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 (21 October 2016): Housing; Earnings Watch

Conference Board Leading Economic Index Increased in September

Here is an overview from the LEI technical press release:

The Conference Board LEI for the U.S. increased in September, after declining in August. Large positive contributions from building permits, the yield spread and average initial claims for unemployment insurance (inverted) fueled September’s gain. In the six-month period ending September 2016, the leading economic index increased 1.1 percent (about a 2.3 percent annual rate), much faster than its growth of 0.3 percent (about a 0.7 percent annual rate) during the previous six months. In addition, the strengths among the leading indicators remain slightly more widespread than the weaknesses. [Full notes in PDF]

Smoothed LEI
Smoothed LEI
HOUSING
U.S. Existing Home Sales Rebound

Sales of existing homes increased 3.2% (0.6% y/y) in September to 5.470 million units (AR) following a 1.5% decline to 5.300 million in August, revised from 5.330 million. Expectations had been for 5.32 million sales in the Action Economics Forecast Survey. Sales of existing single-family homes improved 4.1% last month (0.6% y/y) to 4.860 million following two months of decline. Sales of condos & co-ops declined 3.2% (0.0% y/y) to 610,000 after a 10.5% increase. (…)

Sales rose 5.7% (0.0% y/y) in the Northeast to 740,000. In the West, sales increased 5.0% (1.6% y/y) to 1.250 million. Sales gained 3.9% in the Midwest (2.3% y/y) to 1.320 million, and sales in the South improved 0.9% (-0.9% y/y) to 2.260 million.

The total inventory of homes on the market declined 6.8% y/y to 2.040 million. The months’ sales supply of homes ticked lower to 4.5, down from 4.8 months during all of last year and 5.2 months in 2014.

Look at this CalculatedRisk chart on which I highlight the 2004-07 aberration and you could think we are really not far from the “normal” cyclical high.

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Same with inventory which swelled after prices exploded and with the ensuing crisis. Where many economists and realtors see weakness, I tend to see a return to normalcy, the “old normal” if you will.

Housing starts fell 9.0% during September (-11.9% y/y) to 1.047 million units (AR) following a 5.6% August decline to 1.150 million, revised from 1.142 million. It was the lowest level of starts since March of last year. Expectations were for 1.18 million starts in the Action Economics Forecast Survey.

Last month’s drop reflected a 38.0% plummet (-40.8% y/y) in starts of multi-family homes, which include apartments & condominiums, to 264,000, the lowest level since June 2013. Starts of single-family homes increased 8.1% (5.4% y/y) to 783,000, the highest level since February. (…)

Building permits increased 6.3% (8.5% y/y) to 1.225 million, the highest level since November. Permits to build single-family homes improved 0.4% (4.4% y/y) to 739,000, while permits to build multi-family homes increased 16.8% (15.4% y/y) to 486,000.

Housing starts are a different story, however: “One of the things holding the economy back is the $1 trillion student debt load, which he said has left 35% of males aged 18 to 34 living with mom and dad, not getting jobs and not becoming first time home buyers.” (David Rosenberg)

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  • The underperformance of US homebuilders’ shares has worsened. (The Daily Shot)

Apartment markets softened across all four indexes in the October 2016 National Multifamily Housing Council (NMHC) Quarterly Survey of Apartment Market Conditions. The Market Tightness (28), Sales Volume (42), Equity Financing (33) and Debt Financing (38) Indexes all landed below the breakeven level of 50 – showing weaker conditions from the previous quarter.

“The growing supply of new apartments, primarily in the Class A space, appears to have finally reached a level to slow the historically high rent growth. Additionally, debt and equity markets are more discerning in terms of what deals they are ready to take on, including the continued slowing of available construction loans,”  said Mark Obrinsky, NMHC’s Senior Vice President of Research and Chief Economist. “Despite the softening due to the new development focus on Class A apartments, the overall fundamentals for apartments remain stable, indicated by the strong demand for Class B and C properties.” (…)

The survey also asked about rent growth among different class buildings. Excluding the ten percent that marked “don’t know/ not applicable”, nearly nine of ten (84 percent) respondents reported rent growth for Class B and C apartments as much stronger (33 percent) or somewhat stronger (51 percent) rent growth compared to Class A units. Just five percent reported somewhat weaker rent growth among Class B and C apartments compared to Class A, and two percent thought that B and C apartments exhibited much weaker rent growth. The remaining nine percent reported that rent growth levels were about the same throughout all classes of apartments.

