U.S. Leading Economic Indicators Index Eases

The Conference Board’s Composite Index of Leading Economic Indicators declined 0.3% during December following a 0.1% November uptick, revised from no change. It was the fourth decline in five months. During all of 2019, the leading index rose 1.5% after a 5.7% increase during 2018. From December-to-December the index ticked up 0.1%. (…)

Contributing negatively to the index change were weekly initial claims for unemployment insurance, building permits and the ISM new orders index. Contributing positively were stock prices, factory orders for consumer goods, the yield spread between 10-year Treasuries & Fed Funds, consumer expectations for business/economic conditions and the leading credit index. Exhibiting a neutral effect on the change in the leading index were the average workweek and new orders for nondefense capital goods excluding aircraft.

Three-month growth in the leading index of -1.4% (AR) was negative for the third straight month and below the high of +9.1% in December 2017. The y/y change eased slightly to 0.1% compared to a 6.5% high in September 2018.

The Index of Coincident Economic Indicators rose 0.1% during December after increasing 0.3% in November, revised from 0.4%. (…) Three-month growth in the coincident index held steady m/m at 1.1% (AR) but was down from 2.3% in August.

The Index of Lagging Economic Indicators eased 0.1% during December after a 0.4% November gain, revised from 0.5%. (…) Three-month growth in the lagging index eased slightly to 1.9%, but remained up from -0.4% in October. Twelve-month growth declined to 2.3%, down from 3.5% in July.

The ratio of coincident-to-lagging economic indicators is sometimes considered a leading indicator of economic activity. It increased modestly in December.

Charts from Advisor Perspectives:

Scott Minerd, Global CIO at Guggenheim Partners, asserts that “every US recession has been preceded by 3 negative months of LEI. Since #LEI began in 1959, 3 consecutive monthly declines have resulted in a #recession within 6 months 7 out of 11 times…Three consecutive declines are a necessary but insufficient condition, but 4 negative prints will seal the deal.”

Well, we got the 3 negative months between August and October but November was up one tick and December was down 3 ticks. Now what’s needed to “seal the deal”?

Meanwhile, initial claims are cleanly back within their 2-year channel:

FLASH PMIs

USA: Output growth quickens to ten-month high

U.S. private sector firms indicated a faster expansion of business activity in January, with the pace of growth accelerating to a ten-month high. The upturn was driven by a sharper increase in service sector output, as growth of manufacturing production was unchanged.

Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 53.1 in January, up from 52.7 in December, to indicate the quickest rise in output since last March. The increase in output was solid overall, despite the pace of growth remaining below the series long-run trend.

New business across the private sector continued to rise in January, albeit at a softer pace. The upturn in client demand softened slightly as both manufacturers and service providers registered slower expansions of new orders. In fact, goods producers recorded the least marked improvement in demand since last September, with growth easing further from November’s ten-month high. Meanwhile, new export orders placed with U.S. private sector firms dipped into contractionary territory at the start of 2020.

Nevertheless, firms expanded their workforce numbers at a faster rate in January. Employment grew for the third successive month and at the quickest pace since last July. The rate of job creation accelerated to a six-month high at service providers, while manufacturers registered the slowest rise in workforce numbers since last September.

Meanwhile, price pressures across the private sector remained historically subdued, despite the rate of input cost inflation picking up to a seven-month high. Higher operating expenses were commonly linked to stronger increases in raw material prices and wages. Average output charges rose at only a marginal pace, with the rate of inflation easing from December’s ten-month high.

At the same time, output expectations across the private sector improved at the start of 2020, with optimism reaching a seven-month high in January.

The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index registered 53.2 in January, up from 52.8 in December. This signalled a solid increase in service sector output that was the fastest since last March.

Although the pace of output growth accelerated, the expansion in new orders moderated slightly. The upturn in sales was the third in as many months, and signalled stronger client demand compared to the second half of 2019.

Service providers were buoyed by further business activity growth and increased their workforce numbers, and at a quicker rate.

Service sector firms signalled an improvement in business expectations, as the degree of optimism reached a seven-month high. However, business confidence remained well below the series trend

Finally, the rate of input price inflation quickened to the sharpest since last July, despite being historically muted. In an effort to remain competitive, services firms raised their output charges at only a modest pace.

