China Industrial Output Growth Holds Steady; Construction Dips Industrial production growth in May came in as expected but tepid demand and industrial overcapacity continued to weigh on the world’s second-largest economy, weakening investment.

Value-added industrial output, a rough proxy for economic growth, rose 6.0% in May from a year earlier, the same as the previous month, data from the National Bureau of Statistics showed Monday.

Fixed-asset investment—spending on things like property and factories—grew just 7.4% in May from a year earlier, a sharp drop from the 10%-plus growth in the first four months of the year. Nonrural fixed-asset investment, a closely watched measure of construction activity, climbed by a less than expected 9.6% year-over-year in the January-May period, compared with an increase of 10.5% for the first four months of the year.

The unexpected weakness was largely due to a falloff in private investment, which grew 3.9% in January-May, down from an already weak 5.2% in the January-April period. Industrial deflation, excess production capacity and difficulty in getting corporate loans were major factors behind May’s weak private investment figures, said Sheng Laiyun, a spokesman with the statistics bureau. “The slowdown in private investment shows that economic growth momentum needs to be strengthened,” Mr. Sheng said at a press conference, adding that China’s economic fundamentals remain sound.

Retail sales grew by a slightly less than expected 10.0% in May compared with a year earlier, down from a 10.1% increase in April. (…)

Consumer confidence in China edged down in May over April, according to the ANZ-Roy Morgan China Consumer Confidence Index, with fewer respondents expecting their personal financial situation to improve in the immediate future, it said.

Profits at state-owned enterprises declined 8.4% in the first four months of 2016 from the same period a year earlier, according to official data. (…)

Housing sales rose 53.4% year-over-year during the January-to-May period, the National Bureau of Statistics said Monday, compared with a 61.4% increase in the first four months of 2016. (…)

China attracted $8.89 billion in foreign direct investment in May, down 1% from a year earlier, the Ministry of Commerce said Sunday, with some 70% of FDI in the first five months directed at the services industry. (…)

China Car-Sales Growth Reaches Five-Month High

Car makers delivered a total of 1.79 million passenger vehicles—sedans, sport-utility vehicles and minivans—to dealers in the world’s largest auto market last month, up 11% from a year earlier, the government-backed China Association of Automobile Manufacturers said on Monday.

The performance compared with a 6.5% year-over-year gain in April, and a 6.8% year-over-year increase in the first quarter. (…)

According to Ways Consulting Co., a Chinese consulting firm focused on the automotive industry, dealers offered an average 10% discount on cars in May, which was largely unchanged from April. (…)

While shipments to dealers gained 11% last month, auto makers produced 5.5% more cars in China compared with the year-earlier period.

This is being reflected in dealer inventories. The latest survey of China’s more than 20,000 dealers by the China Automobile Dealers Association, a government-backed trade group, showed that at the end of April, dealers on average had inventories equal to 1.54 months of sales, down slightly from 1.55 months in March. In China, analysts say 1.5 months of sales on lots is the level at which dealers should begin to be concerned about high inventory.

The overall pace of sales has been slowing after a decade of extraordinary gains for auto makers. In a bid to support the industry, Beijing has introduced a series of support measures. A halving of the 10% purchase tax on small-engine cars, coupled with favorable credit policies, has helped increase sales since the fourth quarter of last year. (…)

In total, China’s combined sales of passenger and commercial vehicles reached 2.1 million units in May, up 9.8% from a year earlier, the auto manufacturers’ group said. (…)

• IMF warns on China’s corporate debt

(…) He warned that efforts to address China’s corporate debt load — which at 145 per cent of GDP was “very high by any measure” — had seen only “limited progress”. (…)

Mr Lipton highlighted the state-owned enterprises, which he said were responsible for 55 per cent of the corporate debt pile despite representing 22 per cent of economic output and which “are essentially on life support”.

“In a setting of slower economic growth, the combination of declining earnings and rising indebtedness is undermining the ability of companies to pay suppliers or service their debts,” Mr Lipton warned. “Banks are holding more and more non-performing loans [and] the past year’s credit boom is just extending the problem.”

While concluding the issue is “manageable”, he warned that a recent IMF estimate that put the potential losses for China’s banks from bad corporate loans at 7 per cent of GDP was a conservative estimate that excluded exposures in the “shadow banking” sector.

The risk was also that if the problem wasn’t dealt with speedily it could grow into a large crisis. “Company debt problems today can become systemic debt problems tomorrow,” Mr Lipton said. And “systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both.”

Fitch lowers outlook on Japan

Fitch Ratings on Monday lowered its outlook on the world’s most indebted country to negative, saying it doubted Japan’s commitment to fixing the public finances.

