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: 22 OCTOBER 2019

Trump Says China Signals Trade Talks on Target for November Deal

President Donald Trump said China has indicated that negotiations over an initial trade deal are advancing, raising expectations the nations’ leaders could sign an agreement at a meeting next month in Chile.

“They have started the buying,” Trump said Monday during a Cabinet meeting at the White House, referring to Chinese purchases of U.S. agriculture products that the president has pushed for as part of a deal. “I want more,” he added. (…)

Ross also told Fox Business Network that the “actual meat” of the agreement would come in two additional phases yet to be completed. While the White House touted a preliminary agreement earlier this month, officials in Beijing have yet to confirm anything is set in stone. (…)

Meatless is the new trend.

JPMorgan Warns U.S. Money-Market Stress Likely to Get Much Worse

JPMorgan Chase & Co. says the money-market stress that sent short-term borrowing rates surging last month is likely to get much worse despite the Federal Reserve’s attempts to inject billions of dollars into the financial system. (…)

JPMorgan says it’s not convinced the Fed has resolved the issues in the funding markets, according to a note from analysts led by Joshua Younger in New York. Funding pressures resurfaced last week even after primary dealers, firms approved to trade directly with the Fed, took all of the available overnight liquidity from the central bank and sold it as many T-bills as possible. (…)

“With year-end coming up, this is all likely to get much worse, in our view, before it gets better.” (…)

The overnight liquidity provided by the Fed goes directly to primary dealers, whereas those most in need of it are the non-primary dealers, the JPMorgan analysts wrote. The success of the program therefore depends on how much of the liquidity is passed along, but primary dealers are deterred from doing so by rules specifying how much capital they must hold to protect against losses.

Meanwhile, a preliminary analysis of balance sheets at the largest banks based on their third-quarter results suggests they may have to cut back on repo activity even more at year-end to avoid liquidity charges. (…)

JPMorgan’s note follows similar warnings from Bank of America Merrill Lynch and Goldman Sachs Group Inc., who have also attributed September’s funding stresses to factors including post-financial crisis bank regulation. Even after the Fed’s latest moves to ease the log-jam in funding markets, “intermediation bottlenecks remain,” Goldman Sachs said. (…)

Surprised smile Big drop in lending:

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Wave of Financial Stress Hits Low-Rated Companies An array of business challenges are hitting low-rated companies across the U.S. economy, driving selling in the bottom tier of the corporate-debt market.

(…) Investors and analysts closely watch junk bonds because companies with subpar credit ratings tend to be affected by economic problems sooner than others. Right now, many remain confident that the problems befalling certain companies aren’t symptomatic of broader economic challenges. Still, others worry that cracks at the very bottom of the market shouldn’t be taken lightly and could ultimately spread to a larger group of assets. (…)

Stress in high-yield bonds can be explained partly by problems in the energy sector, which makes up the largest portion of the market. But the trend is basically the same in the speculative-grade loan market, which is more heavily weighted toward other sectors, such as health care and technology. There, the extra yield that investors demand above the benchmark London interbank offered rate has been climbing since June for triple-C loans while remaining steady for higher-rated single-B and double-B loans.

Meanwhile, the number of loans downgraded by S&P Global Ratings has outpaced upgrades over the past three months by the largest amount in a decade. Default rates have also started to edge higher, though they remain well below their levels even from a few years ago. (…)

As Warren Buffett says, a receding tide reveals who’s swimming naked. Total Business Sales growth peaked in May 2018 at +8.3%. It was +1.1% last  August and let’s all cheer for the American consumer. The chart does not include September data. Recall that U.S retail sales fell 0.3% MoM in September, the first weak month since February.

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Retailers’ inventories are in good shape in contrast to others. Double the cheering for the consumer. If you missed it, last Friday’s Daily Edge had many charts on the consumer.