Bill McBride from CalculatedRisk:

As I’ve mentioned before, this index helped me call the bottom for effective rents (and the top for the vacancy rate) early in 2010. This is the fourth consecutive quarterly survey indicating looser conditions – it appears supply has caught up with demand – and I expect rent growth to slow (the vacancy rate is generally creeping up too).

Looking for housing inventory? (via The Daily Shot)

Philadelphia Fed Factory Business Outlook Survey Indicates Growth

The Philadelphia Federal Reserve reported that its General Factory Sector Business Conditions Index remained positive in October. At 9.7, it was third consecutive positive reading, and followed an unrevised 12.8 in September. (…)

The ISM-Adjusted General Business Conditions Index, constructed by Haver Analytics increased to 49.8 this month, the highest level since March. The ISM-Adjusted headline index is the average of five diffusion indexes: new orders, shipments, employment, supplier deliveries and inventories with equal weights (20% each). This figure is comparable to the ISM Composite Index. During the last ten years, there has been a 71% correlation between the adjusted Philadelphia Fed Index and real GDP growth.

The new orders component jumped to its highest level since March, while shipments turned positive. Unfilled orders, delivery times and inventories improved as well.

The employment component increased to the highest level since May. During the last ten years, there has been an 81% correlation between the jobs index and the m/m change in manufacturing sector payrolls.

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Restaurant CEOs Blame Presidential Election for Hurting Sales

(…) “Overall, retail trends and the results of other businesses dependent on consumer discretionary spending confirm that during the quarter, many preferred to stay home versus going out.” (…)

U.S. WAGES EXPLODING?

The Atlanta Fed wage tracker jumped to +4.2% last month!

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U.S. mall investors set to lose billions as retail gloom deepens
Daimler Sees Growth Stalling on North America Truck Market Woes

(…) Daimler, also the world’s largest maker of heavy-duty vehicles, is battling with declining demand in key truck markets. The company said pricing competition was on the rise in Europe and predicted that the market in North America would fall 15 percent this year. It said there is no turnaround in sight for Brazil’s commercial-vehicle sector. (…)

Earnings at Daimler’s truck division, which cut its profit forecast in May because of lower demand in the U.S. and the Middle East, tumbled 37 percent to 510 million euros. That pushed the adjusted return on sales to 6.5 percent, below its 8 percent target. Truck deliveries dropped 24 percent to 97,100 vehicles in the quarter, prompting Daimler to reduce output in markets like Brazil. (…)

Peers are also suffering. Volvo AB, the world’s second-largest truckmaker, reported a 4.7 percent drop in third-quarter earnings burdened by the downturn in the U.S., where Volvo owns the Mack brand, a rival to Daimler’s Freightliner. Volvo said it would make further adjustments to production in North America as inventories remain too high. (…)

Euro hits 7-month low against the dollar Stocks mixed after European Central Bank keeps quiet on quantitative easing outlook

From The Daily Shot:

The currency bloc’s equity markets did well as a result of the weaker euro. The chart below compares the Dax Index with the S&P 500 over the past three months.

GE Cuts Outlook as Sluggish Economy Crimps Industrial Demand
David Rosenberg Calls For A Multi-Trillion, “Helicopter Money” Stimulus Package

(…) One of the things holding the economy back is the $1 trillion student debt load, which he said has left 35% of males aged 18 to 34 living with mom and dad, not getting jobs and not becoming first time home buyers. Employment growth for the 65s and over is 7%, meanwhile, as the aging boomers have to work longer because they didn’t save enough for retirement.

“Helicopter money is QE plus where, say, the treasury issues a perpetual– call it, like, a century bond, a $2 trillion bond on the Fed’s balance sheet. And so when that bond matures, it’s, like, we’re all dead in the long run at that point. And then the Treasury can use that money to stimulate growth. ”

The beauty of this idea, according to Rosenberg is that you don’t have to go through Congress, with such difficulty in achieving corporate or personal tax reform.  “It would lead to a permanent increase in the monetary base. Inflation expectations would go up, which means that real interest rates would go negative. And the theory is that that would provide a bigger thrust towards getting what we all want, which is sustainable and accelerating nominal income growth.“ (…)

“The problem is that when you have the economy running on average 1% growth, or 1% plus, which is not a big cushion. And so, you know, it’s a complicated question to try and handicap a recession on us right now. There’s a lot of people out there that are convinced that a recession is coming.”

To watch the full interview with David Rosenberg, visit Real Vision TV.  You can access this and many more interviews with a free trial.

