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

THE DAILY EDGE: 30 JANUARY 2020

U.S. Pending Home Sales Decline Throughout the Country

U.S. pending home sales fell 4.9% (+4.6% y/y) during December, according to the National Association of Realtors (NAR). The shortfall was the second in the last three months. During all of 2019, the average index level of 105.7 was 1.0% higher than in 2018 when the index declined 4.0%.

Sales declined in each region of the country last month. They fell 5.5% (+7.4% y/y) in the South, the third consecutive monthly decline. In the West, sales were 5.4% lower (+7.0% y/y) and have moved irregularly sideways for almost a year. Midwest sales fell 3.6% (+1.3% y/y), the second decline in three months. Sales in the Northeast declined 4.0% (-0.1% y/y) to the lowest level since May.

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Fed Holds Benchmark Rate Steady All 10 members of the Fed’s rate-setting committee voted to hold the fed-funds rate in a range between 1.5% and 1.75% and reaffirmed the Fed’s make-no-moves posture.

“We’re comfortable with our current policy stance and we think it’s appropriate,” Fed Chairman Jerome Powell said at a news conference after the central bank announced its decision.

But his comments suggested that lingering risks to the global economy and difficulty sustaining inflation at the Fed’s 2% target meant that if Fed officials were to change rates, they would be more likely to cut them than to raise them. (…)

“We have seen this dynamic play out in other economies around the world and we’re determined to avoid it here in the United States,” he said. Mr. Powell later said the review was designed to address how “ongoing powerful, global disinflationary trends” have hampered central banks around the world. (…)

The Fed’s postmeeting statement Wednesday offered a mixed assessment of the economic outlook. It described consumer spending growth as moderate, a downgrade from “strong” in December, and said business investment had remained weak. (…)

ONLY AROUND RICHMOND?

Richmond Fed’s Regional Surveys of Business Activity:

Survey results suggest strong wage growth among service sector firms in January, as this index rose to an all-time high of 50. Measures of employment and the average workweek also indicated growth, but firms reported difficulty finding workers with the necessary skills. They expected this struggle to persist but wages and employment to grow in the near future.

The average growth rates of both prices paid and prices received by survey participants fell in January, as growth of prices paid continued to outpace that of prices received. Respondents expected both growth rates to slow further in the coming months.

Fifth District Survey of Service Sector Activityimage

China first quarter growth may dip below 5% as virus spreads: government economist

(…) Zhang, an economist at the Chinese Academy of Social Sciences – a top government think tank – said his forecast was based on the assumption that the outbreak will peak in early to mid-February and end by the end of March.

Zhang is among many government economists and, while the Academy’s views often serve as a recommendation for Chinese policymakers, his views may not fully align with those of the government, which has yet to issue any assessments. (…)

In response, the government is likely to step up policy support, which could boost the annual budget deficit as a share of GDP to over 3% in 2020, he said. (…)

German Unemployment Falls as Industry Outlook Starts to Brighten

The number of people out of work dropped by 2,000 in January to 2.277 million, defying economist predictions for an increase. The jobless rate held at 5%, near a record low. (…)

Germany’s government raised its growth projection for this year to 1.1% and sees momentum accelerating further in 2021. Even though that’s an improvement from 2019, when output expanded at the weakest pace in six years, Economy Minister Peter Altmaier said Wednesday that rates at those levels are hardly satisfactory. (…)

Eurozone economic sentiment jumps as unemployment reaches new decade low

Compared to the other eurozone surveys that have come out this month, the ESI was surprisingly upbeat with an increase to 102.8 from 101.3. German and French industry, in particular, became a lot more optimistic about the outlook and somewhat less pessimistic about recent production developments. These are signs that the bottom in manufacturing is now getting close.

One has to be cautious in interpreting these numbers though as uncertainty around the impact of the coronavirus on the global economy is mounting. That has not been factored into these results just yet, meaning that the revival of optimism could be short-lived. (…)

What the Middle East Peace Plan Really Means

(…) the Deal of the Century is remarkable for the overwhelming support it has among Gulf Arab states. Saudi Arabia, the United Arab Emirates, Egypt, Bahrain, Qatar and Morocco have all endorsed the proposal, though they have offered nothing specific about what they would do to see it through. Still, their collective rush to champion the deal is notable for what the breach between Arab Gulf states and the Palestinian Authority signifies: the new geopolitical reality emerging in the Middle East, one arrayed against the actions of Turkey and Iran.

