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$ (11 DECEMBER 2015):

November retail sales +0.2% after unrevised +0.1% in October.

U.S. Retail Sales Rose 0.2% in November Consumers spent more across a range of categories, including electronics and appliances, clothing, sporting goods and books

Pointing up Excluding gasoline retail and food sales rose 0.3% after +0.15% between September and October.

Ex-auto retail sales rose +0.4%, better than expected and ex-auto and gas retail sales climbed +0.5%, much better than expected.

UPS Struggles to Keep Up With Surge in Web Orders

On-time delivery rates for UPS ground packages based on their normal shipping transit times last week fell to 91%, according to an analysis of millions of packages by software developer ShipMatrix Inc. During the same week last year, the on-time rate was 97%, which is UPS’s usual average during nonpeak months.  FedEx Corp.’s early numbers were also lower than usual at an estimated 95%.

UPS has been slammed with unexpectedly high volumes, extra pickups and not enough staff and equipment to handle all of the packages in some locations, according to people familiar with the matter.

“Volumes are coming in much higher than planned,” said John Haber, CEO of Spend Management Experts, who advises retailers on shipping matters. (…)

Most of the problems surfacing so far involve UPS, which does more residential deliveries than FedEx and has been trying to contain costs. (…)

Pointing up Economic Growth Migrates Toward the Coasts

What a difference a year of low oil prices makes.

In the second quarter, the U.S.’s hottest growth areas traveled toward the coasts where service-oriented sectors like finance and professional services dominate, away from the mining-focused heartland. (…)

 
U.S. Import Prices Down 0.4% in November Prices for imported goods fell for the fifth straight month in November, highlighting the drag on inflation from cheap oil, a strong dollar and slow overseas growth.

November’s decline was broad-based. Prices for petroleum and natural gas, industrial supplies like metal, food, autos and capital goods all fell. (…)

In November, petroleum import prices were down 44.5% from a year ago. Overall import prices were down 9.4% from a year earlier.

The index for nonfuel imports was down 3.2% over the past year, which is near the biggest annual decline since September 2009.

U.S. export prices fell 0.6% in November from the prior month. Export prices are down 6.3% year-over-year.

Prices of core imports fell 0.2% MoM in November after falling 0.9% in the previous 3 months. Core import prices are down 3.1% YoY. Consumer Goods prices ex-automotives seem to have stabilized being unchanged over the past 4 months and down only 0.7% YoY in November.

Fed Report Shows U.S. Household Net Worth Declined Americans lost nearly $1.2 trillion in wealth in the third quarter, with a shaky stock market contributing to the losses, according to a Federal Reserve report released Thursday.

The decline was driven mostly by a decline in corporate equities, which shed over $2.3 trillion over the quarter. (…)

Despite the decline, the aggregate wealth in the U.S. is near the highest levels ever recorded. The $85.2 trillion in net worth is down from the record $86.4 trillion recorded in the second quarter. By contrast, households had $66.5 trillion in net worth in 2007 before the recession started. At the low point of the recession, the wealth had dropped to $55 trillion. (…) (Charts from Doug Short)

Household Net Worth

Net Worth Log Scale

Older Americans reshape the middle class Over-60s are forecast to drive half of all US spending growth

(…) New data from the Pew Research Center show that households aged 65 and over have been the biggest economic gainers this century, as well as since the beginning of the 1970s.

The group has seen the largest move up the income ladder of any major demographic over the period, with the share of people aged 65 and over in the upper-income brackets more than doubling since 1971 to 17 per cent. That still leaves people in that age group more likely to be lower income than the other demographics tracked by Pew.

Separate projections by the McKinsey Global Institute to be released early next year show the ageing population’s dramatic impact on future US spending patterns. Americans aged 60 and over are forecast to drive half of all US spending growth between 2015 and 2030. Spending by people aged 60-74 will rise by 3.2 per cent a year in real terms over that period, while consumption by people aged 75 and older will increase 5.1 per cent — well above the 2.4 per cent growth rate predicted for the population as a whole, the estimates show.

World oil markets to remain oversupplied through 2016: IEA

(…) While demand grew at the quickest pace in five years in the third quarter rising up 2.2-million barrels per day, the agency says that growth is decelerating. For 2016, it expects consumption to grow by 1.2-million barrels a day, not nearly enough to sop up the excess in production and reduce inventories.