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  • Surely helping: Prime Spending Power

(Bloomberg via The Daily Shot)

But that engine runs on only half its cylinders:

An above-average percentage of consumers — 44% — reported incomes that don’t cover their expenses, or barely cover them, according to a quarterly UBS survey of around 2,100 U.S. respondents. That figure has risen by a percentage point over the last year. And 40% said they had encountered a credit problem like trouble obtaining a credit card or a student loan default, a 3 percentage-point rise from a year ago, the survey said. (…)

Just 17% of households reported their financial condition had improved in the last 6 months, down 3 percentage points from a year earlier. (Bloomberg)

BUY HIGH, SELL LOW!

Consumer confidence measures are merely coincident indicators. Sentimentrader reports on the Bloomberg Comfort Index:

The index has 3 components, one of which is asking whether consumers think it’s a good or bad time to buy. According to the latest survey from earlier in October, consumers have never thought it was a better time to buy than right now.

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There’s also an investor discomfort index:

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Half the World’s Banks Are Too Weak to Survive a Downturn, McKinsey Says

A majority of banks globally may not be economically viable because their returns on equity aren’t keeping pace with costs, McKinsey said in its annual review of the industry released Monday. It urged firms to take steps such as developing technology, farming out operations and bulking up through mergers ahead of a potential economic slowdown. (…)

“Going forward, scale will likely matter even more as banks head into an arms race on technology,” the report says.

(McKinsey’s report here)

STOXX 600: Q3 2019 Earnings

This should be the 3rd consecutive quarter of declining earnings in Europe. Note also the ongoing deceleration in revenue growth to zero in Q3. Forward estimates are wishful thinking. Two months ago analysts were seeing flat earnings this quarter.

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WeWork’s Board to Evaluate Emergency Bailout Plans The board is set to meet to weigh emergency-financing options including a takeover by SoftBank that would slash the co-working company’s valuation to about $8 billion

Ahead of a Monday deadline to submit bids, SoftBank has offered to lend $5 billion to the struggling startup and accelerate a $1.5 billion equity investment that had been scheduled for next year, people familiar with the matter said. SoftBank also would offer to buy more than $1 billion of stock from existing investors and employees, some of the people said. The moves would boost its equity ownership above 50%.

JPMorgan Chase & Co. plans to submit a competing $5 billion debt package backstopped by the bank that would bring together a group of outside investors including Barry Sternlicht’s Starwood Capital Group. (…)

The scramble to cobble together a rescue for WeWork reflects the company’s grim reality: It only has enough money to last a few more weeks and not many investors beyond SoftBank, which already owns a one-third stake, are eager to step into the fray. (…)

If its deal goes through, SoftBank will have invested well over $10 billion, and lent $5 billion more, to a company now valued at $8 billion or less. Its investments are split between the Japanese-listed parent company and the $100 billion Vision Fund in which SoftBank’s own money is mingled with that of outside investors. (…)

WeWork’s swift fall, in which it lost nearly $40 billion of value, marks a stunning collapse with little precedent for what was once one of the country’s most valuable startups. (…)

WeWork also is planning to cut thousands of employees, but delayed the layoffs earlier this month because it couldn’t afford the severance costs, people familiar with the matter have said. (…)

BTW, Softbank and its “Vision” Fund last invested in WE at a $47B valuation last January…

Fortune’s Term Sheet letter today:

There was sympathy for WeWork: Jill Woodworth, the chief financial officer of newly-public fitness equipment maker Peloton, expressed sympathy for WeWork’s management. “I look at WeWork and I have so much sympathy,” she said on a panel at the Most Powerful Women Summit. “When I look at how quickly the market sentiment can change and companies don’t live up to expectations, it’s absolutely gut-wrenching for management.” (Note: She made these comments before the latest WeWork news broke.)

