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

NEW$ & VIEW$ (16 August 2016)

WHAT GOES UP… 

Bearnobull’s web site was down several hours yesterday due to a servers issue at the host. Some of you might have missed the post above.

U.S. Consumer Prices Held Flat in July Consumer prices were flat in July, with falling gasoline costs offsetting modest gains elsewhere, a sign inflation pressures in the economy remain modest.

The consumer-price index, which measures what Americans pay for everything from furniture to child care, was unchanged on a seasonally adjusted basis in July from the prior month, the Labor Department said Tuesday. The index had climbed 0.2% in each of the prior two months

Excluding often-volatile categories of food and energy, consumer prices rose 0.1% in July.

From a year earlier, overall prices rose 0.8% and core prices advanced 2.2%.

Energy prices fell 1.6% in July, led by a 4.7% decline in seasonally adjusted gasoline prices. Food prices were unchanged last month. Medical care services increased 0.5% last month and were up 4.1% from a year earlier. (…)

Tuesday’s report showed shelter costs, which account for about one-third of CPI, rose 0.2% in July, a slower increase than the prior two months. Prescription drug prices rose 0.9% last month and new car prices increased 0.2%.

Headline and Core CPI since 2000(Doug Short)

Industrial Production Rose 0.7% in July Industrial production, a measure of everything made by factories, mines and utilities, rose a seasonally adjusted 0.7% in July, the Federal Reserve said Tuesday. Capacity utilization, a measure of how much industries are making as a share of potential output, rose to 75.9%.

Industrial production, a measure of everything made by factories, mines and utilities, rose a seasonally adjusted 0.7% in July, the Federal Reserve said Tuesday. Capacity utilization, a measure of how much industries are making as a share of potential output, rose to 75.9%.

  • Thanks to a surge in AC usage by the look of it…

Industrial production rose 0.7 percent in July after moving up 0.4 percent in June. The advance in July was the largest for the index since November 2014. Manufacturing output increased 0.5 percent in July for its largest gain since July 2015. The index for utilities rose 2.1 percent as a result of warmer-than-usual weather in July boosting demand for air conditioning. The output of mining moved up 0.7 percent; the index has increased modestly, on net, over the past three months after having fallen about 17 percent between December 2014 and April 2016. (Via Zerohedge)

  • NY manufacturing activity (the Empire Manufacturing Index) was weaker than expected. Moreover, NY factory hiring plans hit the worst level since 2009. (The Daily Shot)

Freight Shipments, Spending Declined in July

The Cass Freight Index, a barometer of the health of the shipping industry produced by data company Cass Information Systems Inc. and investment bank Avondale Partners, showed that the volume of U.S. shipments by rail and road fell 2.6% in July compared with a year earlier. Spending on shipping fell 5.1% over the same period.

Shipping volumes have now fallen for 17 consecutive months, according to the Cass index. (…)

However, the American Association of Railroads reported that U.S. rail traffic tied to retail markets faltered in July. North American intermodal shipments, which include the transportation of shipping containers from ports to distribution centers, which typically carry consumer goods, fell 6.9% in July compared to the year-earlier month. (…)

Cass Freight Index July 2016

U.S. housing starts rise to five-month high in July

Groundbreaking increased 2.1 percent to a seasonally adjusted annual pace of 1.2 million units, the highest level since February, the Commerce Department said on Tuesday. June’s starts were largely unchanged at a 1.19 million-unit rate.

Permits for future construction dipped 0.1 percent to a 1.15 million-unit rate last month. Economists polled by Reuters had forecast housing starts slipping to a 1.18 million-unit pace last month and building permits rising to a 1.16 million-unit rate. (…)

Groundbreaking on single-family homes, the largest segment of the market, rose 0.5 percent to a 770,000-unit pace in July, also the highest level since February. Single-family starts rose in the South and West, but tumbled 23.9 percent in the Northeast and fell 2.6 percent in the Midwest.

Housing starts for the volatile multi-family segment increased 5.0 percent to a 441,000-unit pace. Groundbreaking on multi-family housing projects with five units or more jumped to the highest level since September 2015. (…)

Permits for the construction of single-family homes fell 3.7 percent last month to a 711,000-unit rate, the lowest level since September 2015, while multi-family building permits rose 6.3 percent to a 441,000-unit pace.

(CalculatedRisk)

China Factories Turn to Robots as Wages Rise, Culture Shifts China’s appetite for European-made industrial robots is rapidly increasing, as rising wages, a shrinking workforce and cultural changes drive more Chinese businesses to automation.

(…) The types of robots favored by Chinese manufacturers are also changing, as automation spreads from heavy industries such as auto manufacturing to those that require more precise, flexible robots capable of handling and assembling smaller products, including consumer electronics and apparel.