Manufacturing firms noted a slower improvement in operating conditions in January, as signalled by a slight dip in the IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) from 52.4 to 51.7 in January. Notably, the latest upturn in the health of the sector was the softest since last October.

Although output continued to rise at a moderate pace, new business growth was only marginal as both domestic and foreign client demand softened. Furthermore, new export orders fell for the first time since last September, though only slightly.

Nevertheless, goods producers continued to increase their workforce numbers at the start of 2020, albeit at the slowest pace for four months. The softer rise in employment coincided with signs of easing capacity pressures, with January seeing the first fall in backlogs for four months.

At the same time, price pressures eased across the manufacturing sector in January. A weaker increase in cost burdens occurred alongside only a fractional rise in factory gate charges.

Eurozone growth remains muted at start of 2020

Flash PMI data for January indicated that the eurozone economy failed to pick up growth momentum at the start of 2020. Business activity increased at the same slight pace as was seen in the final month of 2019 as the rate of expansion in new orders remained muted.

Underlying data showed that growth of services activity eased slightly, while the manufacturing sector moved closer to stabilisation. Combined growth of the ‘big-2’ eurozone economies picked up, but this was offset by near-stagnation across the rest of the single-currency area.

The ‘flash’ IHS Markit Eurozone Composite PMI® was unchanged at 50.9 in January, signalling a further muted increase in activity across the euro area economy. The rate of expansion has remained broadly stable since the start of the final quarter of 2019, running at the weakest for around six-and-a-half years.

The overall expansion in business activity was again centred on the service sector. That said, services activity rose at a slightly weaker pace than in December. Meanwhile, manufacturing production remained in contraction, but the rate of decline eased to the softest in five months.

The ongoing muted pace of output growth reflected a lack of momentum in new order inflows. New business increased for the second month running in January, but the rate of expansion remained marginal. There were signs of manufacturing new orders nearing stabilisation at the start of the year, with the rate of decline in new work easing to the softest since November 2018. This was also the case with regards to manufacturing new export business.

While rates of growth in output and new orders remained muted at the start of the year, companies were increasingly confident regarding the year-ahead outlook for activity. Business sentiment rose to a 16-month high, largely thanks to a fifth successive improvement in confidence among manufacturers amid signs that the worst of the recent downturn has passed.

Confidence in the outlook for output encouraged companies to take on additional staff in January. The rate of job creation quickened from that seen at the end of 2019, but remained muted amid further job cuts at manufacturers. Rises in operating capacity enabled companies to deplete backlogs of work again at the start of 2020.

The rate of input cost inflation quickened to an eight-month high, but remained relatively muted. In turn, companies raised their selling prices at a pace that was broadly in line with those seen through the second half of 2019.

A sharp and accelerated increase in input costs was recorded in the service sector, while the current sequence of decline in manufacturing input prices was extended to eight months.

The ‘big-2’ eurozone economies of France and Germany saw a positive start to the year, with combined output growth at a five-month high. Germany in particular showed signs of recovery as overall output rose for the second successive month amid a first increase in new orders since June last year. A stronger expansion in services activity and a less marked decline in manufacturing production contributed to the improving picture.

The recent solid performance of the French economy continued in January as both output and new orders rose for the tenth month running. Rates of expansion softened, however, amid weaker growth in the service sector.

The rest of the euro area showed signs of weakness. Output growth slowed to a six-and-a-half year low, signalling a near-stagnation in business activity outside Germany and France. In fact, new order volumes were unchanged and firms raised staffing levels only fractionally.

Japanese economy rebounds at the start of 2020

The headline Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI)® increased to 49.3 in January, up from a previous reading of 48.4, thereby signalling continued contraction of the goods-producing sector. However, the decline was the slowest since last August and only mild overall.

The headline Business Activity Index [Services] moved above the neutral 50.0 mark during January, rising to 52.1 from 49.4 in December. This signalled a rebound of services activity and the quickest output expansion in four months. Stronger increases were also recorded for new business and employment, while output charges moved up into inflation territory.