Woodworth explained that there’s a negative bias toward unprofitable companies that hit the public markets, but she hopes that sentiment changes in the long term. She elaborated: “For us, it’s growth—not at all costs—but growth is 100% our priority. If your opportunity is massive, you should just grow as fast as you can.” (…)

Woodworth said she doesn’t feel added pressure for Peloton to become profitable faster now that it’s a public company. Several months ago, she said, an investor asked her the following question: “What will change when you’re public?” 

“And I said, ‘Nothing.’ My job is to help this company build shareholder value,” Woodworth said. “It doesn’t change when you’re public. I’ve seen how market sentiment can shift on you, and the idea of changing your entire strategy based on a market shift is not something we want to do.”

Miss Woodworth may be very smart (MIT grad) but she has equity market history upside down. Tech companies have changed their entire strategy based on a market shift away from profits to growth-at-all-costs. Current signs are indeed of a market shift… back to what is the old, time-tested normal: valuing equities on profits and cash flows.

Cisco’s Kelly Kramer, the third CFO on the panel, expressed caution when choosing which metric to prioritize.

“We’ve been around 30 years, and we have a very long-term investor base,” Kramer said. “Our investor base gives us the top metrics it cares about, and they’re always margin rates and cash flow. The business has to make tradeoffs sometimes, but long-term, we have to explain profitable growth.” (…)

Almost Daily Grant’s on Oct. 10:

(…) Then there’s Peloton Interactive, Inc., which has absorbed a 20% stock-price drop since its Sept. 25 listing.  On Tuesday, Peloton sued competitor Echelon Fitness LLC over its “cheap, copycat products” which imitate “the Peloton Bike experience.” Peleton, which sells exercise bicycles for $2,245 and describes itself as “a technology company, a media company, an interactive software company, a product design company, a social connection company, a [direct-to-consumer] retail company, an apparel company, and a logistics company” in its form S-1, posted a $203 million operating loss in the 12-months ended June 30. That compares to a $48 million loss the year prior.

Cycling in a sea of red ink, Peloton is no outlier. According to Jay R. Ritter, the Joseph B. Cordell Eminent Scholar Chair at the University of Florida, 80% of IPO’s last year sported negative earnings per share, trailing only the year 2000 for the highest ratio of money losers in the last 28 years.  That threshold has crossed 60% only eight times during that period, but in every year since 2013. 

Echoes with the late-90’s tech bubble extend beyond just the aggregate data. Speaking on CNBC Monday, former Nasdaq CEO Robert Greifeld observed that the IPO market “remind[s] me back of the dot-com era, when you had companies going public that had no known path to profitability.” Of We Co. in particular, Greifeld remarked: “[It is] in some ways a parody of some of the hubris you see in the start-ups.” 

2020 ELECTIONS STUFF

From David Rosenberg:

The number of new eligible young voters will be nearly 16 million in November 2020 while the number of people over the age of 65 who have since passed away exceeds 8 million. That’s a huge four-year shift.

And what we see in the polling data is that 29( of the 18-29 age group favor Bernie and 26% support Warren. Only 13% would vote for Joe Biden right now – like Trump, his support (40%!) comes from the 65+ crowd (…) (interestingly, Warren has 33% support from the 65+ group versus 5% for Bernie). (…)

And rare is the four year period where 16 million newbie teenagers have the ability to head to the voting polls – if 8 million-plus show up, at a time when there are more than 8 million fewer older voters, that could end up being a huge swing factor.

