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$ (19 JUNE 2015): No U.S. Recession in Sight; Wageflation Sighted.

Conference Board Leading Economic Index Increased Again in May

The index rose 0.7 percent, which follows a 0.7 percent April increase.

The Conference Board LEI for the U.S. increased sharply in May, with building permits and the yield spread once again making large contributions. In the six-month period ending May 2015, the leading economic index increased 2.2 percent (about a 4.4 percent annual rate), slower than the growth of 3.4 percent (about a 7.0 percent annual rate) during the previous six months. However, the strengths among the leading indicators remain more widespread than the weaknesses.

Smoothed LEI

No recession in sight from the Conf. Board’s LEI.

Philly Fed Surpasses Expectations

As shown, breadth in this month’s report was strong with just two components (Delivery Time and Number of Employees) declining while seven increased. 

Rosenberg: Get ready for rising U.S. labour demand

Everything is going as planned.

The lags from years of Fed easing always play out this way, it’s just that the timing can vary from cycle to cycle. But the process of events remains the same.

First comes the asset inflation (stocks, real estate).

Then comes the commodity inflation (this came and went already).

Then comes the credit inflation (check out what bank lending is doing).

Then comes the consumer inflation (oh yes, this has started).

And now, as is the case in every cycle, when the deflation/disinflation to reflation to inflation gets entrenched, then comes the wage uptrend. This is in its infancy stage and always is the last part of the pricing cycle to take hold because there is no other market other than labour that responds to reflationary policy measures with such a long lag. (…)

Labour demand is clearly on the rise, as is evident in the Manpower survey, hiring announcements from Challenger and record-high job openings. It’s also evident in the National Federation of Independent Business (NFIB) poll for May, which showed that the small businesses job creation index rose to 12 per cent from 11 per cent in April and 10 per cent in March – the highest this year.

This has big implications. While there may be ample supplies of iron ore, nickel, copper, timber and crude oil, this is far from the case when it comes to the U.S. labour market. One piece of ignored information is the “pool of available labour” series published by the U.S. Bureau of Labour Statistics. It sums up the ranks of the official unemployed and those not in the labour force but would take a job if offered one. This “pool” shrunk 75,000 in May, has contracted now for four months running and has declined 1.8 million in the past year to a seven-year low of 14.7 million. At this rate, the United States runs out of sidelined workers within a decade.

There’s another element to all this. The years of neglect in terms of business investment, which has led to the weakest growth rate of all other cycles in terms of the private sector capital stock, has reared its ugly head in terms of contracting, not just slowing, productivity. Thank goodness for the Silicon Valley boom or else things would be even worse. Output per hour worked in the nonfarm business sector fell at a 3.1-per-cent annual rate in the first quarter on top of a 2.1-per-cent decline in the fourth quarter of last year. (…)

But this will be good news for workers, at the least, as the income spoils now gravitate to labour at the expense of capital. Not the best news for sky-high profit margins, that is for sure. (…)

So what is happening? Well, compensation growth per hour, both nominal and real, are in notable uptrends. As is the employment cost index. The average hourly earnings data are also starting to show a pulse. And the big daddy of them all, unit labour costs, or productivity-adjusted wages, soared at a 6.7-per-cent annualized pace in the first quarter – and this followed an almost equally red-hot 5.6-per-cent rate in the fourth quarter of 2014.

The data are lumpy and the year-over-year trend is less severe at plus-1.8 per cent. But any cost-plus analysis would suggest that 2-per-cent-plus inflation is not too far out in the future.

And guess what? This is probably the new environment the bond market is repricing itself for.

Bloomberg’s Richard Yamarone, who listens to hundreds of corporate conference calls, agrees:

The price of labor is on the rise, and has caught the attention of policy makers. These signs have been emerging in conference calls for some time, suggesting that the Federal Reserve might want to act sooner rather than later. Once the wage inflation genie is out of the bottle, it’s nearly impossible to contain it. (…)

Expectations of higher employment costs continue to appear in conference calls. Ross Stores President and COO Michael B. Sullivan noted, “[W]hat are we planning to do on wages, we’ve mentioned on the call in February that we expected to see more wage rate pressure this year and that we would be making adjustments to keep wage rates competitive. One of the adjustments we will be making in the second quarter is to raise our minimum entry level hourly rate to $9 and that adjustment together with any offsets is built into the earnings guidance.” (…)

Other example of higher wage expectations include comments from department store retailers and consumer product companies. Kohl’s CEO Mansell said, “[O]ur expectation is wages will continue to rise and we’ve put that into our thinking over the course of the year and my expectation is wages will probably continue to rise and we’ve always managed that.”

