China Says Part of Phase 1 Trade Deal Text ‘Basically Completed’

China said parts of the text for the first phase of a trade deal with the U.S. are “basically completed” as the two sides reached a consensus in areas including standards used by agricultural regulators.

The Saturday comments followed a call Friday with Chinese Vice Premier Liu He, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin. The trade negotiators “agreed to properly resolve their core concerns and confirmed that the technical consultations of some of the text agreement were basically completed,” China’s Ministry of Commerce said in a statement on Saturday. (…)

In the statement from China, the two sides reached an agreement for the U.S. to import cooked poultry products from China, as well as to regard its catfish product regulation system as equivalent to the U.S. The Asian country will also lift the ban on American poultry exports and apply the Public Health Information System for meat products, the ministry said.

U.S. officials have said the first phase of the agreement will also include Chinese commitments on intellectual property and currency provisions. China is also expected to resume purchases of U.S. agricultural products at a level last seen before the trade wars started in 2019, in return for a pause in further U.S. tariffs, according to people familiar with the matter. (…)

Hmmm….”parts of the text for the first phase of a trade deal” about cooked poultry and catfish product regulations. We must assume that the other “parts of the first phase” involve the not-so-easy stuff mentioned in the last paragraph…

Elsewhere, Reuters informs us that

Beijing wants the United States to cancel some existing U.S. tariffs on Chinese imports, people briefed on the Friday call told Reuters, in return for pledging to step up its purchases of U.S. commodities like soybeans.

The United States wants Beijing to commit to buying these products at a specific time and price, while Chinese buyers would like the discretion to buy based on market conditions. (…)

One of the sources briefed on the talks said China’s offer would start at around $20 billion in annual purchases, largely restoring the pre-trade-war status quo, but this could rise over time. Purchases also would depend on market conditions and pricing.

USTR head Robert Lighthizer has emphasized China’s agreement to remove some restrictions on U.S. genetically modified crops and other food safety barriers, which U.S. sources say could pave the way for much higher U.S. farm exports to China. (…)

“They want to make a deal very badly,” Trump told reporters at the White House on Friday. “They’re going to be buying much more farm products than anybody thought possible.”

In today’s Geopolitical Futures:

China and the US Are Dealing With the Easy Stuff

(…) what’s important now is that the U.S. appears willing to settle on a deal that overwhelmingly ignores the stickiest points of contention altogether – at least for the time being. And recent moves from China suggest that it thinks a window of opportunity has indeed opened to lock in the handful of points where agreement is possible. A long-delayed Chinese Communist Party conclave this week will shed light on just how far Beijing is ready to push forward with critical reforms the U.S. is demanding.

At this point, even a limited, largely symbolic agreement would be a big deal to the extent that it staves off future escalation by the United States and shields U.S. businesses and consumers from the round of tariffs – by far the most painful – scheduled for mid-December. Just don’t expect this particular deal to do away with the bulk of existing tariffs, much less to resolve the underlying drivers of the dispute. Steep political constraints on Beijing will make a more comprehensive settlement even harder to reach down the road. Ultimately, the prospects of a final deal will hinge on just how much the United States, not China, is willing to cave. (…)

On the biggest issues, moreover, Beijing is going in the opposite direction. Its structural slowdown, trade pressure and soaring debt risks are forcing it to lean even more heavily on the state sector, for example. And to avoid falling into the fabled “middle-income trap,” bolster the People’s Liberation Army and reduce its dependence on foreign technologies, it’s doubling down on its support for advanced manufacturing sectors. (…) resistance to liberalization from entrenched state-sector stakeholders in China, combined with the party’s existential fear of widespread job loss, means Beijing is defaulting to the tools it trusts most to sustain stability.

There are also a number of points of contention that the U.S. itself isn’t willing to negotiate on – particularly those with national security implications resulting from China’s development of “emerging and foundational technologies.” (…)

And since the U.S. will need to hold on to leverage to ensure implementation of whatever Beijing concedes on trade, expect most of the existing tariffs to remain in place for the time being as well.

(…) the problem for the U.S. is twofold: One, reaping the easy, low-hanging fruit in negotiations now leaves only the hard stuff. Two, absent a cataclysmic loss of CPC control, Beijing can’t and won’t concede on most of the hard stuff just to get out from under tariffs. Rather, they’ll just push China deeper into its shell.

World trade monitor The CPB World Trade Monitor shows that the volume of world trade increased 0.5% in August, having increased 1.4% in July (initial estimate 1.9%).