Will China’s slowing economy drag oil demand down with it? Credit Suisse doesn’t think so, citing the country’s continued thirst for one key petroleum product: gasoline. Analysts forecast that oil demand in the Middle Kingdom will grow 4 percent year-over-year in the next two years thanks to car sales. China is the world’s largest auto market and although sales growth dropped sharply this year — 2015 car sales are expected to grow 7.5 percent compared with an average of 17 percent over the past five years — growth is expected to jump to 15 percent next year, mainly driven by government tax cuts on small cars and the rising wealth of China’s ever-expanding middle class.

Gasoline demand growth models developed by Credit Suisse project that Chinese gas demand will rise somewhere between 280,000 and 360,000 barrels per day in 2016 and 2017, which is two to three times higher than the International Energy Agency’s forecast. Supplying that demand would require China’s refiners to cut gas exports, import gas or significantly expand throughput. That last option would be bullish for the global refining system, which Credit Suisse notes is short of gasoline manufacturing capacity.

Auto BTW: China vehicle sales in November were up 20% YoY.

JUNK FUNK
Junk Fund’s Demise Fuels Concern Over Bond Rout Third Avenue Focused Credit Fund is barring investor withdrawals while it liquidates its high-yield bond fund, an unusual move that highlights the severity of the monthslong junk-bond plunge.

The decision by Third Avenue Management LLC means investors in the $789 million Third Avenue Focused Credit Fund may not receive all their money back for months, if not more. (…)

While hedge-funds have occasionally prevented investors from taking out their money, such a move is uncommon for a mutual fund. (…)

High-yield bond assets at U.S. mutual funds hit $305 billion in June 2014, according to Morningstar Inc. data, triple their level in 2009.

But investors have pulled money lately. Outflows in November were $3.3 billion, the most since June, according to Morningstar data. (…)

Devil As the Third Avenue fund’s holdings began to decline, rival traders at hedge funds shorted, or bet against, some of the mutual fund’s holdings, wagering that Third Avenue would experience investor withdrawals and be forced to sell some of its holdings, according to the company and one trader who made this move. (…)

  • Rating agency Fitch calculates that during October, 18 per cent of the 1.4tn in junk bonds outstanding were issued by energy companies (with another 5 per cent in the equally beleaguered metals and mining space).
  • The Fitch default rate excluding energy companies is less than 1 per cent, against nearly 3 per cent when energy is included. (FT)

Beware of the narrow exit doors as this chart from Alberto Gallo’s 2016 outlook illustrates (via FT Alphaville):

Fingers crossed Corporate Credit May Bend But Not Break

(…) Though the high-yield spread now well exceeds its 418 bp median of the previous two business cycle upturns, today’s well-above-average spread does not convincingly warn of an impending recession. For example, the high-yield spread’s three-month average exceeded its recent band on three previous occasions and a recession failed to materialize within a year. The latest “false negative” stretched from October 2011 through June 2012, or when the high-yield spread’s three-month average ranged from 718 bp to 758 bp. (Figure 1.)

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Unlike the high-yield spread, the moving three-month averages of the unemployment rate and the Treasury yield curve are much more trustworthy indicators of the business cycle. The record shows that once the unemployment rate’s moving three-month average rises for three straight months, a recession is nearby. Current expectations rule out an extended climb by the jobless rate throughout 2016.

In addition, each three-month inversion by the Treasury yield curve since 1967 has preceded or accompanied a recession. For now, the Treasury yield curve is expected to narrow from a recent 210 bp to a still wide 175 bp by 2016’s final quarter. (…)

Recent spread widening has been more pronounced at lower credit ratings. At the end of November 2015, the median Caa-grade bond spread had broadened to 809 bp. Not since the 852 bp of August 2011 has the Caa spread moved out to so wide of a band. However, unlike August 2011, the broadenings of the Ba and single-B spreads have been relatively limited. At the end of November, the median spreads were 383 bp for Ba and 510 bp for single-B. By contrast, the end of August 2011 showed significantly wider medians of 521 bp for Ba and 666 bp for single-B. Thus, August 2011’s composite high yield spread of 737 bp was much wider than the 644 bp of November 2015.

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Fitch: 2016 US HY Default Rate Forecast at 4.5%, Energy at 11%

Fitch Ratings forecasts the 2016 US high yield bond default rate at 4.5% as weak prices will continue to challenge energy and metals/mining issuers. The energy sector default rate is projected to hit 11% in 2016, eclipsing the 9.7% rate seen in 1999.