  • Brace for a Voter-Turnout Tsunami

(…) In a recent paper, the Democratic voter-targeting firm Catalist projected that about 156 million people could vote in 2020, an enormous increase from the 139 million who cast ballots in 2016. Likewise, Public Opinion Strategies, a leading Republican polling firm, recently forecast that the 2020 contest could produce a massive turnout that is also unprecedentedly diverse. (…)

McDonald thinks the turnout surge in 2020 could shatter even older records, estimating that as many as two-thirds of eligible voters may vote next year. If that happens, it would represent the highest presidential-year turnout since 1908, when 65.7 percent of eligible Americans cast a ballot, according to McDonald’s figures. Since 18-year-olds were granted the vote, the highest showing was the 61.6 percent of eligible voters who showed up in 2008, leading to Barack Obama’s victory. And since World War II, the highest turnout level came in 1960, with John F. Kennedy’s win, when 63.8 percent of voters participated. (…)

In last year’s midterm, nearly 120 million people voted, about 35 million more than in the previous midterm, in 2014, with 51 percent of eligible voters participating—a huge increase over the previous three midterms. The 2018 level represented the largest share of eligible voters to turn out in a midterm year since 1914, according to McDonald’s figures. Catalist estimated that about 14 million new voters who had not participated in 2016 turned out two years later, and they preferred Democrats by a roughly 20-percentage-point margin. (…)

The nature of the population eligible to vote is evolving in a way that should indeed help Democrats. McDonald estimates that the number of eligible voters increases by about 5 million each year, or about 20 million from one presidential election to the next. That increase predominantly flows from two sources: young people who turn 18 and immigrants who become citizens. Since people of color are now approaching a majority of the under-18 population—and also constitute most immigrants—McDonald and other experts believe it’s likely that minorities represent a majority of the people who have become eligible to vote since 2016. (…)

States of Change, a nonpartisan project studying shifts in the electorate, projects that Millennials (born, according to the organization’s definition, from 1981 to 2000) will constitute 34.2 percent of eligible voters next year. Post-Millennials (born after 2000) will make up another 3.4 percent. That means those two groups combined will virtually equal the share of eligible voters composed of Baby Boomers (28.4 percent) and the Silent and Greatest Generations (another 9.4 percent).

These shifts have enormous implications because of the generational gulf in attitudes toward Trump and the parties more broadly. His approval rating has consistently lagged among the more racially diverse, socially tolerant younger generations. Though Trump and the GOP have shown some signs of weakness recently among seniors, he has generally polled much better among voters older than 50, in part because a much larger share of Americans in that cohort are white. (…)

In recent elections, white working-class voters have turned out at a rate slightly above minorities’, but well below that of white voters with at least a four-year college degree. College-educated whites have been moving toward the Democrats in recent decades, a transition that has accelerated under Trump. (…)

In relying as heavily on working-class white people as he does, Trump is pushing against a demographic current that has steadily run in the opposite direction for many years.

Data from States of Change show that over the past quarter-century, white voters without a college education have typically declined as a share of actual voters little by little over each four-year presidential cycle: They fell from 61 percent of voters in 1992 to 44 percent in 2016. Minority voters, meanwhile, have increased over those seven election cycles from 15 percent in 1992 to 26 percent in 2016. And college-educated whites have drifted up, from 24 percent in 1992 to 30 percent in 2016. (…)

Those changes pose obvious problems for Trump in winning the national popular vote. But they also present a challenge for Democrats, because these shifts are not evenly distributed among the states. The electorate is not diversifying nearly as fast in the three Rust Belt states that Trump dislodged from the Blue Wall—Michigan, Pennsylvania, and Wisconsin. Those states, for years to come, will remain older and whiter than the nation overall, meaning that to win them, Democrats have to run better with older, whiter voters than they do in most places.

And while the minority population is growing steadily in existing and emerging Sun Belt battlegrounds—such as Arizona, Florida, North Carolina, Georgia, and even Texas—Trump has demonstrated a formidable ability to offset that change by turning out older, rural, evangelical, and blue-collar white people in those places. In stark contrast to the national forecasts, Schwerin says Priorities USA projects that non-college-educated whites will represent a slightly larger share of the vote in the battleground states next time than they did in 2016.

Unless and until Democrats can tip some of the potential Sun Belt battlegrounds, particularly Arizona, Florida, and North Carolina, the party can’t reach 270 Electoral College votes without recapturing some of the Rust Belt states least affected by demographic change.