• World trade volume increased 0.5% month-on-month (growth was 1.4% in July, initial estimate 1.9%).
• World trade momentum was -0.5% (non-annualised; -0.3% in July, initial estimate -0.1%).
• World industrial production increased 0.0% month-on-month (having increased 0.3% in July, initial estimate 0.2%).
• World industrial production momentum was -0.3% (non-annualised; -0.1% in July, unchanged from initial estimate).

GM Workers Ratify Labor Deal, Ending 40-Day Walkout The United Auto Workers ended its nationwide strike at General Motors factories after 40 days of picketing, as workers approved a new four-year labor deal and prepared to return to work immediately.

GM workers voted 57% in favor of approving the new four-year agreement, which includes better wages, hefty signing bonuses and a commitment from GM to invest $7.7 billion in its U.S. manufacturing operations, securing 9,000 jobs.

The new labor accord, covering more than 46,000 blue-collar workers, will allow GM to move forward with closing three U.S. factories, including a massive assembly plant in Lordstown, Ohio. Workers will return to work immediately, and GM plans to resume production as soon as possible at more than 30 U.S. factories that have sat idle for six weeks, a company spokesman said.

The car company will schedule overtime to make up for lost production, giving workers who have been without a paycheck for six weeks a way to recoup their finances.

Among the auto maker’s first priorities is to fill back-ordered parts at dealerships, which have had to delay repairs. GM plans to have its plants running full-tilt again early next week, the spokesman said. (…)

The damage to GM’s bottom line is likely to exceed $3 billion with most of the hit to be reported in the fourth quarter, according to Bank of America. On top of that, the new union agreement is expected to tack on $100 million or more a year in higher labor costs, industry analysts estimate.

The strike’s impact also cut deep for GM’s auto-parts suppliers. Many were forced to idle their own plants and temporarily lay off workers. For some, such as Magna International Inc. MGA 0.22% and Lear Corp. , the work stoppage could shave more than 3% from their 2019 earnings, according to analysts at Citigroup Inc.

GM workers won some considerable gains in this latest round of bargaining, including better pay for new hires, a path to full-time status for temps and no changes to the employee health-care contribution, currently at 3% and far lower than the average for other private-sector workers. They also will receive a one-time $11,000 bonuses for ratifying the contract. (…)

EARNINGS WATCH

From Refinitiv/IBES:

Through Oct. 25, 199 companies in the S&P 500 Index have reported earnings for Q3 2019. Of these companies, 78.4% reported earnings above analyst expectations and 15.1% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 20% miss estimates. Over the past four quarters, 74% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 4.6% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.3% and the average surprise factor over the prior four quarters of 5.3%.

Of these companies, 60.9% reported revenues above analyst expectations and 39.1% reported revenues below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 59% of companies beat the estimates and 41% missed estimates.

In aggregate, companies are reporting revenues that are 1.0% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 0.9%.

The estimated earnings growth rate for the S&P 500 for 19Q3 is -2.0%. If the energy sector is excluded, the growth rate improves to +0.5%.

The estimated revenue growth rate for the S&P 500 for 19Q3 is 3.4%. If the energy sector is excluded, the growth rate improves to 4.6%.

Actual earnings growth for the 199 companies having reported is +1.7% on revenue growth of +3.9%.

By comparison, after 185 reports during Q2, the beat rate was 75%, the surprise factor +3.1% and the blended growth rate +0.2%, down from +0.3% on July 1. Actual earnings growth for the 185 companies having reported was +4.1% on revenue growth of +3.6%.

Five sectors are expected to post declining earnings in Q3, including Consumer Discretionary for the first time in a long while:

The estimated earnings growth rate for the S&P 500 for 19Q4 is 2.2% (from +4.1% on Oct. 1 with all sectors revised down). If the energy sector is excluded, the growth rate improves to 4.5% (+5.0% last week).

Revisions turned positive last week:

Trailing EPS are now $162.96, down 0.8% from $164.31 at the end of September and down 0.4% from $163.62 after 185 reports during Q2.

At 3016 on the S&P 500 Index, the Rule of 20 P/E is 20.9 and the conventional P/E is 18.5, both measures at a high since September 2018.

TECHNICALS WATCH

Lowry’s Research says “significant longer-term improvements” are developing beneath the surface. “Perhaps most relevant as it relates to an eventual major upside breakout is evidence of returning risk appetite. Historically, sustained expansions in investors’ risk appetites often coincide with explosive, broad-based long-term advances as money flows out of defensive asset classes like cash and bonds and into stocks.”

