INFLATION WATCH
As regular readers know, I am a big proponent of Bob Farrell’s rule #9: “When all the experts and forecasts agree — something else is going to happen.” Low U.S. inflation is the single most universally agreed upon economic statistic these days. Hence my watch, especially since signs abound that inflation may be picking up. This is even more important given the impact that inflation has on equity valuation and interest rates. As usual, I look at the facts:
A gauge of U.S. inflation surged in March, driven by volatile categories that may not push broader price measures out of their long stretch of sluggishness.
That is the common narrative to keep you sleeping well. Next is today’s reality, from the very same WSJ article:
The producer-price index for final demand, which measures changes in the prices businesses receive for their goods and services, rose a seasonally adjusted 0.5% from February, the Labor Department said Friday. It rose 0.6% excluding the volatile categories of food and energy.
Economists surveyed by The Wall Street Journal had expected the index to rise a more modest 0.1%, and predicted a 0.2% increase excluding food and energy. It had fallen 0.1% in February.
The index was up 1.4% in March from a year earlier, the biggest year-over-year increase since last August.
“It could be that the difficult weather over the past few months has distorted prices, and wholesale inflation will settle down in April,” PNC chief economist Stuart Hoffman wrote in a note to clients. “But there is also the possibility that inflation may be picking up, as firms raise prices given the recent limited acceleration in wage growth and stronger demand.” (…)
March’s 0.5% rise in the PPI was driven by prices for services, which rose a seasonally adjusted 0.7% from February, the largest one-month increase since January 2010. Trade services, a volatile category measuring margins received by wholesalers and retailers, rose 1.4% in March after falling 1% in February.
Overall prices for goods were flat in March. Food prices rose a seasonally adjusted 1.1% from February while energy prices sank 1.2%.
The prior top-line PPI reading, now known as “finished goods,” was down 0.1% in March from a month earlier, but up 1.7% from a year ago.
More facts:
Total PPI is up 2.4% annualized in the last 3 months, 1.8% annualized last 4 months (December’s was 0.0%). Core PPI is up 2.8% annualized in the last 3 months and 3.0% in the last 4months. This measures final demand.
Intermediate demand PPI is up 4.5% in last 3 months, 4.6% in last 4 months. Core intermediate PPI is up 2.8% (3 ms) and 2.7% (4 ms).
Import prices increased 0.6% (-0.6% y/y) during March following an unrevised 0.9% February rise. A 0.2% rise had been expected in the Action Economics survey. A 0.6% improvement (0.1% y/y) in nonpetroleum prices led the pricing strength as it followed a 0.1% February uptick. During the last three months, nonoil import prices rose at a 5.0% annual rate. Petroleum prices ticked up 0.1% (-2.4% y/y) after a 4.7% February surge.
Last month’s gain in nonpetroleum prices overall reflected a 2.1% surge (0.5% y/y) in nonpetroleum industrial supplies & materials prices. Foods, feeds and beverage prices also strengthened 3.7% (4.9% y/y). Elsewhere, pricing power remained tepid. Capital goods prices ticked 0.1% higher (-0.6% y/y) after a 0.3% drop. Automotive prices were unchanged (-1.6% y/y) as were nonauto consumer goods prices (0.4% y/y).
Amid Warnings of Low Inflation, J.P. Morgan says Prices Set to Rise The IMF again sounded the alarm bell at the weekend over low global inflation. But has the worst of anemic price rises already passed the world economy? That, at least, is the view of J.P. Morgan & Chase economists.
(…) J.P. Morgan now expects inflation to pick up. There are a few factors at play.
Global growth is picking up, with the U.S. economy leading the way. This should “gradually turn the tide away from global disinflation,” the bank said.
Agricultural commodity prices are firming this year after a 23% slide from their June 2012 peak. Partly this is due to dry weather, which has hurt global cereal crop output.
Japan’s sales-tax increase on April 1 is also likely to add to the uptick in global prices in the short term, the bank said.
That doesn’t mean the specter of disinflation has disappeared. It remains a risk in Europe, where J.P. Morgan noted the central bank has been reluctant to use additional stimulus despite low inflation.
The Bank of Japan also is expected to ease further this year as consumer demand fades in the wake of the sales-tax hike. Asia’s poor exports performance, and concerns over Chinese growth, add to the worries.
Many economists would disagree that disinflation is no longer a worry. International Monetary Fund economists, in a recent piece, argued that low inflation is as bad as disinflation, as it deters consumers from spending and companies from investing.
Still, J.P. Morgan at least is calling the bottom for prices.
Top Earners See Tax Increases The jump in federal tax rates that kicked in last year is causing sticker shock for many higher earners this tax season.