EARNINGS WATCH
  • 107 companies (27.1% of the S&P 500’s market cap) have reported. Earnings are beating by 7.0% while revenues are surprising by 0.9%.
  • Expectations are for revenue, earnings, and EPS of 2.4%, -0.7%, and 1.3%, respectively.
  • EPS is on pace for +6.4%, assuming the current beat rate for the remainder of the season. This would be +10.1% excluding Energy.
Who Is Buying? Another $5 Billion Pulled From US Equity Funds, Outflows In 6 Of Past 7 Weeks

It may come as a surprise to some that as the S&P500 has remained in a tight trading range over the past month, investors continued to withdraw substantial amounts of cash. According to the latest EPFR weekly data, global equities saw another $3.9bn outflows (comprised of $6.2bn in mutual fund outflows vs $2.3bn ETF inflows), which brings the number of weekly outflows to 5 in the past 6 weeks. Of note here is that while Europe has now suffered a record record 37 straight weeks of outflows, the US has been comparably pressured, with outflows in 6 of the past 7 weeks.

On a global basis, a whoppping $146 billion has now been pulled across equity funds, with $79 billion in ETF inflows offsetting $225 billion in mutual fund outflows.

As money was leaving equities it entered bonds, which saw not only $2.7bn inflows in the latest week, but inflows in 15 of past 16 weeks. Precious metals, the “forgotten category” benefited from $0.5bn in inflows in the last week, making that 4 straight weeks of money being allocated to PMs. (…)

So we go back to our favorite question: with everyone pulling their cash, who is buying? Traditionally the normative answer would be buybacks, however we mostly entered buyback week two weeks ago, so the question certainly remains unanswered.

M&A PEAKS JUST BEFORE EQUITIES

M&A Is In Very Late Cycle Mode

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Deutsche Bank Shares Back to Level Before DOJ $14 Billion Demand
Bloomberg’s Editorial Board: Trump Threatens Law, Order, Democracy

THE DAILY EDGE (19 October 2016):

China Growth Holds Steady With Help From Stimulus China’s economy steadied in the third quarter, clocking in 6.7% growth fueled by easy credit, a hot property market and other stimulus measures that economists say come at the expense of needed restructuring.

(…) Industrial production increased by 6.1% year-over-year in September, compared with 6.3% in August, according to the National Bureau of Statistics. Investment in factories, buildings and other fixed assets in nonrural areas climbed 8.2% year-over-year in the January-September period, edging up from the 8.1% pace for the first eight months. Retail sales, helped by cuts in vehicle taxes, edged up to 10.7% growth in September from a year earlier, compared with 10.6% in August.

Private investment, a major source of concern for policy makers, rose last month after slowing from the start of the year. Investment by private firms grew 2.5% during the January-to-September period from a year earlier, faster than the 2.1% growth in the first eight months, official data show. (…)

Housing sales rose 43.2% in the first nine months of the year from a year earlier. Medium- and long-term household loans, almost all of which are mortgages, accounted for 60% of new loans last quarter, up from 47% in the second quarter and 23% in the first quarter. Authorities in more than 20 cities have introduced restrictions to damp speculation without choking off growth. Investment in property development grew 5.8% in the January-to-September period, accelerating from the 5.4% increase in the first eight months.

   
  • Real growth in disposable income slowed again last quarter and has been below 6% all year.
  • New housing-project starts fell 18%, reflecting developers’ lack of confidence in the durability of recent housing-market strength.
U.S. CPI Increase Driven by Energy Costs; Core Weakens

The consumer price index increased 0.3% (1.5% y/y) during September following an unrevised 0.2% rise. It was the strongest increase since April, and matched expectations in the Action Economics Forecast Survey. Prices excluding food & energy notched 0.1% higher (2.2% y/y) after a 0.3% increase. A 0.2% rise had been expected.

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From the Cleveland Fed:

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Saudi Energy Minister Sees End of Oil-Price Slump

(…) “We are now at the end of a considerable downturn,” Mr. Falih told an audience that included top executives from oil firms such as Exxon Mobil Corp., Royal Dutch Shell PLC and Total SA. (…)

Mr. Falih said the industry needed $24 trillion in new capital spending if it is to meet global energy demands over the next 25 years. Speaking to an audience that included bankers from London’s powerful financial institutions, Mr. Falih, Falih said the reluctance many of them had to lend to energy companies would ease as oil prices rise. (…)

U.S. Home-Builder Sentiment Edged Lower in October U.S. home builders reported a slight drop in optimism in October but sentiment remained elevated, a sign the market for new single-family homes should continue its slow but steady recovery in coming months.