The decision makes Fitch the first credit rating agency to change its position on Japan following prime minister Shinzo Abe’s decision to delay a rise in consumption tax that was scheduled for April next year. (…)

“Fitch no longer expects the consumption tax to rise in its base case,” it said, predicting that the ratio of government debt to gross domestic product will now keep rising by 1 or 2 percentage points a year until 2024, instead of peaking at 247 per cent in 2020 as it previously forecast. (…)

By contrast, Standard & Poor’s was more upbeat. “The postponement of the consumption tax hike increases household disposable income next year, and is therefore positive for near-term expenditure and growth,” said Paul Gruenwald, the agency’s Asia-Pacific chief economist. (…)

Korea’s Industrial Slump

South Korea’s economy looks increasingly fragile. Industrial production in Asia’s fourth-largest economy fell for the second straight month in April due to sluggish global demand, particularly in China, where imports have fallen 19 months in a row. Korean output dropped 1.3 percent from the previous month and 2.8 percent from a year ago, led by a fall in automobile and electronic parts production.

Capacity utilization has fallen to 71 percent, the lowest level since the first quarter of 2009, and investment in equipment contracted for the sixth consecutive month in April. (…)

SENTIMENT WATCH

4 Reasons Why This Stock Rally Has Legs Wells Capital’s Jim Paulsen argues that the U.S. stock market has more going for it than it did last year.

(…) the contemporary rally looks and feels much more likely to break to new record highs than it did last year. Much of the character of the 2016 stock market rally is very different from the character of the 2015 rally.

First, the 2016 rally is much “broader” than the participation exhibited by the 2015 stock market rally. The equally-weighted S&P 500 index has strongly and persistently outpaced the market-cap weighted index. That is, this rally has much broader participation than was the case in 2015 when the stock market recovered from the correction but it was led by a small number of S&P 500 stocks while most underperformed.

This is also highlighted by the outperformance during this rally of small cap stocks and by the equal-weighted Value Line index of 1700 stocks, both of which did poorly or only matched the S&P 500 index in the 2015 rally. (…)

Second, unlike the 2015 rally, the stock market is not facing any pressure from the bond market this year. The stock market rally last year was pressured by an almost 50 basis point rise in the 10-year treasury yield which ultimately contributed to its failure to establish a new high. Today, by contrast, despite the stock market knocking on the door of a new all-time high, the 10-year treasury yield is currently almost identical to where it was when the stock market bottomed in mid-February!

Third, U.S. economic momentum is far more supportive for the current rally than it was in 2015. Take for example the Bloomberg U.S. economic surprise index. While this index was essentially flat to down throughout the 2015 stock market rally, it has risen persistently during the contemporary rally. The 2015 rally faced flat economic momentum and rising bond yields. Today, however, the stock market enjoys a nice combo – rising economic momentum without any rise in bond yields!

Finally, in sharp contrast to last year, the current stock market rally has barely improved investor sentiment. Almost hard to believe we are within an eyelash of new record highs and investor sentiment today is as bad as it was at the correction low in August 2015! When the stock market rallied from its low in 2015, calls for a renewed bull market were commonplace. Today, despite even a bigger recovery in the stock market from its February low, most still expect another failed attempt at new highs. (…)

Overall the current rally looks and feels much more sustainable compared to the correction rally in 2015. This rally is benefiting from much broader participation, a total lack of competitive yields pressures, increasingly positive U.S. economic momentum and continued investor pessimism.

Our guess is the S&P 500 index will soon breach the overhead resistance of old record highs and perhaps rise to about the 2200 level. Just some food for thought as stocks attempt to finally break out northward!

Another multi-legged market. The last time I commented on market legs was in the April 19, 2016 New$ & View$ after David Rosenberg suggested that the “rally may have some legs”. The S&P 500 closed at 2099 on April 19, having rallied 16% from the Feb. 11 low of 1810.

Never mind that only two of the S&P ten sectors have reached new highs this year, utilities and consumer staples!

But since Paulsen is talking about the 2016 rally, I suppose his starting point is the Feb. 11 low. Let’s look at some facts on that specific period:

• 135 stocks, only 27% of the S&P 500 Index components, have risen 16% or more to outperform the broad market. The median appreciation of the outperformers was 22.2%. The median underperformer rose only 6.8% during the period. Seventeen percent of the S&P 500 stocks declined since Feb.11 with a median loss of –6.5%.
• 52 of the 135 outperformers (nearly 40%) are heavy cyclicals (Energy, Metals and commodity-sensitive Industrials).
• 32 are Financial and Utility stocks with dividend yields averaging 2.8%.
• In total, 64% of the outperformers were either commodity-sensitive or interest-rate sensitive.
• Looking at the characteristics of the 135 stocks that led this rally, the only ones that stand out relative to the S&P 500 universe are above average Earnings Surprises, Earnings Revisions and 2017 EPS Growth expectations.