Stephen Robb, CFO of Clorox, argued, “A]s we’ve pointed out, logistics costs are up, wage inflation is real, healthcare costs are up, commodities are actually still up in the first half of the fiscal; they went flat in the third quarter. But we have yet to get any relief. So the pricing that we have taken, we think it’s the right pricing for the business. It’s certainly cost-justified. While it’s early days, it’s certainly we’ve executed the price increase as well.”

One recent concern — perhaps a precursor of bad things to come — was a reported surge in first-time claims for unemployment benefit insurance in California. During the week ended June 6, the Golden State reported an increase of 10,917 new claims due to “layoffs in the service industry.” This appears to be the function of higher minimum wage legislation.

The Bloomberg Orange Book of CEO Comments highlighted this issue back in May. Famous Dave’s CEO Ed Rensi said, “I don’t know if you read recently that Oakland, California took their minimum wage way up. And it’s closing down small businesses all over that city and it’s very problematic. And we’re fortunate that we’re not in those city limits right at the moment. But who knows what communities may do. That’s something we’re going to have to keep our eye on and be very vigilant about.”

Want to dig more?

Iran Offers West New Oil Terms Iran is prepared to offer longer, more profitable contracts to international oil firms if sanctions are lifted but expects substantive partnerships with Iranian firms.

The contract outline, which Iran has discussed with foreign companies but not yet released in its entirety, would pay companies more for boosting production, last longer and encourage joint ventures from the earliest stages of field development, said Ali Kardor, the vice president for investment and finance at the National Iranian Oil Co.

The companies will also be expected to share more technology and management expertise with their Iranian partners. (…)

Iran’s energy sector needs at least $185 billion in investment over the next six years, saidAmir Zamaninia, a senior deputy oil minister who left Iran’s nuclear negotiating team five months ago to oversee the ministry’s interactions with dozens of major foreign companies flocking to Iran to explore opportunities. (…)

The new contracts, which will be offered for work on somewhere between 34 and 74 oil fields, could last for the duration of a field’s life, up to 30 years, and will link payments closely to production levels, Mr. Kardor said. (…)

He said the ministry expects negotiations with foreign firms to take as long as six months once sanctions were lifted. Meanwhile, he said Iran’s national oil company has been testing how long it takes to restart wells that have been shut down since sanctions halved exports. Those tests have encouraged Mr. Zanganeh’s recent assertions that Iran could pump as many as one million more barrels a day within six months, he said. (…)

SENTIMENT WATCH
China Shares Suffer Worst Week Since 2008 Shanghai and Shenzhen benchmarks fall into correction territory, ending down 6.4% and 5.9%, respectively

The Shanghai Composite finished down 6.4% at 4478.36 and lost 13.3% for the week, marking the second time this year it has fallen into correction territory. It dropped more than 10% from a recent high in late May, before rebounding to hit its highest level since January 2008 earlier this month.

The smaller Shenzhen benchmark also fell into correction territory Friday, finishing down 5.9% at 2742.18. The benchmark is now down 12.7% from its record close of 3140.66 on June 12. (…)

Investors pulled out $2.1 billion from Chinese stock funds in the week ending Wednesday, after $7.1 billion in outflows the previous week, according to the latest data from ANZ Bank. (…)

Buying the dips?

JPMorgan Says Buy China Stocks as Government Backstops Rally

The biggest weekly drop in Chinese stocks in seven years is a buying opportunity because the government will act to keep the bull market intact, said JPMorgan Chase & Co.

Authorities can reduce the pace of initial public offerings, clarify margin trading rules or encourage President Xi Jinping’s plan to build overseas transport links to boost investor sentiment, said Adrian Mowat, chief Asian and emerging-market equity strategist at JPMorgan. (…)

Given the influence of individual investors in the mainland market, “the way you make money is to trade with the themes rather than getting caught up looking at the PE multiples,” he said.