(…) Put simply, the expansion of Iranian influence has become the security priority to which all other foreign policy issues take a back seat. The same could be said in response to Turkey, which has been aggressively advancing its interests in Syria and the Eastern Mediterranean. (…)

In that sense, the “Deal of the Century” is not about an Israel-Palestine peace; it’s about reconfiguring the alliance structure of the Middle East. Sunni Arab countries are beginning to pivot from foreign policies grounded in post-WWI realities and nationalisms stemming from 20th-century colonial mandates that defined the regional balance of power. Now they are becoming more visible in redefining regional geopolitics and aligning with former adversaries, grounded in new, emerging security threats. (Geopolitical Futures)

EARNINGS WATCH

We now have 143 S&P 500 companies in, a 71% beat rate (20% miss rate) and a +4.0% surprise factor. Aggregate earnings of those 85 companies are up 5.2%, much better than at the same time during Q3’19.

Pointing up The 22 IT companies having reported so far sport a 100% beat rate on earnings and 86% on revenues (S&P 500 avg: 65%). Their surprise factor is +8.9% on earnings and +2.9% on revenues (+0.7% avg). IT companies are 24% of the S&P 500 market cap and 20% of earnings. Analysts are now expecting IT earnings up 5.4% in Q4, from +0.5% on Jan. 1.

Q4’19 earnings are now seen unchanged (+2.7% ex-Energy). Q1’20 estimates are +5.6%, down from +6.3% on Jan. 1.

FYI from Goldman Sachs:

The EURO STOXX 50 derives 10% of its revenues from China, roughly twice as much as S&P 500 companies (6%). For some indices, such as the DAX, as much as 15% of company revenues come from China. In terms of sector exposure, Luxury stocks, Basic Resources and Autos are the most exposed (exhibit 2). Our China exposure basket, GSSTCHNA, generates about 25% of its revenues in China.

2. The exposure of the EURO STOXX 50 to China is about twice that of the S&P 500. Data available on request.

TECHNICALS WATCH

  • NDR Crowd Sentiment Poll
SENTIMENT WATCH
  • Bonds continue to see historic inflows

The week ended Jan. 8 saw the largest inflows to bonds ever recorded and the following week (which ended Jan. 15) saw the fourth highest total on record. Those two weeks combined set a record for bond inflows during a two-week period, according to Lipper data. (Axios)

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The world’s business elite is convinced that Donald Trump will win a second term in the White House in November, and investors seem to believe there’s little risk they will end up victims of the U.S. election.

In reality, investors face triple uncertainty about the outcome—and should be concerned. The election is highly likely to be close, because modern America is split down the middle—and that makes it inherently uncertain. The Democratic candidate isn’t yet chosen, and could be radical. And a victory by Mr. Trump might not provide the relief that investors expect. (…)

So far, markets have stayed sanguine. Shares have had a great run interrupted only by the fears from the Wuhan virus in the past few days. There’s little sign that investors are scared of anything on the political front.

They should be: The prospect of a socialist-leaning White House would surely hurt stocks in the short run, while Mr. Trump could hurt stocks for longer with a new trade war. CEOs and investors are too sure both of Mr. Trump’s prospects and that their share prices would do as well in his second term as they did in the first.

KKR’s views:

While all presidential elections are important, 2020 could be particularly consequential, as both a referendum on President Trump’s disruptive leadership and a harbinger of future direction for U.S. policy and politics. (…)

The historical context for this election is also important to keep in mind. Since 2015, insurgent candidates have won overwhelmingly across the world. This trend goes back further in the U.S. where, over the past 20 years, U.S. voters have increasingly voted against incumbents in favor of opposition parties. President Trump was elected as the ultimate insurgent, but today he is the incumbent. He will benefit most from a strong economy (since 1924, the only incumbent President’s defeated for re-election faced a recession in the two years prior to the vote). Recent tensions with Iran could help the President as historically Americans rally around their Commander in Chief during times of global crisis. Focus on Iran could also reduce coverage of and miniaturize impeachment proceedings against President Trump. Also, the power of any sitting President to set policy, build his party machine and make news is not to be underestimated, particularly when coupled with a unified GOP and President Trump’s remarkably effective communications and marketing skills.