(…) The latest tax-rate increases, passed at the start of 2013, have added to that burden, at least for the highest earners. Those changes included a bump in the top ordinary income rate to 39.6% from 35%, a limit on itemized deductions and an increase in the top rate on investment income. The Obama health-care overhaul also included some tax increases, including another boost in investment taxes.
Largely as a result, overall federal tax receipts from the top 1% of earners rose by 1.3 percentage points to 29.3% of all federal tax revenue, the nonpartisan Tax Policy Center estimates. The share of overall income for the top 1%, now at around 17%, according to the Tax Policy Center, has roughly doubled since the early 1980s, according to Congressional Budget Office figures.
It isn’t just the super-rich who find their share of the burden growing. The increase in the individual income tax burden borne by the top 20%—including, say, couples with two children making more than $150,000—has gone from 65% in 1980 to more than 90% as of 2010, the most recent year available, according to the CBO. (…)
The European Union’s statistics agency Monday said output rose by 0.2% from January, and by 1.7% from February 2013. The rise in output was in line with expectations. Eurostat also revised its calculations for January, and now estimates production was unchanged during the month, having previously recorded a decline of 0.2%.
Production of durable consumer goods fell by 1.2% from January, and were down 0.6% from February 2013. Durable goods such as washing machines and other items of household equipment are the type of nonrecurring purchases that consumers postpone if they expect to see price falls.
The rise in output wasn’t widespread across the currency area, with declines recorded in Italy, Greece, Portugal, the Netherlands and four other members. Output rose most rapidly in Ireland, while the pickup was also driven by increases in Germany, France and Spain.
Last 3 months: –0.1%; last 4 months: +1.5%; last 6 months: +0.7%. Only November’s +1.6% was strong and that was because of a 2.7% jump in energy production (must be the weather!) and a 2.8% one-month rise in cap. goods production.
The FT’s headline (Euro zone’s February output suggests gradual recovery strengthening) hardly supports the facts.
EARNINGS WATCH
Twenty-seven companies reported Q1 earnings and aggregators have sent their first interim reports. Factset sees EPS declining 1.6% YoY (-1.3% on March 31) but cautions that spring may actually turn out better than expected.
The estimated earnings decline for Q1 2014 of -1.6% is below the estimate of 4.3% growth at the start of the quarter (December 31). Nine of the ten sectors have recorded a decrease in expected earnings growth due to downward revisions to earnings estimates, led by the Materials, Financials, and Consumer Discretionary sectors. The only sector that has seen an increase in projected earnings growth over this period is the Utilities sector.
The estimated revenue growth rate for Q1 2014 is 2.2%, below the estimated growth rate of 3.0% at the start of the quarter (December 31). Nine of the ten sectors are predicted to report revenue growth for the quarter, led by the Health Care and Consumer Discretionary sectors. On the other hand, the Energy sector is the only sector expected to report a decline in revenue for the quarter.
The first quarter of 2014 marks the fourth time in the past 12 quarters (3 years) that a year-over-year decrease in earnings was projected at the end of a quarter, prior to the start of the earnings season for the quarter. However, the index only reported an actual decline in earnings in one of the three previous quarters (Q3 2012).
Over the past three years, 71% of companies in the S&P 500 have reported actual EPS above the mean EPS estimates on average. As a result, the earnings growth rate has increased 3.1 percentage points on average from the end of the quarter through the end of the earnings season due to these upside earnings surprises.
If this average increase is applied to the estimated earnings decline at the end of the first quarter (March 31) of -1.3%, the actual earnings growth rate for the quarter would be 1.8% (-1.3% + 3.1% = 1.8%).
Standard & Poors is the “official” aggregator. Their Operating Earnings are currently very different than others’ because they (rightly) treated pension liability adjustments as operating items in the last 12-15 months. S&P’s forecasts of Q1’14 EPS of $27.25, up 7.3% YoY, would bring trailing 12 months EPS to $108.78, up 1.4% from the trailing EPS after Q4’13. Q1 EPS estimates declined 1.3% from $27.60 at the end of March.
The beat rate is 54%, similar to that at the same time after Q4’13.
Analysts, taking their cue from economists and corporate officers, are blaming the Mr. Winter for the shortfall. Spring having finally arrived, estimates for the next 3 quarters have barely changed, being up 12.5%, 14.1% and 14.0% respectively.
