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$ (17 NOVEMBER 2015): Where’s Waldo follow up; Submerging Cos.

N.Y. Fed: Business Conditions Decline Fourth Straight Month

The Empire State’s business conditions index came in at -10.7 this month, compared with -11.4 in October and -14.7 in September. (…)

Details of the report painted a mixed picture of the New York-area manufacturing sector. The new orders subindex improved to -11.82 from -18.91, while shipments improved to -4.1 from -13.61. But unfilled orders and inventories deteriorated to -18.18 and -17.27, respectively. They had been at -15.09 and -7.55.

Labor-market indicators, meanwhile, steadied slightly, consistent with the Labor Department’s recent report, with the index measuring the number of employees at -7.27, from -8.49 last month.

Given the continuing weakness, it was no surprise that manufacturers’ attitude about future conditions turned more negative. The index measuring the six-month outlook fell to 20.33 from 23.36 last month, while the gauge of future capital spending plans edged up slightly to 12.73 from 12.26. (…) (Charts from Haver Analytics)

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WHERE’S WALDO? (follow up)

Following up on yesterday’s post WHERE’S WALDO? three big retailers reported this morning:

Earnings were 99 cents a share in the period, excluding some items, the Bentonville, Arkansas-based company said in a statement Tuesday. Analysts had predicted 98 cents on average, according to data compiled by Bloomberg.

For the current quarter, Wal-Mart forecast earnings of $1.40 to $1.55 a share. Analysts polled by Thomson Reuters had forecast $1.42 in per-share profit.

The company now expects profit of at least $4.50 a share this year, up from a previous forecast of at least $4.40.

Pointing up Comp sales at Walmart U.S. were positive for the fifth consecutive 
      quarter, up 1.5%. Traffic increased 1.7%.

Home Depot Inc , the world’s No. 1 home improvement retailer by revenue, reported a better-than-expected rise in quarterly same-store sales, helped by strong demand from both retail customers and professional contractors and builders.

Call me Richard S., a Bearnobull reader, rightly observes that many of the dinostores actually cater to the first victims of the Fed’s ZIRP.

The problem with demand is that the retirees and near retirees (the dinosaurs) aren’t buying because their interest income is zero.  The stores which serve these customers are showing the impact.  The FED is hurting the economy.

I don’t know Richard’s age but I am not considering myself a dinosaur, just yet anyway. Winking smile

Meanwhile, Shake Shack last week talked about “growing labor costs” and so did Panera.

U.S. Producer Prices Post a Surprising Decline

The overall Final Demand Producer Price Index fell 0.4% during October (-1.6% y/y) following an unrevised 0.5% September decline. Prices excluding food & energy were off 0.3% (+0.1% y/y) and repeated the prior month’s decline.

Final demand goods prices (35% of the total index) fell 0.4% (-4.8% y/y), down for the fourth straight month. The latest decline was led by a 0.8% drop (-4.2% y/y) in food prices. (…) Gasoline prices rebounded 3.8% (-37.9% y/y), but home heating oil prices eased 0.1% (-40.9% y/y). Residential natural gas prices also were off 0.1% (-10.8% y/y) and residential electric power costs fell 0.5% (+0.1% y/y).

Final demand goods prices excluding food & energy declined 0.3% (-0.1% y/y) after remaining steady in September. Core finished consumer goods fell 0.2% (2.6% y/y) and reversed the prior month’s rise. Core consumer nondurables costs remained steady (3.3% y/y) following a 0.2% rise, but consumer durables dropped 0.5% (+1.0% y/y). Private capital equipment costs eased 0.2% (0.9% y/y) while core goods prices for government purchases were off 0.1%, unchanged y/y. Prices of goods for export fell 0.4% (-3.5% y/y), down for the fourth straight month.