Shares on mainland exchanges trade at an average of about 256 times reported earnings. The median stock has a ratio of 98, while the Shanghai Composite, which has a heavy weighting toward low-priced bank shares, is valued at 23 times.

In short, never mind values, buy the “themes”. Sounds like 1998 stuff to me. Also, consider that Mr. Mowat has been advising buying China since last November.

No wonder there is no volatility in U.S. equities. It has all been exported to China!

Although, some is also seen in Europe, down nearly 7%:

image

Meanwhile, in calmer waters

U.S. futures higher a day after Nasdaq set record high

– U.S. stock index futures were slightly higher on Friday, a day after the Nasdaq Composite index broke its last standing milestone from the dot-com era as it set a record intraday high.

NEW$ & VIEW$ (18 JUNE 2015): Core CPI +1.7% YoY; Fed Ready; Oil Imbalance Continues.

U.S. Consumer Prices Rise 0.4% in May U.S. consumer prices posted the largest monthly increase in May in more than two years, a sign modest inflation pressures are beginning to build.

Excluding volatile food and energy categories, so-called core prices increased 0.1%.

Compared with a year earlier, overall prices were unchanged and core prices were up 1.7%.

Energy prices rose 4.3% last month, but are still down 16.3% from a year earlier. Gasoline prices were up 10.4% on a seasonally adjusted basis in May, the largest monthly gain since June 2009. Gasoline prices remain 25% below year-earlier levels.

Food prices were unchanged last month and were up 1.6% from a year earlier.

A separate Labor Department report showed Americans’ inflation-adjusted weekly earnings fell 0.1% in May. The decline reflects a pick up in inflation offsetting a modest increase in wages.

Fed Flags Slow Pace for Rate Hikes The Federal Reserve kept rates near zero but signaled it was moving toward interest rate increases in the months ahead now that signs of a dip in economic activity early in the year are waning.

“Economic conditions are currently anticipated to evolve in a manner that will warrant only gradual increases in the target federal-funds rate,” Fed Chairwoman Janet Yellensaid in a press conference following the Fed’s two-day policy meeting.

As part of its release, the Fed suggested it might raise rates only once in 2015 by a quarter percentage point, rather than twice as many officials previously anticipated. By December 2017, the Fed expects its benchmark short-term interest rate to remain below 3%, far lower than it has been for the past half century this long into an economic expansion. (…)

The median estimate for rates in 2016 has shifted down to 1.625% from 1.875% in March. The median estimate for 2017 has shifted down to 2.875% from 3.125% in March.

“I want to emphasize sometimes too much attention is placed on the timing of the first increase in the federal-funds rate,” Ms. Yellen said in the postmeeting press conference. “What should matter to market participants is the entire expected trajectory of policy.”

The shifts in interest-rate projections suggested officials have become less certain about the longer-run vigor of the U.S. economy and its capacity to withstand higher rates. (…)

In economic projections accompanying the Fed’s statement, the central bank revised down its estimate of growth for 2015. In March the Fed saw economic output expanding by 2.3% to 2.7% this year. In the latest estimate it revised output growth to 1.8% to 2.0%. (…)

The Fed is populated by officials with a wide range of views about where rates ought to go in the coming years. In 2016, for example, rate estimates among officials inside the Fed range from just above 0.25% to near 3%.

Fed officials believe short-term rates could get to 3.75%, and probably won’t even be there, by the end of 2017.

Fed Given Green Light by Pay Prospects An improving wage picture sets the stage for the Federal Reserve to start raising interest rates in September.

The Fed on Wednesday kept its target range on overnight rates steady at zero to 0.25%, but clearly indicated it doesn’t expect rates to stay there much longer. In its postmeeting statement, the Fed noted that job growth has picked up, and the economy is again growing after this winter’s icy patch.

Meanwhile, the median forecast of policy makers’ updated projections put the midpoint of overnight rates at 0.625% at year-end. That suggests the central bank will put through two quarter-point increases this year—probably at its September and December meetings. (…)

“Wage increases are still running at a low level, but there have been some tentative signs wage growth is picking up,” Fed Chairwoman Janet Yellen said during her post-meeting press conference.