On the other hand, President Trump, who has never achieved a 50% approval rating, has also mobilized and unified his critics. Remember the Trump GOP machine has lost many elections in 2017, 2018 and 2019. Consistent with the backdrop of a more politically charged environment, the 2018 midterms saw the highest eligible voter turnout in 104 years, and many of the 2019 off-year elections also produced historic turnout. Hence, our view is that President Trump will have more difficulty winning the popular vote. However, we all know that American Presidents are elected by the Electoral College, which means fewer than 10% of eligible voters in seven states — Florida, Michigan, Minnesota, North Carolina, Pennsylvania, Wisconsin, and Arizona — will select the next President of the United States. Within those states, pay particular attention to white working class men and suburban female voters.

U.S. Senate elections will also be important as the closely divided Senate will have a critical voice on new policy. The GOP’s four seat majority is potentially in peril, as several Republicans in Democratic leaning states face serious challengers. Prediction markets may underestimate this possibility, in our opinion. (…)

THE DAILY EDGE: 29 JANUARY 2020: Global Warning!

Durable-Goods Orders Rise, Masking Manufacturing Weakness Increase was driven by jump in defense spending

The reading, part of a report on U.S. orders for long-lasting goods, showed that new orders for nondefense capital goods excluding aircraft fell 0.9% in December from the previous month, to $68.6 billion, the Commerce Department said Tuesday. Those so-called core capital goods orders—which set aside volatile defense and transportation orders—are widely viewed as a measure of businesses’ willingness to spend on items such as machinery, equipment and computers.

The department also said new orders for all durable goods—products designed to last at least three years—rose 2.4% in December from the previous month. The increase was driven by defense orders, and came during a month when Congress approved a boost in military spending. (…)

Demand for military equipment surged in December after a steep decline in the prior month, with orders for defense capital goods up 90.2% on the month. New orders for transportation equipment were up 7.6%, boosted by a 168% jump in orders for defense aircraft. (…)

Excluding the often-volatile category of transportation, orders fell by 0.1% last month. Omitting defense, which also can be volatile, orders were down even further, by 2.5%.

Orders for nondefense aircraft fell sharply, which several economists attributed to the continued grounding of Boeing’s 737 MAX passenger jet. Overall orders in November were also weaker than previously estimated, revised to down 3.1%. (…)

New durable goods orders overall decreased 1.5% for all of 2019 compared with 2018, with core orders up 0.8% on the year. (…)

Business investments, capex, is generally shown as manufacturing shipments of goods. But software investment has been rising steadily, even if still relatively small:

fredgraph (50)

YoY:fredgraph (51)

QoQ: not pretty:

fredgraph (52)
Executives Try to Assess Financial Impact of Coronavirus Measures

(…) Companies across a range of industries, including travel, leisure and consumer products, could be negatively affected by the continued spread of the virus that originated in the Chinese city of Wuhan and has since moved across China and to other countries, including the U.S., according to analysts at Moody’s Investors Service.

“The fear of contagion could dampen consumer demand, and affect tourism, travel, trade and services in affected countries,” said Atsi Sheth, a managing director at Moody’s, according to a news release.

Stocks of some travel companies, alongside casino and hotel operators, have taken a hit, and more businesses are expected to report a financial impact should the virus keep spreading, analysts said. (…)

Ford said it is still assessing the costs of the prolongation of the Lunar New Year holiday, which has been extended until early February. Other foreign companies with large facilities in China, including German chemicals maker BASF SE, said it is too early to quantify potential hits to the business from the spread of the virus. (…)

Petrofer Chemie H.R. Fischer GmbH + Co. KG, a German chemicals company with operations in China, said the spread of the virus could hamper its supply chains, both with regard to raw materials as well as with finished products. “We will have problems, but it is too early to tell what the financial impact will be,” managing director Constantin Fischer said in an interview.