“Positive signs have emerged for Japan’s economy at the start of 2020, with flash PMI data pointing to a domestic-led economic recovery. While official data are yet to confirm it, the fourth quarter looks on track to register an ugly decline in GDP. The January flash numbers will certainly allay fears for now of an impending technical recession in Japan. (…)

“Nevertheless, manufacturing confidence edged up in January in the wake of easing US-China tensions and some optimism regarding Japanese relations with South Korea. Panel comments suggesting that demand conditions in the semi-conductor industry have picked up is a promising sign.

New Warehouse Supply Projected to Exceed Demand Over Next Two Years

Developers are expected to deliver about 301 million square feet of new warehouse space in the U.S., Canada and Mexico this year, while tenants will lease about 242 million square feet, according to a new report from Cushman & Wakefield PLC.

The real-estate firm projects builders will deliver another 272 million square feet in 2021, outpacing projected demand of 218 million square feet. (…)

Cushman & Wakefield said in its report that builders added more space in North America in 2019 than tenants could take on, the first time since 2009 that has happened. (…)

Goldman to Refuse IPOs If All Directors Are White, Straight Men

Goldman Sachs Group Inc. Chief Executive Officer David Solomon issued the latest ultimatum Thursday from Davos. Wall Street’s biggest underwriter of initial public offerings in the U.S. will no longer take a company public in the U.S. and Europe if it lacks a director who is either female or diverse. (…)

BlackRock Inc. and State Street Global Advisors are voting against directors at companies without a female director. Public companies with all-male boards based in California now face a $100,000 fine under a new state law. (…)

Almost half of the open spots at S&P 500 companies went to women last year, and for the first time they made up more than a quarter of all directors. In July, the last all-male board in the S&P 500 appointed a woman. (…)

Next year, the bank will raise the threshold to two diverse directors, which includes diversity based on sexual orientation and gender identity, Goldman said in a statement. (…)

EARNINGS WATCH

We now have 74 S&P 500 companies in, sporting a low 68% beat rate (74% last 4 quarters) and a 23% (19%) miss rate, with a +3.9% surprise factor. The actual earnings growth of these 74 companies is +0.5% in Q4 on a +3.4% increase in revenues.

During Q3’19, the first 73 companies to report had an 84% beat rate and a 12% miss rate, with a +4.3% surprise factor. Their actual earnings growth was –0.9% on a +2.9% revenue gain.

Q4’19 earnings are now seen down 0.7% (+2.0% ex-Energy), from –0.3% on Jan. 1.

IT companies are leading this rally, perhaps because all 9 companies that have reported their Q4 beat estimates with a +2.5% surprise factor. Tech earnings are still expected up only 0.8% in Q4, slightly better than the +0.5% growth expected on Jan 1.

Analysts see a nice rebound in growth starting in Q1’20 and accelerating big time to +15.7% in Q4’20. Let’s hope they have more luck this year than last. That said, tech analysts are in good company on earnings forecasts…

• The chart suggests that the tech sector appears stretched, at nearly 20% above its 200-day moving average. (Isabelnet) Image: Strategas

Same with large caps overall as Ed Yardeni illustrates:

IT stocks are selling at 22.3x forward EPS, a 26% premium over non-IT equities.

Net earnings revisions have turned positive for IT companies:

They sure need it given their current PEG ratio:

At today’s opening of 3325 on trailing EPS of $163.20:

Cash or No Cash? Optimist, Pessimist or Realist?

David Kotok at Cumberland Advisors:

(…) Think about this question when the 5 largest stocks are 1/5 of total market weight and are in the highest beta sector.  Remember cash is zero beta: The S&P 500 index of all 500 stocks has a beta of 1; those 5 largest stocks have a beta above 1.5.

So far, this 2019–2020 stock market rally has been fierce. It started at the low point on Christmas Eve in 2018. Since then, the bias toward the large-cap tech sector has dominated the market. Consider that there are four companies with market caps above $1 trillion. They are Amazon, Apple, Microsoft, and Alphabet (Google). A fifth large-cap stock, Facebook, sits at a mere $700 billion. The total of the FAAMG stocks now equals about 19% of the market capitalization of the S&P 500 Index. The other 495 stocks make up 81% of that market cap. And the market cap-to-GDP ratio is the highest in the entire history of the American stock market while the profit share of that GDP is stagnant except for the benefit of the tax cuts.