This Factset chart illustrates how the commodity rally has given legs to the market since March 31.

Equity investors have thus embraced the commodity rally while at the same time buying high dividend payers. These are the legs of this “broad” rally.

This while interest rates remained under pressure and Citigroup’s Economic Surprise Index stayed negative as this Yardeni.com chart shows. Not to mention the “considerable” and “sizeable” uncertainties that Mrs. Yellen now faces in her drive to normalize interest rates as she, and the global bond market for that matter, do not seem to share Paulsen’s views of an “increasingly positive U.S. economic momentum”.

As to the continued investor pessimism as a contrarian indicator, my reading of the II Bull/Bear ratio is more neutral than negative, contrary to last February’s readings.

I was not very fond of the legs David Rosenberg was seeing last April. Paulsen’s taste for legs is of the same kind.

Here’s a potentially better leg up, if it holds: the 100-day m.a. is crossing over a rising 200-d. m.a. With a better economic and earnings undertone, this technical signal could have more importance. But will it hold?

I always find it fascinating when market pundits detail their forecast without even talking about earnings.

So, here’s Factset’s preview for Q2:

EARNINGS WATCH

(…) analysts have made smaller cuts than average to earnings estimates for Q2 2016 to date. On a per-share basis, estimated earnings for the second quarter have fallen by 1.9%. This percentage decline is smaller than the trailing 5-year average (-3.2%) and trailing 10-year average (-3.8%) for approximately this same point in time in the quarter.

The estimated earnings decline for the second quarter is -4.9% this week, which is slightly larger than the estimated earnings decline of -4.8% last week. If the
Energy sector is excluded, the estimated earnings decline for the S&P 500 would improve to -1.5% from -4.9%.

In addition, a slightly smaller percentage of S&P 500 companies have lowered the bar for earnings for Q2 2016 relative to recent averages. Of the 112 companies that have issued EPS guidance for the first quarter, 81 have issued negative EPS guidance and 31 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 72%, which is slightly below the 5-year average of 74%.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings decline for Q2 2016 is -4.9% today, which is larger than the expected earnings decline of -2.7% at the start of the quarter (March 31). Four sectors are predicted to report year-over-year earnings growth, led by the Telecom Services and Consumer Discretionary sectors. Six sectors are projected to report a year-over-year decline in earnings, led by the Energy, Materials, and Information Technology sectors.

As a result of downward revisions to sales estimates, the estimated sales decline for Q2 2016 is -0.8%, which is larger than the estimated sales decline of -0.5% at the start of the quarter. Six sectors are projected to report year-over- year growth in revenues, led by the Telecom Services and Health Care sectors. Four sectors are predicted to report a year-over-year decline in revenues, led by the Energy and Materials sectors.

If the Energy sector is excluded, the estimated sales decline for the S&P 500 would improve to 2.2% from -0.8%.

 Terrible News

David R Kotok, Chairman and Chief Investment Officer, Cumberland Advisors

We will not recap the news flow about Orlando. Nor that about the thwarted attack in Los Angeles. No recap is needed.
Bullets:
Surveillance is already intense in the United States. It will become more intense in the wake of what happened early this morning in Orlando. Essentially everything anyone does or says or records is subject and will be subject to scrutiny. Judicial decisions about invasions of privacy by law enforcement are made in private. The world continues to change.
The presumption of innocence is eroding. The suspicion of guilt is rising.
The political climate has changed. We have had an “October surprise” in June. The attack in Orlando will galvanize the political debate in Florida, a battleground state in this national election year. It will have a similar impact in the rest of the country.
A million opinions about what to do and how to do it will be energetically argued. Who knows what is right or what improves safety?
The perpetrator bought a gun legally, using his credentials as a security guard. The implications of that fact broaden the debate about guns.
As for the protection of Americans’ rights, we direct readers to the public portion of a secret document that allowed for the assassination of an American-born radicalized Islamic imam in Yemen. You can read it here:https://www.justsecurity.org/wp-content/uploads/2014/06/OLC-Awlaki-Memo.pdf. Anwar al-Awlaki was the Al Qaeda theorist and leader who sponsored the notion of “lone-wolf” attacks like the one that took place in Orlando.
The logic defending the legality of ordering an American to be  assassinated in a foreign land or in this country is subject to debate. But the post-Orlando mood of our country raises the nation’s propensity to endorse preventive actions.
More surveillance, more invasive presumptions of guilt, more obstacles and barriers, more searches, more metal detectors, more patience required for transit and admission, more costs for security, more cameras, and more records. Orlando has added to this evolution of paranoia and xenophobia in America.
It is a sad day for the nation and for the victims and their loved ones.
The massacre in Orlando marks yet another appalling lone-wolf attack in a sequence that is unfortunately likely to continue.
A growing element of fear now influences behaviors in our country. We need to think about that accordingly.