The economic and earnings picture, world-wide, for the first half of 2020 is messed up by the spreading of the virus. Not only is consumer demand impacted, but corporations are also feeling the brunt on their own spending and supply chains, already disrupted by the trade war.

ING: “We expect retail sales in China to drop from 8%YoY to around 3% – 4%YoY. Meanwhile, global tourism, which relies heavily on Chinese tourists, could experience a negative growth of more than 30%. We expect Chinese GDP growth to be reduced by 0.3 percentage points to 5.6% in 2020.”

We should thus expect slower economic growth in Q1 and Q2 and a long string of reduced guidance and downward earnings revisions likely starting with the Q4’19 earnings calls of the next 3 weeks.

Central bankers across the world will lean dovishly amid the uncertainty. China’s PCB, in particular, will likely ease up further, along with the government which will surely announce more stimulus. During the SARS episode in 2003, China’s quarterly growth rate slipped by 2% in one quarter according to economists. Since China’s GDP was then growing 11%, the rest of the world did not feel it as much as if it had been growing by 6%, like it is now. China was 5% of global GDP in 2003. It is now 16%.

This outbreak is happening during China’s biggest spending season and authorities have reacted much earlier and much more seriously than in February-March 2003. The World Health Organization issued a global alert on March 12, 2003. The disease was stopped in July.

U.S. National Debt Will Rise to 98% of GDP by 2030, CBO Projects Sustained federal budget deficits and debt will hit the highest levels since World War II over the next decade, according to a Congressional Budget Office report.

The government will spend $1 trillion more than it collects in 2020 and deficits will reach or exceed that threshold every year for the foreseeable future. As a share of gross domestic product, the deficit will be at least 4.3% every year through 2030. That would be the longest stretch of budget deficits exceeding 4% of GDP over the past century, according to the CBO, an nonpartisan arm of Congress.

Debt held by the public is projected to be 81% of GDP this year and to reach 98% by 2030. That stems from the combination of tax cuts and projected increases in spending—particularly on safety-net programs such as Medicare and Social Security as the population ages and health-care costs rise. (…)

“Not since World War II has the country seen deficits during times of low unemployment that are as large as those that we project,” said CBO Director Phillip Swagel, who warned that the budget is on an unsustainable path.

Tuesday’s deficit forecasts may end up being too low. The CBO’s projections assume there are no changes to current spending and tax law. Deficits and debt would be larger if Congress extends individual tax cuts beyond their scheduled expiration at the end of 2025.

Congressional Republicans want to extend those tax cuts, and President Trump is preparing to propose further cuts as part of his re-election campaign. (…)

Longer-time-span deficit forecasts are even more daunting as the population ages. The federal debt is projected to hit a record 174% of GDP by 2049, 30 percentage points higher than what the CBO forecast last year. (…)

The CBO projected economic growth will gradually slow from 2.2% in 2020 to 1.7% after 2021, and unemployment will start to rise in 2022 while remaining below historical averages. (…)

In the current expansion, annual economic growth averaged 2.3% through 2018, the latest year for which full-year data is available.

That compares with 2.9% during the previous expansion from late 2001 to 2007, and 3.6% in the 10-year expansion that ended in early 2001, according to the Commerce Department. (…)

Could the budget deficit hit double digits?

A couple of weeks ago the White House National Economic Council Director Larry Kudlow hinted that “Tax Cuts 2.0” could be unveiled during the U.S. Presidential election campaign. We’ll wait for more details before considering altering our 2020 U.S. GDP growth forecast which currently stands at 1.9%. But the very mention of tax cuts may not resonate as well as it used to with voters. A recent poll conducted by the Pew Recent Center noted that more than half of Americans view the federal budget deficit as a “very big” problem. Latest projections from the Congressional Budget Office won’t reassure those folks.