The National Association of Home Builders housing-market index fell two points from the prior month to a seasonally adjusted 63 in October, the trade group said Tuesday. That is the second-highest level of the year, following a September reading of 65. (…)

While two components of the index slipped slightly—the present conditions and the buyer traffic indexes—the measure of forward-looking sentiment ticked up one point to its highest level in a year, and has been above 70 for the past two months.

TRUCKING STILL DOWNHILL

Trucking volume continues to weaken with not even a whiff of upward seasonality. Even worse, autos and housing, perhaps the only ok sectors in 2016, are slowing as well.

After offering a glimmer of ‘less bad’ hope in August (only down 1.1% YoY and up 0.4% sequentially), the Cass Freight Index shipments data in September disappointed, providing hindsight that August only gave us ‘false hope.’ September data is once again signaling that overall shipment volumes (and pricing) continued to be weak in most modes, with increased levels of volatility as all levels of the supply chain (manufacturing, wholesale, retail) continue to try and work down inventory levels. That said, there have been a few areas of growth, mostly related to e-commerce, with lower levels of expansion being experienced in transit modes serving the auto and housing/construction industries. All of this added up to lower shipment volume in September on a YoY (Year-over-Year) basis, marking the nineteenth straight month of year-over-year decline. Bottom line, the Industrial Recession in the U.S. that began in March of 2015 continues to weigh on overall volumes.

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The Cass Truckload Linehaul Index decreased 3.5% year over year in September, representing seven consecutive months of year over year declines. According to analysts at Avondale Partners, softening demand and increasing capacity warrant a pricing forecast of -3% to 1% through mid-2017.

Rate Increases for Health Plans Pose Test for ACA Finalized rates for big health insurance plans show the magnitude of the challenge facing the Obama administration as it seeks to stabilize the insurance market under the Affordable Care Act.

Market leaders that are continuing to sell coverage through HealthCare.gov or a state equivalent have been granted average premium increases of 30% or more in Alabama, Delaware, Hawaii, Kansas, Mississippi and Texas, according to information published by state regulators and on a federal site designed to highlight rate increases of 10% or more.

In states including Arizona, Illinois, Montana, Oklahoma, Pennsylvania and Tennessee, the approved rate increases for the market leader top 50%. In New Mexico, the Blue Cross Blue Shield plan agreed to resume selling plans through the online exchanges after sitting out last year, but has been allowed to increase rates 93% on their 2015 level.

Dominant insurers in Connecticut, Georgia, Indiana, Kentucky, Maine, Maryland and Oregon have been allowed to raise premiums by 20% or more, and rate increases from similarly situated carriers in Colorado, Florida and Idaho are brushing up against that threshold.

Most of the 10 million people who currently get coverage through an insurance exchange such as HealthCare.gov don’t pay the full premiums because they receive subsidies from the federal government that are pegged to insurance prices in their area. As many as nine million people currently buy individual coverage without using the site, but at similar prices, and most of them aren’t eligible for subsidies.

The Obama administration has characterized the year as one of “transition,” in part because insurers priced aggressively low in the opening enrollment periods for coverage under the law, and has pledged new efforts to encourage healthier people to sign up.

Federal officials plan to focus much of their outreach campaign this year on people who qualify for the subsidies toward the cost of their coverage.

“Headline rates do not reflect what most consumers actually pay,” said Marjorie Connolly, a spokeswoman for the Department of Health and Human Services. “Eighty-five percent of Marketplace consumers receive tax credits, and this year, most HealthCare.gov consumers will again have the option to select a plan for less than $75 per month.”

But in all, the premiums offer the clearest portrait yet of health plans’ assessment of the stability of the individual insurance market on the eve of the fourth, critical, sign-up window for the law.

“The situation is serious,” said Alissa Fox, senior vice president of the Office of Policy and Representation for the Blue Cross Blue Shield Association. “The reason the premiums are where they are is that the people we are covering have serious conditions and they’re using a lot of medical services because of their chronic illnesses. That’s clear. And there’s not enough young, healthy people to balance out those costs.” (…)

For the average American, the year of transition was 2013 when spending on healthcare and insurance began to skyrocket. From Chris wood’s Greed & Fear (tks Gary):

(…) healthcare spending and insurance increased by US$157bn over the past 12 months to August, accounting for 35% of the increase in nominal personal consumption [crushing Americans’ discretionary consumption].