The Rule of 20 being backward looking, it is not buoyed up by the current blue skies and warmer temperatures across the U.S.A.. Only recorded changes in inflation alters its mood. However, the recent 4.3% setback in the S&P 500 Index has brought the measured undervaluation back into the less risky darker green area. Using core inflation of 1.6%, the Rule of 20 states that fair market value is 1974 (18.4 x trailing EPS of $107.30), some 9% above current levels. If Q1 EPS reach the expected $27.25, trailing EPS will soon rise to $108.78, pulling the Rule of 20 fair value up to the “magical” 2000 level, 10.2% above current levels.
The Rule of 20 tool is again proving its usefulness in offering an objective, dispassionate measure of risk and reward based on actual facts. It is interesting to note that in spite of all the QEs of the world (literally) and of the radical change in sentiment (sell side, media, investors) of the past several months, the S&P 500 Index has refused to cross the “20” line into the overvalued area for the third time in this extraordinary bull market.
In early December 2013, I wrote in ENTERING THE DARK SIDE:
The Rule of 20 suggests that fair value on the S&P 500 Index is 1869, a mere 3% above current levels. Since 1956, the Rule of 20 P/E (actual P/E + inflation) has gone through the 20 fair value level 9 out of the 13 times it rose to “20”. Another way to look at it is to say that every time the Rule of 20 P/E rose to “20”, it kept rising into the “higher risk” area except between 1963 and 1966 and since 2009.
But while the recent streak of rational valuation in the S&P 500 Index remains unbroken, it is fair to say that we did get a good dose of irrational exuberance since last December. It was simply concentrated in small caps, biotechnology and the new generation of tech stocks, now suffering a well-deserved setback.
Upside to fair value in the 10% range is the best we have seen since the summer of 2013. Since the end of August, the S&P 500 Index has appreciated 11% while trailing EPS rose 9.5% and inflation remained stable.
The S&P 500 Index has broken its (still rising) 100-day moving average (1829). Technicians would say that the next resistance stands 3% lower at 1762 which is the (still rising) 200-day m.a.. Unless Q1 earnings come in much worse than currently expected and corporate guidance sees very unseasonal weather ahead, equities should not suffer a brutal correction.
That is unless inflation surprises everybody on the upside. Much faster core inflation just as the Fed is openly fearing deflation within an “accelerating economy” would justifiably spook investors. It seems wiser to keep the equity light on the cautious yellow for a while longer. Let’s see how the Q1 earnings season ends and how inflation behaves.
SENTIMENT WATCH
Partly because of the icy winter, overall profits for companies in the S&P 500 index are expected to slip 1.2% compared with last year’s first quarter, according to FactSet. That would be the first decline since 2012’s third quarter.
Hmmm…Factset’s April 11, 2014 Earnings Insight begins with:
The estimated earnings decline for Q1 2014 is -1.6%. If this is the final percentage for the quarter, it will mark the first year-over-year decline in earnings since Q3 2012 (-1.0%).
What the heck, let’s not get distracted by such mundane facts. On with the WSJ’s piece:
The pileup of recent stock-price losses is forcing money managers and investors to reckon with what they see as the growing possibility that stocks will be down at least 10% from their highs at some point this year. U.S. stocks haven’t fallen that much since 2011. (…)
A slide of 20% from the peak would put stocks in bear-market territory, and last week’s widespread selling deepened worries about a replay of the bear markets in 2000 and 2007. In many ways, though, the overall stock market, economy and Federal Reserve policy don’t suggest that a bear market is looming, say long time money managers and economists.
While continued turmoil in stock prices is likely, bear markets usually occur “when the Fed is trying to slow the economy down and other events intervene to make things worse,” says Ethan Harris, co-chief economist at Bank of America Merrill Lynch, part of Bank of America.
The last two bear markets struck after the Fed raised target short-term interest rates to cool inflation and a hot economy. Now the central bank is holding rates down even as it begins winding down its bond-buying program.
“The Fed’s message is that it is the good cop, not the bad cop,” Mr. Harris says.
If stocks swoon or economic growth falters, the Fed likely would try to steady the market, economists and money managers say. That wasn’t the Fed’s posture before the last two bear markets. (…)
Friday’s report of unexpectedly high wholesale inflation rattled some investors, though economists said the surprising number was due mainly to changes in the index. The bigger worries include slower growth in China and stocks that suddenly seem overvalued to many investors. That combination of factors suggests that 2014 will be mediocre for stocks but not disastrous. (…)
(…) The index has dropped 8.2% since closing at a 14-year high of 4357.97 March 5, weighed down by particular weakness in recent highflying biotechnology and technology stocks. (…)
Traders said there was no specific news behind Friday’s selloff. After a relatively quiet start to the session, volumes increased as losses accelerated. (…)
The iShares Nasdaq Biotechnology exchange traded fund slid 2.9%, and has lost 20% amid a seven-week losing streak. (…)
Zoe’s Kitchen rose 65% above its initial public offering price on its first day of trading. The Mediterranean-themed restaurant chain priced its 5.8 million share offering late Thursday at $15 each.