As today’s Hot Chart shows, under current law, i.e. before taking into account “Tax Cuts 2.0”, the CBO is projecting the federal budget deficit to increase to almost 6% of GDP by 2030. That assumes no U.S. recession over the forecast horizon. In other words, should there be an economic downturn within the next decade ─ which will almost certainly dent revenues and boost expenditures via automatic stabilizers ─, the budget deficit as a % of GDP may well end up in double digits. (NBF)

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GLOBAL WARNING
The world is drowning in debt

The world’s already huge debt load smashed the record for the highest debt-to-GDP ratio before 2019 was even over.

In fact, it broke that record in the first nine months of last year. Global debt, which comprises borrowings from households, governments and companies, grew by $9 trillion to nearly $253 trillion during that period, according to the Institute of International Finance.

That puts the global debt-to-GDP ratio at 322%, narrowly surpassing 2016 as the highest level on record.

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More than half of this enormous number was accumulated in developed markets, such as the United States and Europe, bringing their debt-to-GDP ratio to 383% overall. (…)

Despite favorable borrowing conditions, the refinancing risk is massive. A total of more than $19 trillion of syndicated loans and bonds will mature in 2020. It’s unlikely that all of these will be refinanced or repaid. (…)

Surprised smile Apple now has $207.06 billion in cash on hand, up slightly from last quarter
European Banking Regulator Encourages Mergers to Boost Profits The eurozone’s main banking regulator encouraged lenders to consider mergers and acquisitions to boost profits, reinforcing an increasingly vocal message to bankers across the region.
  • Eurozone bank margins have been drifting lower as rates dipped into negative territory. (The Daily Shot)

Personally, I would not have used “drifting lower”. NIMs have actually been sinking as a result of the ECB’s policies.

BTW:

The U.K. has decided once and for all to allow cellular carriers to use equipment made by Chinese telecom giant Huawei and other “high-risk vendors” in their 5G buildouts. The announcement isn’t exactly a surprise; some British carriers had already been moving forward with Huawei. Still, it’s important, in part because the U.S. has continued threatening to curtail intelligence-sharing with countries that include Huawei in their 5G networks. Just yesterday, Senate Republicans introduced legislation that would turn such threats into a formal ban. As a core “Five Eyes” member, the U.K. boasts a robust intelligence relationship with the U.S., so London’s decision, especially if the U.S. proves to be bluffing on the matter, will likely serve as a de facto green light to other countries that have been reluctant to do business with the Chinese. The Pentagon’s move last week to block Commerce Department plans to ban exports of components and software to Chinese telecom firms will further undermine the U.S. campaign to isolate Huawei.

It’s worth noting that the U.K. isn’t exactly embracing Huawei wholeheartedly. It’s effectively limiting Huawei gear to what’s known as the “edge” of 5G networks – think base stations, routers and antennas – where the security vulnerabilities are arguably the lowest and the buildout costs are certainly highest. It’s also limiting the market share of “high-risk vendors” to 35 percent in order to address sabotage concerns, while banning their equipment from networks around military bases and other sensitive installations. (Geopolitical Futures)

EARNINGS WATCH

We now have 104 S&P 500 companies in, a weak 68% beat rate (22% miss rate) but a +4.6% surprise factor. Aggregate earnings of those 85 companies are up 3.5%, much better than the –0.6% seen at the same time during Q3’19.

SENTIMENT WATCH

From SentimenTrader:

With a combination of no commissions and a runaway market, retail traders haven’t been this active in 15 years. Brokerages with a heavy retail customer base have seen trading activity skyrocket relative to overall market volume.

Daily average revenue trades (DARTs)

The introduction of commission-free trading throws a big wrench into this data, because when something is free, people use more of it, and it will become more difficult for the brokers to define what exactly it means for a trade to generate revenue. But activity spikes like this have not been positive for stocks.

Last week, there was a jump in the number of stocks within the S&P 500 that reached a 52-week high then reversed to close below the prior week’s close. More than 10% of stocks triggered one of these buying climaxes, the 2nd-most in almost 2 years.

S&P 500 buying climaxes key reversals

Over the past 25 years, any week with more than 50 buying climaxes saw an annualized forward return of -3.3% in the S&P 500, compared to nearly +23% after a week with no climaxes.