Lowry’s considers trends in small caps as indicative of risk appetite. “(…) in recent days, the small-caps have achieved some potentially significant milestones.” Its analysis is “suggesting further strengthening ahead for small-cap stocks.” Lowry’s says that “not only are the number of strong stocks in the riskiest market cap segment expanding, but
perhaps more importantly, the weakest of smallcap stocks are also recovering more broadly.”

On the other hand, as discussed in recent weeks, “during the rally in prices from the October lows, Buying Power failed to recovery in a substantial way. A meaningful breakout of the major price indexes to new highs should include a similar trend in Buying Power.”

I have been warning against small caps since May 2018 (TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL) and again in June 2019 (SMALL STILL NOT BEAUTIFUL) Since April 30, 2018, the S&P 600 is up 2.0%, the Russell 2000 +1.4% and the S&P 500 +14.0%.

Based on current estimates, S&P 600 Index earnings will crater -18.0% this year (-16.1% ex-Energy) with 8 of 11 sectors in the red. This assumes that Q4 earnings surge 13.5% (+7.0% ex-E) after being down 7.6% in Q3 (-2.1% ex-E) if estimates are met. Through October 22, Ed Yardeni’s numbers show that S&P 600 Net Earnings Revisions were still very negative at –10.0% including heavy markdowns in Energy (-34%) and Financials (-15%) which are still expected to grow Q4 earnings 105% and 24% respectively.

It thus seems prudent to fade the spike in the green line below…

…particularly when you look at P/E ratios based on forward earnings…

…keeping in mind that small caps seem to have a secular margins problem exacerbated by more recent costs challenges…

…that, in the 11th year of a cycle, while still carrying an enormous debt burden.

Also note that 11% of S&P 600 companies are losing money (13% of the Russell 2000) while only one (1) S&P 500 company is losing money on a trailing 12 month basis.

Finally, if you think stock buybacks are fooling large cap investors, you should run away from small caps where buybacks have cut shares outstanding by more than half since 2000 while boosting debt:equity ratios.

China Carriers to Offer 5G for Public on Nov. 1, Beijing News Says

NARRATIVES

My old friend Hubert Marleau reviews Robert Shiller’s recent book “Narrative Economics-How Stories Go Viral and Drive major Economic Events”:

(…) His new ground-breaking book on narrative economics is a must read because Shiller’s many examples are convincing as to the importance of narratives in individual decision making and on aggregate economic phenomena. It essentially offers a new way to think about the economy and it’s change. He basically lays the foundation for a way of understanding the ebb and flow of how new exogenous or re-emerging perennial stories driven as much by feeling as fact. (…)

He shows how to take stories seriously because they drive our lives. Thus, he argues that we need to incorporate the contagion of narratives into economic theory. According to Forbes, we otherwise risk being blind to the very real, very palpable, very important mechanisms for economic change, as well as a crucial element for economic forecasting. Ultimately, narratives are major vectors of rapid change in culture, in zeitgeist, and in economic behaviour.

When a man of Robert Shiller’s stature is willing to risk his esteemed reputation on the idea that volatile human emotion counts for more than investors think in the objective valuation of stocks, bonds, commodities, currencies and real estate, one should listen to what he has to say. By narrative economics, he means the study of the spread and dynamics of popular accounts of events, particularly those of human interest and emotion, and how these change through time explain economic fluctuations.

He notes: “The human brain has always been highly tuned towards narratives, whether factual or not, to justify ongoing actions, even such actions as spending and investing. Stories motivate and connect activities to deeply felt values and needs. Narratives “go viral” and spread far, even worldwide, with economic impact.” He argues that stories people tell can affect or even cause major economic events and therefore merit the attention of investors. Indeed, ideas can and have gone viral and moved markets—whether it’s the belief that tech stocks can only go up, that housing prices never fall, or that some firms are too big to fail. (…)

Indeed. This is why Edge and Odds’ “The Daily Edge” post always displays articles’ headlines and main narrative so investors get the flavor of the time to better understand financial markets’ ebbs and flows and valuation trends that move along with media narratives.

My first blog launched in January 2009 was called “News-To-Use”, offering “a new way to think about the economy and financial markets”. I am not suggesting that Shiller was influenced by my blogging, if so he would have dismissed his CAPE valuation approach many years ago. CAPE, a faulty valuation tool, is still being supported by widespread narratives that remain blind to the facts…