price just means stronger returns and more activity are on the way.

China Leans on Stimulus to Hit 6.7% Growth China used a surge of easy credit and state spending to eke out a 6.7% rise in economic growth for 2016, the weakest rate in a generation.The rate is within leaders’ target range of 6.5% and 7%, but economists say Beijing only got to the final number by relying heavily on short-term measures.

(…) Growth in the final quarter of the year was 6.8%, China’s National Bureau of Statistics said Friday, the fastest pace all year after three straight quarters of 6.7% growth.

(…) official data suggest economic growth has relied heavily on activities related to the property market, such as construction or manufacturing of steel and glass. Meanwhile, contributions to GDP growth from consumption dropped by 1.8 percentage point last year, according to the data. (…)

The Daily Shot has the important charts. No clear rebound yet.

(…) While in the past the PBOC has engaged in similar moves ahead of the new year, the latest move suggested there were additional factors involved in draining liquidity: “Today’s move seems to suggest that liquidity conditions are tighter than authorities’ expectations, as capital outflows remain strong,” said Zhou Hau, senior emerging markets economist at Commerzbank in Singapore. (…)

EARNINGS WATCH
  • 54 companies (15.5% of the S&P 500’s market cap) have reported. Earnings are beating by 4.5% while revenues are missing -0.2%.
  • Expectations are for revenue, earnings, and EPS growth of 4.1%, 4.6%, and 6.4%, respectively.
  • EPS is on pace for 10.2%, assuming the current beat rate for the remainder of the season. This would be 8.7% excluding the benefit of easy comps at AIG and GS. (RBC)
SENTIMENT WATCH
Soros says Trump ‘uncertainty’ will cause global markets to falter

(…) “Right now uncertainty is at a peak,” Soros told Bloomberg in a TV interview at the World Economic Forum’s annual meeting in Davos, Switzerland. “And, actually, uncertainty is the enemy of long-term investment. So I don’t think the markets are going to do very well.” (…)

But uncertainty will come back to the fore, he said, as Trump gets into battles with Congress.

“You’ll have the various establishments fighting with each other,” leading to unpredictable outcomes, Soros said.

THE DAILY EDGE (19 January 2017): Inflation Watch

Inflation Gauge Tops 2%, Supporting Fed’s Plan to Raise Rates

The Consumer Price Index during all of 2016 increased 2.1% from December-to-December, the quickest y/y gain since June 2014. The 2.2% advance in prices excluding food & energy compared to a 2.1% rise in 2015. During December alone, the CPI increased 0.3% following a 0.2% November gain. The rise equaled expectations in the Action Economic Forecast Survey. Prices excluding food & energy rose a stable 0.2%, as expected. (…)

Prices for services provided another area of strength with a 3.1% y/y increase, up from 2.6% during all of 2015. The 3.6% y/y rise in shelter prices accelerated, compared to price deflation in 2010. Owners’ equivalent rent of residences rose 3.6% y/y and rents of primary residences advanced 3.6% y/y. Medical care prices inched 0.1% higher last month, but the 3.9% y/y gain accelerated from 2.9% in 2015. Recreation services prices strengthened 2.9% y/y after a 2.5% rise in 2015. Education & communication prices were fairly stable y/y, and public transportation costs fell 2.3% last year following a 1.0% decline in 2014.

Heightened competition kept inflation in the goods-producing sector under wraps last year. Prices for goods excluding food & energy eased 0.6% y/y, and have been falling since 2012. Home furnishing prices declined 2.2% y/y, down nearly 10.0% since 2010. Appliance prices fell 4.4% y/y and have been working lower since 2009. Apparel prices dropped 0.7% last month, about as they did in November. They eased 0.1% y/y for a second yearly decline. Recreation product prices were off 3.5% y/y, continuing the price deflation in place for several years. New vehicle prices remained little changed all year, but medical care goods prices surged 4.7% during the year.

Declining food prices added to last year’s price weakness. They were little changed during the last three months, and slightly lower y/y. Meat prices eased slightly during the last four months and moved 4.2% lower during the year. Egg prices declined by more than one-third versus December 2015; and dairy product prices fell 1.3%, continuing the price deflation of 2015. Fruit & vegetable prices fell 2.4% y/y, and cereal prices eased 0.7% y/y.

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Core CPI is up 2.2% YoY. Its annualized trend was +2.0% in Q4 and +2.4% in the last 2 months of the year.

Philly Fed Soars As Prices Paid Spike To 5 Year Highs

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  • Most firms (61 percent) reported an increase in underlying demand, but 56 percent characterized the increase as moderate. Sixty-three percent of the firms anticipate increasing production in the first quarter, and 25 percent expect to cut production.
  • Both the delivery times and unfilled orders indexes were positive for the third consecutive month, suggesting longer delivery times and an increase in unfilled orders.
  • With respect to prices received for firms’ own manufactured goods, 31 percent of the firms reported higher prices, up from 16 percent in December. The prices received index increased 19 points to its highest reading since July 2008.