Final demand services costs (63% of the total index) declined 0.3% (+0.1% y/y) after a 0.4% fall. This was led by trade services which fell 0.7% (-0.7% y/y); trade services represent the margins charged by retail and wholesale dealers and merchants. (…)

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Deeper into the red  Emerging market companies under debt pressure

(…) By some estimates, $7tn of QE dollars have flowed into emerging markets since the Fed began buying bonds in 2008. Now, a year after the Fed brought QE to an end, companies in emerging markets from Brazil to China are finding it increasingly hard to repay their debts.

The excess capacity these companies created became apparent just as China’s slowing economy triggered a collapse in global commodity prices, hurting companies across the emerging world and sending Brazil’s economy into deep recession. Some experts say QE policies by the Fed and other central banks have left a legacy of oversupply from which it will take years to recover.

They also warn that the leveraging of QE money has resulted in piles of debt around the emerging world that are very hard to measure or even detect. As Carmen Reinhart, a Harvard University economist, said recently, it is often only after things go wrong that the size and destructive power of hidden debts become apparent. (…)

What is clear is that debt has risen to alarming levels. As a percentage of gross domestic product, private sector debt (households and companies) is now greater in emerging markets than it was in developed markets on the eve of the financial crisis.

Taking on more debt for productive investment may well be a good idea, but it is not what has happened. Philip Turner and colleagues at the BIS looked at leverage and profitability at 280 big EM corporate bond issuers. They found that while leverage at those companies was up, profitability was sharply down. (…)

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Last week, the Institute of International Finance said bank lending conditions in emerging markets — a broad measure that includes credit demand, availability and non-performing loans — had deteriorated sharply, with some measures at their worst levels since the IIF began monitoring conditions in 2009.

Hung Tran, the IIF’s managing director, says EM companies are finding it harder to repay their debts and raise new money for investment, putting further downward pressure on growth. And he does not buy the argument that currency mismatches — especially in the overseas debts of EM governments — no longer present the danger they did in the crises of the 1990s.

“People say, this time there is no currency mismatch,” he says. “They are not wrong. But the problem now is much deeper and much more general than a currency mismatch. This is a pure and simple problem of over-indebtedness and of slowing economic growth.”

(…) too much borrowing invested in too much capacity, coming to market as demand is falling. This misallocation of capital is blowing the ill winds of deflation to the developed world. The process is not over yet: as the Fed pulls back, the ECB and BoJ are in full QE mode.

(…)  He says the developed world is heading for a recession similar to the one that followed the turn of the century; if no action is taken, he expects the impact to be worse than the Asian financial crisis of the late 1990s.

“QE has made this possible,” says Luis Oganes, head of EM research at JPMorgan. “Our concern is not of a full-blown EM crisis but of the heavily indebted companies and the banks exposed to them, as they fall into a vicious circle of low profitability, higher non-performing loans and tighter credit conditions. We should not expect an investment-led recovery anytime soon.”

Chinese companies may have more immediate help. Beijing has reined in credit over the past two years to curtail overcapacity, mainly through restrictions on shadow banking. But this year, official lending has again been on the rise. (…)

SENTIMENT WATCH
  • Investors continue to pull money out of equity mutual funds: -$128B out of equity mutual funds and ETFs YtD. Surprised smile
  • Evercore ISI hedge fund survey plunged -1.1 to 47.4, “close to an outright BEARISH reading”.

Understand that hedgies are not born with a much better crystal ball than anybody else. The last time they were as bearish was in Dec. 2012…

WHERE’S WALDO?

Trends in employment (+2.0% YoY), working hours (0.0%), and hourly wages (+2.5%) together provide a good proxy for current labor income growth of around +4.5% YoY. With overall inflation at zero, real labor income growth is also around +4.5% YoY. The savings rate in Q3 was unchanged from last year. Gas prices are down more than $1/gallon (-30%) from last year and food-at-home inflation is a low +0.8% YoY.

Why is it then that discretionary spending looks so weak? Has the U.S. consumer, always so ready to fulfill his/her patriotic shop-and-spend obligation changed so much? Even as we approach the annual pilgrimages to the malls? Where’s Waldo the American consumer?