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CETERIS NON PARIBUS
China to World: We Don’t Need Your Factories Anymore Chinese manufacturers once bought high-tech materials from overseas firms. Rising expertise means they now shop locally, altering global trade.

(…) Exports to China, which had risen nearly every year since 1990, fell 14% last year, the largest annual drop since the 1960s. They are down another 8.2% this year, through September. The decline helped shave 0.3 percentage point off world trade growth last year, and is a big reason that growth is expected to slow to 1.7% this year from the 5% a year it has averaged over the last two decades. (…)

Some of that decrease is the result of economic slowdown and a glut of goods—in China and globally. But China also is increasingly turning inward for its manufacturing needs, pushing to substitute local inputs for foreign, especially in plum, high-margin areas such as semiconductors and machinery.

That is disturbing for many global manufacturers, which have ceded low-end production to Chinese rivals but are banking on staying ahead in higher-end goods and ingredients that feature more advanced technology.

“The very high end is still not there,” says Ka Lok Cheung, head of operations in Zhuhai for Germany’s Eckart, noting that local rivals still have trouble maintaining consistent quality in some hard-to-make pigments. “But for many things, they’re really catching up.”

The value of components and materials imported by China for use in other products fell 15% last year from the prior year, the largest annual decline since the global financial crisis, and it dropped another 14% in the first nine months of this year, according to Wind Info, a Chinese data provider that uses official Chinese customs figures.

Part of that decline is because Chinese exporters have been using less of those imports in their goods, data from an International Monetary Fund study suggests. The proportion of foreign-made inputs in Chinese exports has been shrinking by an average 1.6 percentage points a year over the past decade, and last year fell to 19.6%, from more than 40% in the mid-1990s, according to Chinese trade data. (…)

To build domestic capabilities on the high end, the Chinese government last year announced a plan to raise the domestic content of core components and key materials to 40% by 2020 and 70% by 2025. It has been spending large amounts on research and development: $213 billion last year, or 2.1% of gross domestic product, according to state media reports. In June it pledged more money for “technological innovation.”

Biotechnology, aerospace and other high-tech-related exports to China fell 5% this year through September, compared with the same period last year, according to Wind Info, extending a two-year decline. (…)

Because domestic suppliers are 10% to 20% less expensive than foreign ones, says Mr. Huang, who previously worked for a German industrial-coatings company, the shift has been a “game-changer” for GMM. (…)

EARNINGS WATCH
  • 57 companies (16.6% of the S&P 500’s market cap) have reported. Earnings are beating by 7.3% while revenues are surprising by 1.2%.
  • Expectations are for revenue, earnings, and EPS of 2.4%, -1.3%, and 0.7%, respectively.
  • EPS is on pace for +6.8%, assuming the current beat rate for the remainder of the season. This would be +10.4% excluding Energy.

Financials compose 12 of the 57 companies having reported and they surprised by 11.3% with a 100% beat rate. Ex-Financials, the beat rate is 73% so far and EPS are beating by 4.6% per RBC Capital.

YIELD CHASERS, BE WARNED, AGAIN

In HARD HAT ZONE last August, I demonstrated the risk of yield chasing utility stocks at 21x EPS of companies boasting highly leveraged returns on assets of a mere 2.9%. 

(…)Admittedly, electric utilities’ margins have expanded tremendously in the past 2 years as coal and natural gas prices have collapsed. But this is a regulated sector, isn’t it?

Yield hunters are thus chasing stocks of utility companies which collectively are achieving historically low returns on their highly levered assets even though the operating and financing conditions are near optimum. The cashflow coverage of their debt is historically low and their dividend payout ratio very high. God forbids a significant rise in coal or gas prices, let alone interest rates. What if regulators wake up and order lower electricity prices for their constituents? Or if solar panels become much more affordable and popular?

Well, could be that crunch time is near:

A November ballot measure backed by Las Vegas casinos and other firms would end the monopoly of the state’s largest utility, NV Energy, owned by Warren Buffett’s Berkshire Hathaway Inc., and create a competitive retail power market where customers could choose their provider. (…)

Power prices in states with restructured power markets rose from 1997 to 2007, according to a 2015 report from researchers at the University of California. But they fell in the following five years—along with falling natural gas prices—while prices in regulated states rose steadily over the 15-year period, the report shows.

About 72% of Nevada voters support the measure, according to a September poll by Suffolk University in Boston. (…)

Switch estimates it is currently paying NV Energy as much as 80% more for green power than it would pay a competitive supplier, said Adam Kramer, an executive vice president at the company. (…)

Americans Work 25% More Than Europeans, Study Finds