The five FAAMG companies are all stellar business operations. They all have multidimensional and multinational business reach. They are all growing despite their enormous size.

So the question facing investors is not if these are viable companies, and not if they are making or losing money, and not if they have adequate capital. Those answers are “Yes!” The questions facing the investor are (1) how do I deal with momentum, and (2) how high is the price before it represents an extreme valuation.

Both questions are subject to robust debate. Please note that you could have had this debate months ago when the prices were lower. And also note that you may have it again months from now when prices may be higher. Pundits and analysts can talk and write all day long about risks and issues. They do not face the buy-sell-hold decisions that a professional money manager faces every single day.

In today’s world, the momentum issue is the most difficult one. We know momentum is powerful. We know it can continue for much longer than folks expect. We do not know when it will change, and we can only guess at the catalysts for change.

In today’s world a special factor is the policy of the world’s central banks. In the United States, the Federal Reserve has been expanding the size of its balance sheet and is maintaining interest rates at a very low level. The policy interest rate in the United States is below the various inflation rates, which means that the use of money (in real terms) is free. When that happens, asset price momentum is upward and will likely continue to be upward as long as money expands and the cost of money is next to zero.

In Europe and Japan, policy is expansive, and the cost of money is free or subsidized by negative interest rates. Remember, when the interest rate is negative, the theoretical asset price can go to infinity. With the usage of cross-currency interest-rate swaps, there is a clear transmission mechanism such that the negative rates in Europe and Japan end up raising asset prices in the United States.

In sum, this stock market is driven by momentum, and it is a force that must be respected. The market could go higher or much higher. It could stumble into a serious correction. We saw a 20% correction within the last two years. To be sure, this stock market could go both much higher and much lower in the coming year.

Meanwhile, we have some cash in reserve, and we are worried about the extended market behavior of FAAMG and its secondary effects on the broader indexes. Our ETF selection is defensive. Our quantitative strategies hold cash or defensive and lower-beta positions.

Twenty years ago, we faced a problem with the NASDAQ market top and the tech stock bubble. At that time (April 1, 2000), we wrote a piece entitled “Will the NASDAQ sell-off become a crash? A Value Perspective.” Here is a link to our archive. https://cumber.com/pdf/Cumberland-Advisors-April-2000-Will-the-NASDAQ-sell-off-become-a-crash.pdf. The circumstances today are different, and history never repeats itself exactly, though it often “rhymes.” We shall see.

All in one year:

U.S. Satisfaction Surpasses 40% for First Time Since 2005

Forty-one percent of Americans are satisfied with the way things are going in the U.S., a level not seen in nearly 15 years. (…)

The higher level of satisfaction measured in the Jan. 2-15 Gallup poll comes at a time when Americans’ evaluations of the U.S. economy are the best they have been in nearly two decades, perhaps because of continued low unemployment and record stock values. (…)

Consistent with this pattern, 72% of Republicans are currently satisfied with the way things are going in the U.S., compared with 14% of Democrats. Thirty-seven percent of independents are satisfied.

The five-percentage-point increase in overall satisfaction this month is primarily attributable to higher ratings among Republicans. Since last month, there has been a 14-point increase in Republicans’ satisfaction. Meanwhile, the percentage of independents who are satisfied is unchanged since December, and Democrats show a statistically nonsignificant two-point increase.

Since Gallup began measuring national satisfaction in 1979, 37% of Americans, on average, have been satisfied, meaning the current figure is just above the historical average. The highest satisfaction level Gallup has measured was 71% in February 1999.

The prolonged slump in satisfaction ratings since 2005 — with an average 27% satisfied — has brought the historical average down six points from where it stood in 2004.

One reason satisfaction readings have been lower in recent years is that those who identify with the party that does not occupy the White House have been extremely reluctant to say they are satisfied with how things are going in the country. Since 2005, on average, 11% of the opposition party’s supporters have said they were satisfied. Between 1992 (the earliest year for which Gallup compiled party data) and 2004, the opposition party’s satisfaction levels were three times higher, at 34%.

However, reflecting a broader discontent that has taken hold in the country, supporters of the sitting president’s party have also expressed lower satisfaction since 2005 (45%) than they did before (57%).