The Highfliers Are Still Too High Internet and biotech stocks are melting down, but most of the market looks fine. Apple, yes. Twitter, no.
(…) The air has come out of stocks like Twitter (ticker: TWTR), which is off 43% to $40 from its late 2013 high, and the 3-D printing group, the subject of a bearish Barron’scover story last month, is down sharply.
Even with the selloff in the highfliers, most look richly priced because of modest earnings or outright losses (see table). A nicely profitable Facebook (FB) is an exception. Moreover, many techs continue to get valued using a dubious profit measure that ignores often enormous stock-based compensation. Facebook, Twitter, LinkedIn (LNKD), Zillow (Z), andSalesforce.com (CRM) are prime offenders. (…)
Small and midsize stocks still look expensive. The Russell 2000 index trades for about 24 times estimated 2014 profits and the S&P MidCap 400 commands a P/E of 18. (…)
(…) As the lock-ups which prevented insider sales after their 2012 IPOs expired, executives and directors at companies such as Workday, ServiceNow and Splunkhave sold steadily, raising almost $750m between them over the past 12 months. (…)
Many of the sales were made through pre-arranged stock trading plans that spread disposals over a long period of time, so that corporate insiders have no discretion over the timing of individual transactions. Also, the slump in tech stocks has in many cases only wiped out the gains of the past six months, leaving share prices still above the levels at which insiders were selling for much of last year.
Among the biggest sellers, Jeff Bezos, chief executive of Amazon, raised $351m in February, taking his total sales to more than $1bn in just six months – more than three times the amount he had raised in the previous year. (…)
Sheryl Sandberg, chief operating officer of Facebook, has sold more than half her stake since the company’s IPO less than two years ago, benefiting from the steady rise in Facebook’s stock since the middle of last year. However, Ms Sandberg, whose disposals were made under a prearranged plan, began her sales when Facebook’s stock was at $21.08, well below the $58.53 it ended at last week. (…)
Roughly 11 per cent of fundraising rounds for private companies last year included some level of selling by insiders, compared with fewer than 6 per cent three years before, according to research firm PrivCo. (…)
Among insiders to take money out of their companies before going public, early backers of King Digital Entertainment, maker of the Candy Crush Saga game, were paid $504m in dividends in the months before their company went public. The company’s shares ended last week 22 per cent below their March IPO price. (…)
Three executives at Box, a cloud storage company which has posted big losses and raised questions about whether the recent tech stock rally has made it too easy for companies to become public entities, sold $11m of shares during private financings, according to the company’s prospectus.
From Goldman’s Sales & Trading Team,
The equity rout continued. Growth tech names felt the heat once again as Nasdaq led the way down, but the weakness was truly wide spread as all sectors ended in the red – both in domestic and overseas developed markets. Earnings season continued, but derisking is the name of the game in these markets. Financial feel the most pain (-1.1%) on a headline earnings miss, while Oil&Gas and Utilities finished at the top of the pack with only minor weakness.
The VIX marches higher +1.23 to 17.12.
Meanwhile:
Fitch cut the aluminum maker’s rating one notch to double-B-plus, which is in junk territory, from the investment grade rating of triple-b-minus, and said the company’s profitability has been hampered by global oversupply in aluminum.
Fitch also called out the company’s significant pension obligations, noting that Alcoa’s aggregate pension plans were underfunded by $3.2 billion as of Dec. 31.
However, Fitch noted that the rating outlook is stable, which reflects “slowly improving trends” despite prolonged market weakness.
While the March rebound in spending is impressive, household consumption in the first quarter should expand at a subdued 2 percent rate. Moreover, the underlying detail of the data does little to suggest a breakout above the three-year trend in personal consumption of 2.4 percent. Outside of the rebound in auto sales, growth revolved around weather sensitive categories such as building materials, which increased 1.8 percent. Demand for general merchandise expanded at a 1.9 percent rate and apparel increased 1 percent.
Cass/INTTRA Ocean Freight Indexes Report
(…) Data in some of these smaller cities is scarce. But in 100 cities tracked by Nomura HoldingsInc., 42% of those classified as Tier 3 and Tier 4 saw housing prices decline in March from February. Home construction in such cities is racing well ahead of population growth, says Beijing research firm Gavekal Dragonomics, as developers continue to build new projects without buyers. (…)
Robert Arnott: A Better Mousetrap?