Teixeira is one of many Democratic strategists who say the party’s top priority must remain regaining those Rust Belt states, because it cannot yet rely enough on the Sun Belt. “How can you possibly count on these states?” he says. “Democrats haven’t won Florida for a while. Arizona, they haven’t won in a million years. Georgia, Texas—are you kidding me? These are hard states. You cannot build a strategy around having to win those states.”

Chipping into Trump’s base of non-college-educated and rural white voters isn’t the only way for Democrats to win back the Rust Belt states he took in 2016: They could also theoretically recapture them by increasing turnout among young people and minorities, and converting more suburban white people. But in a 2020 election likely to be defined by a historic surge of new voters, many Democrats are resigned to facing the same old challenge of scratching out a few more votes in mostly white union halls and country diners across the Upper Midwest.

Rosenberg again:

All that said, there hasn’t been an election before where the fiscal policy gap was so wide within the Democratic Party, and in comparison to the GOP. This is something totally new – perhaps outside of FDR in the 1930s. This is a battle between capitalism and socialism,and the polling does show that the youth has moved far to the left and that they may be a powerful voting force next year.

Rosie omits the other big issue, the environment, also way up on the list of priorities for younger voters.

THE DAILY EDGE: 21 OCTOBER 2019: Weak Earnings

U.S. Leading Economic Indicators Weaken Again

The Conference Board’s Composite Index of Leading Economic Indicators eased 0.1% (+0.4% y/y) during September following a 0.2% August decline, revised from no change. (…) Performance amongst the components of the Leading Indicator index was mixed last month. Contributing negatively to index change were the readings for ISM new orders, building permits, the yield spread between 10-year Treasuries & Fed Funds and consumer expectations for business/ economic conditions. Offsetting these declines were initial claims for jobless insurance, stock prices and the leading credit index. The average workweek was unchanged.

Three-month growth in the leading index of 0.4% (AR) remained below the high of 9.1% in December 2017. The y/y change also weakened to 0.4%.

The Index of Coincident Economic Indicators held steady (1.5% y/y) during September following an unrevised 0.3% August gain. (…) Three-month growth in the coincident index fell to 1.1% (AR) from 2.3% in August.

The Index of Lagging Economic Indicators improved 0.1% (3.2% y/y) last month following a 0.4% decline during August, revised from -0.3%. (…) Three-month growth in the lagging index declined to 1.9%, down from 4.5% growth as of July.

The ratio of coincident-to-lagging economic indicators is sometimes considered a leading indicator of economic activity. It was little changed versus August and higher than the July low.

The LEI has been trending poorly lately, up only 0.2% in the last 6 months, 0.1% in the last 3 and down in each of the last 2 months totalling –0.3%.

The Conference Board Leading Economic Index (LEI) for the U.S.

From @ScottMinerd, Global Chief Investment Officer of @GuggenheimPtnrs

Sept. decline in Leading Economic Indicators (LEI) plus Aug -0.2% revision sets stage for possible negative print next month. Every US #recession has been preceded by 3 negative mos of LEI. A necessary condition, not sufficient but 4 negative prints will seal the deal. Be warned!

Bespoke confirms Markit’s more accurate Manufacturing PMI:

ISM Offsides, If Not Utterly Incorrect

This week’s manufacturing activity releases from the New York Fed and Philly Fed showed a slightly weaker but generally upbeat assessment of economic activity. The numbers from these two regional surveys may not be fully representative of the aggregate national economy, but they’re usually a pretty good indicator. As shown in the chart below, they’ve been a decent guide to what the ISM Manufacturing index says about national activity since the Empire State manufacturing index started its releases in 2001.

Unlike these two indices, which have shown a general uptick in activity over the last few months, the ISM index shows a different route. But that data isn’t backed up by the average results across the five Fed districts that survey their manufacturers. The size and scale of the divergence is so big that one of these indices is almost certainly wrong, but which?