Excluding these two troubled sectors, defaults are expected to remain below average. Removing energy and metals/mining from the index, the remainder of the high yield universe is expected to finish 2016 with a 1.5% default rate, which is below Fitch’s non-recessionary average of 2.1%. Barring high-yield energy companies, market access continues to be favorable and earnings (again, outside of energy and metals/mining), were generally good.

The current trailing 12-month (TTM) default rate is 3.3%, climbing from 3% at the end of November. In December, more than $5 billion of defaults were recorded, the most tallied in a single month since January. (…)

A 4.5% 2016 high yield default rate equates to $66 billion of defaults and would be the fourth highest default total since 2000. This would be close to the $78 billion amassed in 2001 but well below the record $119 billion posted in 2009.

At the beginning of December, $98 billion of the high yield universe was bid below 50 cents, while $257 billion was bid below 80 cents. The battered energy and metals/mining sectors comprise 78% of the total bid below 50 cents. In addition, 53% percent of energy, metals/mining companies rated ‘B-‘ or lower were bid below 50 at the start of December, compared to 16% at the end of 2014, reflecting the decline in crude oil prices.

The December energy TTM rate is expected at nearly 7% while the exploration & production rate is closing in on 12% following a chapter 11 filing for Vantage Drilling and missed payments for Magnum Hunter Resources and Swift Energy. Energy outstandings are at $259 billion, making up 18% of the market, with $68 billion in the ‘CCC’ rated universe.

We recently revised our oil price assumption down to reflect the risks of a lower-for-longer scenario, lowering our 2016 oil price (West Texas Intermediate) to $50/bbl, 2017 to $60/bbl, and 2018 to $65/bbl prior to an expected recovery to $70/bbl in 2019. After some delay, the heavy capex cuts seen across the industry have begun to pull back supply, particularly from US shale, with US oil production declining 400,000 barrels per day (bpd) to 9.2 mmbpd from peak levels that were around 9.6 mmbpd. However, the US supply response to lower prices has been muted to date, and it appears a second round of capex cuts will be required to bring down bloated global oil inventories and help restore the markets to equilibrium.

Energy and metals/mining comprise 79% of the defaulted volume since the start of the third quarter and account for 70% of the 2015 defaults, after removing Caesars Entertainment Operating Co.

Caesars served as the lone bond default with outstandings exceeding $2.3 billion in 2015 and the overall TTM rate will fall by 1% when it leaves the default universe in January. Nevertheless, Fitch believes there are some large candidates at risk for default in 2016, including Yankee issuer PDVSA.

NEW$ & VIEW$ (10 DECEMBER 2015): Surveys Day.

Look Who’s Spending Less: Higher-Earning, Older Americans

(…) Recently, the pace of consumer spending, outside of big-ticket items such as cars and homes, has eased. That’s puzzled economists who expected solid hiring, improving wage gains and cheap gasoline to drive improved spending.

Data released Wednesday by the JPMorgan Chase & Co. Institute sheds new lights on what’s happening. The report found mid- and upper-income Americans, and those older than 65, pulled back on spending sharply from mid 2014 through June, while outlays among those younger than 35 and those with lower incomes held up fairly well.

The institute taps into anonymized data from 48 million JPMorgan customers in 15 U.S. metro areas to reveal  spending patterns.

The report found overall spending on “everyday” products and services—the type of purchases you would put on your credit or debit card—rose just 0.5% in the second quarter of 2015, from a year earlier. For the prior year, before gas prices dipped and hiring accelerated, spending rose a robust 5%. The data is not inflation adjusted, and price increases were stronger in late 2013 and early 2014.

Pointing up Actually, many goods prices declined in 2015, likely impacting the JPM analysis.

Those on the lower end of the income spectrum are the ones whose budgets benefit most from lower gasoline prices. They are also among that portion of the population likeliest to have found jobs in fast-growing but low-paying industries such as restaurants and retailers. Lower-earning workers tend to spend most of what they earn. (…)

The JPMorgan data showed that the top 40% of earners were a drag on any growth in consumer spending beginning in February.

The biggest pullback in spending, of course, came from less-costly fuel purchases. But spending on durable goods, long-lasting items such as appliances and computers, also declined in the second quarter.