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Yesterday’s NY Fed survey showed similar trends:

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Housing Starts Beat On Jump In Rental Units, Single-Family Permits Rise To Highest Since 2007
UNEMPLOYMENT CLAIMS LOWEST SINCE 1973

In the week ending January 14, the advance figure for seasonally adjusted initial claims was 234,000, a decrease of 15,000 from the previous week’s revised level. The previous week’s level was revised up by 2,000 from 247,000 to 249,000. The 4-week moving average was 246,750, a decrease of 10,250 from the previous week’s revised average. This is the lowest level for this average since November 3, 1973 when it was 244,000. (Chart from CalculatedRisk)

There are Purchasing Managers with their surveys. There are also Sales Managers with their own surveys, generally preceding production:

Resurgent US Economic Growth Continues into the New Year

The Headline Sales Managers’ Index (SMI) continues to grow further in January, recording an index level of 52.5. Buoyant levels of business confidence persist on the back of strong holiday sales and rising prices. The Economy as a whole exhibited steady economic growth during the period, improved from the levels reported in Quarter 4. Prices for goods and services continue to increase in the U.S., at around the 2% mark but with little impact on profit margins.

Headline Sales Managers’ Index (USA)

Prices Charged Index 

Punch Not really conditions that require any more stimulus. Hence

Fed officials prepare ground to cut bank’s $4.5tn balance sheet

(…) A series of Fed speakers have sent up trial balloons in recent days talking of the possibility of reducing the size of the central bank’s $4.5tn balance sheet. Patrick Harker, Philadelphia Fed chief, suggested the topic would become central once short-term interest rates hit 1 per cent — something the Fed is on course to achieve this year if its current forecasts are borne out. (…)

In effect, as David Rosenberg illustrates, the Fed is already draining liquidity at the margin:

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Go back to your stock charts to see what happened in late 2014, mid-2015 and early 2016…

ECB Keeps Stimulus on High Even as Economy Picks Up
Commerce Nominee Offers Preview of Trade Policy

(…) “I think tariffs play a role both as a negotiating tool and if necessary to punish offenders who don’t play by the rules,” Mr. Ross said.

The billionaire private-equity investor didn’t threaten the unilateral, pre-emptive tariffs on U.S. imports from China and Mexico that Mr. Trump repeatedly warned of during the election. (…)

Mr. Ross didn’t rule out the use of broad tariffs, but focused his testimony on the rapid processing of cases against foreign companies accused of benefiting from subsidies or dumping products on the U.S. market below their fair value.

The Trump administration would seek to “self-initiate” such cases, Mr. Ross said, which often lead to punitive tariffs on particular companies or industries, when it makes sense, rather than waiting for the affected industries to bring cases against rivals in China or other countries. (…)

To be sure, Mr. Ross is only one of Mr. Trump’s key trade advisers. His picks for U.S. trade representative—trade lawyer Robert Lighthizer—and the head of a new White House council on trade—economist Peter Navarro—have expressed more hawkish views on breaking with global trade rules to confront Beijing. (…)

The FT has a hawkish view:

EUROPE VS U.S. EQUITIES, YET AGAIN!

This potentially enticing chart from Top Down Charts via ValueWalk:

High five Relative valuation measures are meaningless without relative growth and profitability measures. From The Economist:

What went wrong? Slow growth in Europe has not helped, and a strong dollar has made American firms’ domestic operations more valuable. But four other factors also explain the slide. First, Europe picked the wrong businesses. It focused on old industries such as commodities and steel, and on banking, where new rules have caused a depression in cross-border lending. Europe has gone backwards in technology—it hasn’t created any firms of the scale of Facebook or Google. From the early 2000s its tech-and-telecoms incumbents proved to be poor at reinventing themselves, even as American contemporaries, including Cisco and Microsoft, learned how to evolve.

The second explanation is that Europe focused on the wrong parts of the world. The continent’s firms are skewed towards emerging markets, which generate 31% of their revenues, according to Morgan Stanley, a bank. For American firms the figure is 17%. As the developing world has slowed, it has hit corporate Europe disproportionately hard, from banks to cognac distillers and makers of luxury handbags.

Third, Europe stopped doing deals even as the rest of the world continued to consolidate. The share of global deals by European acquirers fell from a third before the financial crisis to a fifth after it. Meanwhile, American firms have continued to bulk up at home, seeking to dominate their huge domestic market.

Last, European managers’ less aggressive attitude towards shareholder value may account for the difference in market values between Europe and America. European firms generate a lower return on equity and return less cash to shareholders through dividends and buy-backs. That may explain why for every dollar of expected profits and of capital invested, European firms are awarded a lower valuation. (…)

Yet corporate Europe’s waning scale is still a concern. Investment in research and development (R&D) tends to be disproportionately done by multinational firms. Of the world’s top 50 R&D spenders only 13 are European (down from 19 in 2006) while 26 are American. (…)

An obvious response is a renewed push for consolidation within Europe. But such deals are often a nightmare because nationalist emotions boil over. The attempted takeover of BAE Systems, a British defence firm, by Airbus in 2012 collapsed after political arguments; the proposed takeover of the London Stock Exchange by Deutsche Börse could be cancelled after the Brexit vote. The union last year of Lafarge and Holcim, a French cement firm and a Swiss rival, has been mired in rows.

The difficulty of pushing through recent transactions echoes the past. Many careers have been wrecked by pan-European deals. Of the 50 biggest such transactions attempted in the past 20 years, about a third have failed to materialise. The rest have often been bruising to implement. (…)

But if it wants to create giants, Europe may have to restrain more than its nationalist instincts—it may have to temper its tougher approach to antitrust, too. The secret of some big American firms is that they have created oligopolies at home. For example, America has allowed broadband provision to be dominated by a few firms, and profits are high. Europe has scores of operators and its regulators have pushed prices and margins lower. (…)