For a tiebreaker, Markit’s manufacturing survey suggests conditions are at multi-month highs and picking up, more consistent with the data from Fed surveys than ISM. Markit’s sample size is bigger and the index is more representative of the whole sector than ISM only; with all five regional Fed surveys in the mix, they also have a sample size advantage over ISM. Hard data of late (including manufacturing production, exports, and hiring) has all sided against ISM and is showing data more consistent with the Five Fed or Markit surveys. For now, it looks like the brutal ISM results are a bit overstated.

China’s Liu Confirms Phase One of U.S. Trade Deal is in Progress

(…) “China and the U.S. have made substantial progress in many aspects, and laid an important foundation for a phase one agreement,” Vice Premier Liu He said at a technology conference in Nanchang, Jiangxi, on Saturday. He reiterated that China is “willing to work in concert with the U.S. to address each other’s core concerns on the basis of equality and mutual respect.” (…)

Matthews Asia’s Andy Rothman is among the optimists. He also offers some interesting stats:

STEPPING BACK FROM THE BRINK?

(…) Trump’s enthusiastic comments leave me optimistic that a formal deal can be concluded next month. Stating that the two sides had already “come to a deal on intellectual property, financial services,” as well as “a tremendous deal for the farmers,” Trump said, “I have very little doubt that we’ll be able to get this thing finalized now. It’s not overly complex.”

The president remarked “there was a lot of friction between the United States and China. And now, it’s a lovefest.” He also provided some domestic political cover for Xi, describing the deal as “fantastic for China” as well as “fantastic for the United States.”

I remain convinced that both sides are highly motivated to conclude a deal. Trump appears to recognize that a deal is better than no deal for his re-election prospects. No deal would mean continued taxes on Chinese goods, paid for by American families and businesses. No deal would mean a continued Chinese boycott of American soybeans, which is contributing to harsh conditions for farmers in politically important states. No deal would mean continued economic uncertainty, which is leading to weaker corporate CapEx and worries about a recession.

The tariffs are not a huge problem for Xi, as China is no longer an export-led economy, but failure to conclude a deal would open up the risk that a trade war leads to restrictions on China’s access to American tech, everything from semiconductors to research collaboration. That would be a significant setback to China’s economic growth, which Xi wants to avoid.

(…) the dollar value of retail sales in China was equal to 91% of U.S. retail sales last year, up from 36% a decade earlier. But real retail sales rose 6.4% YoY during the first nine months of this year, compared to 1.6% in the U.S. (…)

Over the last five years, the real growth rate of retail sales in China slowed by an average of 0.9 percentage points each year, and during the first three quarters of this year, the growth rate also slowed by 0.9 percentage points, compared to the same period in 2018.

This year and in 2018, sharply weaker auto sales—due to structural issues, including the removal of subsidies that brought forward demand in earlier years—contributed significantly to slower growth in overall retail sales.

Excluding autos, nominal retail sales rose 9.1% during the first nine months of this year, compared to 10.4% during the same period last year and 11% in 2017. (…)

Here is another perspective: household consumption—a metric which includes services as well as goods—rose 9.9% YoY in 3Q19, up from 7.3% in 1Q19 and 8% a year ago. This acceleration reflects the rising share of consumer spending on services, as well as the strength of spending on services, including education and travel. (Spending on education, culture and recreation is up 14% this year, for example.) Services now account for 51% of household consumption, up from 40% in 2008.

This consumer story has been fueled by phenomenal income growth. Real income rose 5.8% YoY during 3Q19, a bit slower than 6.3% a year ago. Over the last decade, real income rose 120% in China, compared to a 17% increase in the U.S.

A key driver of income growth has been the rise of entrepreneurs. There were no privately owned firms in China when I first worked there in 1984, but now 87% of urban employment is by small, private companies.