At stake is whether China can retain its dominance in manufacturing.

(…) the average hourly labor cost—defined as wages plus benefits—of $14.60 in China’s coastal manufacturing heartland has more than doubled as a percentage of U.S. manufacturing wages, from roughly 30% in 2000 to 64% in 2015, according to Boston Consulting Group, making the country less competitive as a destination for manufacturers.

China, in 2013, became the world’s largest market for industrial robots, surpassing all of Western Europe, according to the International Federation of Robotics. In 2015, Chinese manufacturers bought roughly 67,000 robots, about a quarter of global sales, and demand is projected to more than double to 150,000 robots annually by 2018. (…)

At a robotics-research conference in Stockholm in May, companies including Kuka and Switzerland’s ABB Ltd. displayed lightweight robots with agile arms capable of manipulating items as small as bottle caps.

Last year, ABB, introduced a two-armed version of its YuMi robot, a lightweight robot that was designed specifically for the Chinese market. It can put together car-dashboard electronics, wristwatches and eyewear.

(…) Robotics technologies that were once prohibitively expensive are now cheap enough that they are feasible for Chinese factories.

Budapest-based OptoForce Ltd. manufactures €2,500 ($2,796) sensors that can be attached to robotic arms and used to polish metal parts that go into car transmissions and other products. Its head of sales, Szabi Fekete, said such sensors have become significantly cheaper to produce in recent years. (…)

SENTIMENT WATCH
Soros’ S&P Puts Soar Near Record High As Percentage Of AUM

WHAT GOES UP…

Last week, LPL Financial published an interesting and apparently compelling piece concluding that when equities are up 6% or more with 100 days to go in the year, like in 2016, the rest of the year is up 90% of the time with a +5.3% average gain.

Going back to 1928, the S&P 500 has been higher year to date 56 times with 100 days to go. The rest of the year has averaged a return of 4.2% and has been higher 83.9% of the time. The flip side is when it is down year to date with 100 days to go, the rest of the year is down 2.3% on average and higher only 42.9% of the time. In other words, a strong start to a year historically leads to higher prices to end the year and vice versa.

Now, what happens if it is a strong year? There have been 40 other times the S&P 500 was up more than 6% for the year with 100 days to go (like 2016), and incredibly, the rest of the year is up 5.3% on average and higher 90% of the time. Thus, a strong start to the year has led to even stronger returns for the rest of the year. What about the full-year returns? Only once in history has the S&P 500 been up more than 6% with 100 days to go and finished red, and that was in 1929. Therefore, 39 of the previous 40 times the full year finished green, making the chances for a massive sell-off during the rest of this year rather slim.

Always curious and suspicious, Bearnobull digged deeper and found the following rather important facts, considering that the current P/E on the S&P 500 Index is 19.1x trailing EPS and the Rule of 20 P/E (which takes inflation into account, important when analysing long periods) is 21.4 with still declining EPS and accelerating inflation:

  • In 30 of the 40 instances (75%), the Rule of 20 P/E was at or below the 20.0 “fair value” level. Above 20, the valuation downside risk rises above the valuation upside potential making the risk/reward ratio unfavourable to investors.
  • In 7 of the 10 “higher valuation risk” instances, EPS were on an uptrend, helping mitigate the valuation risk somewhat.
  • In all 3 other “higher valuation risk” instances (declining EPS), inflation was declining, also helping mitigate the valuation risk somewhat.
  • Six of the 10 “higher valuation risk” instances ended badly with subsequent drops ranging from –5% to –30% and averaging –18.3%. The other 4 such instances were either at the bottom of economic cycles (1991 and 2003), or saw strong EPS growth (1997 and 1998).

In all, it is rather dangerous to conclude that we are in a 90% probability scenario for a rising equity market simply because it has been rising so far this year: current valuations are historically elevated which necessitates favourable trends in earnings and inflation to sustain investor enthusiasm, trends which are currently not present.

Here are statistics which incorporate valuations and are thus much more significant:

  • Since January 1927, the S&P 500 Index has traded at a Rule of 20 P/E above “20” 34% of the time and above the current 21.4 only 20% of the time. When trading above 20, the S&P 500 Index returned +0.2% on average (median: +1.6%) during the 6 months following (46% positive) and +2.2% (median +4.8%) during the 12 months following (41% positive).
  • When at or above 21.4, the current reading, the average 6-m return was –1.1% (median +0.8%, 47% positive) and the 12-m return –0.4% (median +3.1%, 48% positive).
  • When the Rule of 20 is below “20”, i.e. in the lower risk area, the average return is +5.6% six months out (median +6.2%, 71% positive) and +10.5% twelve months out (median +12.3%, 73% positive).

Voilà!image