The University of Michigan’s consumer sentiment report last week showed that household income-growth expectations have risen markedly. Meanwhile, a quarterly survey of chief financial officers from Duke University’s Fuqua School of Business showed that companies expect wage and salary gains to pick up. (…)

Fed’s Growth Outlook Still Below Wall-Street Consensus

Since at least 2013, both the Fed and Wall Street have started each year far more optimistically than when they ended. This trend continued yesterday with the Fed downgrading its 2015 growth forecast to 1.9 percent, compared with a slightly more bullish Bloomberg consensus estimate of 2.2 percent. One saving grace may be that, in both of the past two years, the Fed — and private economists — wound up lifting their full-year forecasts during the final three months of the year after hitting a bottom in the third quarter.

U.S. Jobless Claims Fall to 267,000 The number of Americans seeking first-time unemployment benefits fell last week, the latest sign of steady job creation.

A broader measure designed to smooth out big swings—the four-week moving average of claims—decreased 2,000 to 276,750 last week. (Chart from CalculatedRisk)

Eurozone Pay Rises Sharply

The European Union’s statistics agency said wages were 2.2% higher than in the first quarter of 2014, double the rate of growth recorded in the final three months of last year and the fastest rise since the third quarter of 2012.

The pickup in wages fueled a 2.2% rise in total labor costs, which include taxes on workers. For many businesses, wages and taxes on workers account for the bulk of their costs. Accelerating labor costs mean they are under more pressure to raise their own prices.

In Germany, however, the jobless rate is below that of the U.S., and recent pay deals between labor unions and employers had signaled a pickup in wages. Eurostat said wages in the eurozone’s largest member were 2.9% higher than a year earlier, an acceleration from the 2% rise recorded in the final quarter of last year.

More surprising are the strong rises recorded elsewhere in the eurozone. In Spain, a country in which more than a fifth of the workforce is unemployed, wages rose by 2.1%, a jump from the 0.4% increase recorded in the previous quarter. French wages rose by 1.6%, an acceleration from 1%, while in Italy wages rose by 1.2%, having fallen in the previous quarter.

OIL
U.S. OIL DEMAND STRONG BUT PRODUCTION KEEPS RISING…

U.S. crude production increased by 10 MBbls per day from last week to 9.1 MMBbls per day, or 1.2 MMBbls per day above this time last year. Since the start of the year, U.S. crude production is up 497 MBbls per day.

Finished motor gasoline demand declined 4.4% from last week to 9.2 MMBbls per day. On a four-week moving average basis, demand is up 3.4% or 306.0 MBbls per day compared to the same time last year.

U.S. petroleum products demand was up 1.0% from last week to 20.0 MMBbls per day. On a four-week moving average basis, demand is up 6.2% or 1,149.3 MBbls per day compared to the same time last year. (Raymond James)

…WHILE PRODUCTION COSTS KEEP FALLING

This is from Canadian Natural Resources but is a good indication of what’s happening overall in the oil patch:

(…) management told a very encouraging story, with expectations of ~$900 mln in cost savings this year. Of this total, management believes 50% of the cost savings realized to date should be sustainable, with initiatives in place to try and increase that to 75% of total cost savings remaining in place once commodity prices normalize. One of the key areas to watch will be on the thermal side of the portfolio where management believes it could squeeze ~25% cost savings. If CNQ and the rest of the industry can achieve that level of success, this may allow top-quartile SAGD projects like Kirby to remain competitive under a lower oil price environment, with management suggesting Kirby economics could still make sense in the US$60-75/bbl range the company outlined for its medium-term commodity price expectation. (Raymond James)

Hence

Global Oil Supply Rising Faster Than Demand

Global oil demand rose to a new record high of 93.8 mbd based on the 12-month average through May. It’s been doing so since it recovered from the Great Recession ever since June 2010. It has been rising at a faster pace in recent months. It rose 1.2% y/y in May, up from a recent low of 0.6% during November 2014.
Does this suggest that global economic growth is picking up? I doubt it. More likely is that the drop in oil prices is boosting demand. That’s the way the price mechanism is supposed to work. While the upturn in demand has helped oil prices to rebound from their lows at the start of the year, there’s plenty of supply keeping a lid on them despite the fall in prices. Indeed, the ratio of demand-to-supply continued to fall in May as it has virtually every month since August 2013. I expect that the price of a barrel of crude will remain range bound between $46 and $68 (the year’s low and high in the nearby futures price) through the end of this year.