Understanding and analysing retail sales has become tricky given the many cross-currents within the retail trade (e.g. on-line growth, market share shifts) and the high divergences in inflation trends by categories due to falling commodity prices and the rising dollar. Seasonal adjustments have also become suspect given the recent wide fluctuations in the economy and the weather.

This is some of the stuff that you might have read from the various analysis of Friday’s retail sales report:

  • Consumer spending at retailers climbed just 1.7% since October 2014, compared with a 4.7% annual increase the year before that.
  • Following a 0.1% dip in September, ‘control group’ retail sales rose just 0.2% (half the expected 0.4% rise).
  • Retail and Food service sales ex-gasoline increased by 4.1% on a YoY basis (1.7% for all retail sales including gasoline).
  • Excluding motor vehicles, sales were up 0.2% in October. And excluding gasoline, sales rose 0.1%. When excluding both categories, sales were up 0.3% last month and a healthy 3.5% from a year earlier.
  • Core sales, the figures that are used to calculate gross domestic product and which exclude categories such as autos, gasoline stations and building materials, climbed 0.2 percent last month, less than the 0.4 percent median forecast of economists surveyed by Bloomberg. The readings for September were revised up to show a 0.1 percent gain compared with a previously recorded 0.1 percent drop.
  • Falling gasoline and food prices probably also restrained the core readings. Sales at general merchandise stores, which include warehouse big-box merchants that also sell gasoline, fell 0.4 percent. Grocery stores, which typically see receipts rise, saw a 0.3 percent decrease.
  • The rate of purchases last month was also held back by a 0.5 percent decrease at auto dealers.
  • Sales at nonstore retailers jumped 1.4% last month, and are up 7.1% from a year ago, the strongest of any retail category. That helped keep the overall sales figure in positive territory in October from a month earlier, up 0.1%, despite a 0.5% slump in auto sales and parts—even as unit sales of cars rose—and a 0.9% decline at gas stations.
  • Large retail chains, including Macy’s Inc. and Nordstrom Inc., warned this week of an unexpected slowdown in spending at their stores. Their disappointing performance sent shares of major retailers tumbling.
  • Nordstrom executives were at a loss to explain a sudden deceleration in sales that began in August and continued through October. “We’ve got less people buying clothes this quarter than we expected, and there’s really nothing else to point to,” Jamie Nordstrom, the company’s president of stores said on a conference call Thursday.

    Nordstrom said its business slowed across all regions, categories and channels, including online, where it had been growing strongly. The slump forced the company to discount more than usual to clear unsold goods.

And the clincher which scared many:

  • The Last Two Times Retail Sales Were This Bad, The US Was In A Recession.

In the confusion, the S&P 500’s consumer-discretionary sector, which includes several retailers, was the biggest decliner on Friday with a loss of 2.7%. The sector fell 4.6% for the week, its largest loss since late August. The S&P Retail Sector ETF is down almost 9% in the last 8 days. That is the fastest collapse in this bellwether industry since August 2011.

Let’s look at this in a dispassionate, organized way using YoY rates of change to avoid the more iffy seasonal adjustments and applying specific inflation measures to get a better read of volume trends:

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  • Discretionary spending is +4.7% in October, +4.6% last 3 months with apparent inflation +1.0%. Apparent volume is thus +3.6%.
  • Car sales are +6.2%, +6.6% last 3 months, virtually no inflation. Apparent volume +6.1%.
  • Housing-related spending is in the +4.0-6.0% range in real terms.
  • “Other goods” may look weak until we understand that their wares are generally deflating.
  • Even apparel looks better when considering declining prices and unseasonal weather.
  • Restaurant sales are strong.

In all, these are no recessionary data, quite the opposite in fact.

Then we have the “general merchants” which include department stores. Their nominal sales are up only 1.6% when “CPI ex-food, shelter and energy” is up 1.0% and CPI-apparel is –1.4%. Hard to say what volume is but it is not negative in my view. The fact is that these big department stores, from Nordstrom to Sears to Walmart, are dinosaurs trying to survive in a rapidly changing world.The whole specie is getting killed by the “non-store retailers” and the shrewd discounters such as TJX. Those still able to fight are mainly trying (able) to eat their congeners.