Contributions to spending growth from services and nondurable items, like clothing and food, eased in the first half of this year. (…)

In all, most of the recent “trends” seem to be caused by diverging inflation patterns between energy, goods ex-energy and services. Between February and September 2015, Goods deflated 2.9% YoY on average with Durables prices down 2.2%. Meanwhile, Services prices rose 1.9% on average. In case you did not notice, Energy Goods and Services prices was –17.9% during the same period. The diverging inflation trends are enough to totally disrupt analysis based on nominal dollars. Too bad because this is an awesome database. 

Snail Fed Plans to Signal Gradual, Cautious Path on Rate Hikes For Federal Reserve officials, deciding to raise short-term interest rates will be the easy part of their meeting next week. The harder part may be agreeing on how to signal the likely path of rate increases in 2016 and beyond.

That’s the plan. But we all know that plans can change…Here’s one thing that could derail the Fed’s current plans. Look at the recent surge! (Chart from Gluskin Sheff)

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Here’s another potential plan buster:

  • From Jesse Felder @jessefelder via FT Alphaville: GUNDLACH: ‘High-yield spreads have never been this high prior to a Fed rate hike.’

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Survey Shows Growing Appeal for U.S. Factories The U.S. is becoming more appealing as a location for manufacturing capacity, a new survey by Boston Consulting Group suggests.

The consulting firm said 31% of manufacturing executives surveyed  in September said they were most likely to add production capacity in the U.S. in the next five years for goods to be sold in that country. That was up from 26% in a similar survey two years earlier. The percentage of executives who named China as the most likely place for such production declined to 20% from 30%. Mexico was named the most likely site by 29%, up from 26% two years before. (…)

Boston Consulting Group said many of the executives cited a wish to reduce shipping costs and the risks of relying on faraway suppliers. In recent years, global supply lines have been disrupted by crises including floods in Thailand and the 2011 Fukushima nuclear accident in Japan. Declining costs for robots and other forms of automation also help the U.S. compete against countries with lower labor costs. Meanwhile, China’s labor costs, though still far below those in the U.S., have risen rapidly in recent years.

Even so, some executives remain hesitant to move production to the U.S. because of “concerns about rising U.S. health-care costs, federal and local regulatory uncertainty, increases in the U.S. minimum wage, and unclear progress on tax reform,” the firm said. Some companies have trouble finding enough skilled labor and suppliers in the U.S. (…)

OPEC: Crude Production Hits Highest Level Since 2012

Output from the Organization of Petroleum Exporting Countries rose by 230,100 barrels a day in November to 31.695 million a day, the highest since April 2012, as surging Iraqi volumes more than offset a slight pullback in Saudi Arabia. The organization is pumping about 900,000 barrels a day more than it anticipates will be needed next year. (…)

Non-OPEC supply will fall by 380,000 barrels a day next year, averaging 57.14 million a day, with an expected contraction in the U.S. accounting for roughly half the drop, the organization said Thursday in its monthly report. It increased estimates for non-OPEC supply in 2015 by 280,000 barrels a day.

The group maintained projections for the amount of crude it will need to pump next year at 30.8 million barrels a day.

Iraqi production increased by 247,500 barrels a day to 4.3 million a day last month, according to external sources cited by the report, which didn’t give a reason for the gain. (…)

Production in Saudi Arabia slipped by 25,200 barrels a day to 10.13 million a day in November, OPEC’s report showed.

From the WSJ:

(…) OPEC’s report said demand would grow about 1.25 million barrels a day, unchanged from its previous forecasts. That is down from 1.53 million barrels a day of growth in 2015. (…)

OPEC said demand for its crude stood at 29.4 million barrels a day this year—lower than its current output, and a downward revision of 200,000 barrels a day from previous estimates. In 2016, demand forecasts for OPEC crude remains unchanged at 30.8 million barrels a day, an increase of 1.5 million barrels over the current year. (…)

America’s Middle Class Is No Longer the Majority That’s the finding of a new Pew Research Center report detailing how incomes and wealth have changed in the U.S. over more than four decades.

More on this on Bloomberg.

Just kidding Billions of Barrels of Oil Vanish in a Puff of Accounting Smoke

Read the above Bloomberg article to better understand the “asset impairment charges” incurred by energy companies with the current low prices. These charges are significantly impacting reported earnings. (And this is only part of the story)