Investors were rattled by Macy’s –3.9% same-store-sales in Q3 but that came after -2.1% in Q2 and -0.7% in Q1. Why the surprise? This followed lackluster WMT sales trends which are also primarily company specific problems.

Meanwhile, JC Penney, not such a terrific merchant but with new leadership, rang sss of +6.4% in Q3, +4.1% in Q2 and +3.4% in Q1. And even with slow traffic in recent months, Nordstrom was able to get +3.5% sss growth in Q3. With goods inflation generally negative, volume is pretty decent.

Amazon’s North American revenues grew 28% YoY in Q3 after +25% in Q2 and +24% in Q1. Quarterly growth averaged 23% in 2014. Costco U.S. comps are up 4% YoY ex-gazoline and FX in October and +6% in September-October. During Costco’s fourth quarter ended in August, comps were also up 6%, as for all of its F2015. No slowdown there and no recessionary trends there as well. Amazon and Costco are not hot newcomers with low sales base.

Waldo is clearly shopping and spending but he’s seemingly tough to find in “dinostores”.

This CalculatedRisk’s chart that simply ex-outs sharply deflating gasoline sales is a good reflection of the actual, meaningful trends, especially if you consider that inflation is close to zero or even negative on core goods: 

Gift with a bow Gallup‘s November update of Americans’ 2015 holiday spending intentions finds U.S. adults planning to spend $830 on Christmas gifts this year, on average. That is up sharply from the $720 recorded a year ago, and is significantly higher than what consumers have indicated in any November since 2007.

Americans' Christmas Spending Estimate From November of Each Year

Gallup’s initial measure of 2015 holiday spending plans, conducted in October, also showed consumers poised to splurge this Christmas, as that month’s $812 average spending figure was the highest Gallup had seen in any October since 2007. The consistency between the two months is a bit unusual, as Gallup typically finds Americans scaling back their spending plans between October and November.

According to Gallup’s modeling of how prior years’ spending forecasts compare with the final November-December retail sales figures for each year, Americans’ latest Christmas spending data point to an estimated increase of between 5.1% and 5.8% in U.S. holiday retail sales.

If Waldo carries on spending, the inventory glut will quickly disappear and the manufacturing sector will soon see rising orders and production, much to the surprise of the doomsayers.

We now have 92% of Q3 earnings in and Consumer Discretionary companies are expected to show EPS growth of 14.7% in Q3, up from +11.4% expected on October 1 and better than the +12.5% recorded in Q2.

In total, S&P 500 companies are on track to register Q3 EPS of $30.05 vs $30.04 in Q3’14 in spite of all the headwinds encountered (see “Questions” within the Nov. 10 New$ & View$). Mid-quarter, pre-announcements for Q4 earnings are positive for 23 companies vs 18 at the same time last year and negative for 66 companies (68 last year). So far, so good.

Factset calculates that ex-Energy, S&P 500 EPs would be up 5.0% in Q3 on revenues rising +1.1%. Margins are not contracting just yet.

If the Energy sector is excluded from the growth calculations for Q4 2015, the estimated earnings growth rate for the quarter would be 1.6%, and the estimated revenue growth rate would be 1.2%. If the Energy sector is excluded from the growth calculations for CY 2015, the estimated earnings growth rate for the year would be 6.9%, and the estimated revenue growth rate would be 1.9%.

At the end of Q3, trailing 12-month EPS are $119.28, up 0.4% from 2014 EPS even with Energy down some 60% and Materials down 5%. The big drag from Energy will peak in Q4 and completely end in Q2 if current estimates are right.

At 2025, the S&P 500 is selling at 17x TTM EPS and 18.9x on the Rule of 20 scale. Upside to fair value of 2157 is 6.5%. Downside to the two recent lows of 17.8x (1900) would be –6.2%.

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