And I think the consumer story is sustainable, in part because Chinese households still save about 27% of their disposable income, compared to an 8% savings rate in the U.S. (…)

In my view, the impact of the tariff dispute on the Chinese economy has been modest. A bigger contributor to slower growth has been the Chinese ongoing campaign to reduce risks in the financial system, which has led to a sharp crackdown in off-balance sheet, or shadow credit, which declined 7.9% YoY in September. This has reduced systemic risks, but it has also meant that the firms that relied on non-standard credit sources, especially small private companies, have struggled (even more than usual) to get access to credit.

It is a positive sign that Beijing has not responded to slower growth by allowing a resurgence of shadow credit. (…)

Aggregate credit outstanding rose 10.9% YoY last month, the same pace as in August and slightly lower than 11.2% a year ago. Credit isn’t tight—it is rising faster than nominal GDP growth—but there is no sign of significant stimulus. This leaves room for stimulus should growth slow more sharply if the trade dispute worsens.

Beijing also has room to cut rates if needed. During 1H19, the weighted average lending rate was 5.7%. (…)

(…) Beijing is taking steps to give banks more leeway to lend, prodding local authorities to borrow to fund big-ticket infrastructure projects like high-speed railways, and allowing the country’s currency, the yuan, to depreciate to counter trade challenges from the U.S.

In the last few years, China’s government has signaled it was de-emphasizing the GDP’s pace, in favor of an emphasis on what officials called the quality of growth. The priority was containing debt. But authorities are now indicating that the headline growth rate is important again. (…)

The problem is that after China’s building binge in the past few decades, it is harder than ever to come up with projects that make economic sense and would meet regulatory requirements, according to ANZ economist Betty Wang, who notes officials are unwilling to stake their political careers on projects that may face a backlash. (…)

SENTIMENT, TECHNICALS WATCH

Investors have been spooked by last year’s 18.7% correction (!!) and recent volatility. Will we see a repeat of 2016-2017?

Image@topdowncharts

  • Thumbs up Lowry’s Research says that “the forces of Supply and Demand suggest the market is consolidating its gains from the Dec. 24, 2018 and June 4, 2019 lows through this sideways trading rather than forming a significant topping pattern. Thus, the probabilities are this period of consolidation will be resolved to the upside through a rally that carries to new all-time highs. (…) Historically, breadth tends to lead price in moving to new highs. Thus, if precedent holds, the new highs in the various Adv-Dec Lines reinforce the probabilities the market’s current sideways movement will be followed by a rally that carries the major price indexes to new highs in the months ahead.”

  • Thumbs up If You’re Not Long, You’re Wrong

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

The reason for my bullishness is simple: Bad news is good news. Policymakers and heads of states see the threat of a slowdown and are more likely to enact stimulus measures to prevent a full-blown recession. This is especially the case in nations with upcoming federal elections—the biggest one being the U.S. presidential election.

President Donald Trump is under pressure from a series of House investigations, not to mention an impeachment inquiry that’s near guaranteed to result in official articles of impeachment. Be that as it may, Trump is the only U.S. president that I’m aware of who sees the market as a barometer of his policies’ success. Every morning, after he wakes up and coifs his hair in the mirror, he wonders what his administration can do to drive stocks higher. We’ve already seen aggressive corporate tax cuts and a wave of deregulation, and we may expect to see more as Trump seeks reelection. So even though you may not like the man’s governing style or his Twitter activity, he always has investors’ interests in mind.

Friday saw the highest equity put volume since August 2011. As a % of NYSE volume, it was the highest since February 2009. Bullish or bearish?

Image@sentimentrader

As recent weeks pass it seems the investor sentiment measures are increasingly indicating an investor that is becoming more bearish even as the market continues to trend higher this year. The current investment environment seems like one where the market is climbing the proverbial “wall of worry.” A case in point is the spike on Friday in the CBOE Equity Put/Call ratio to .99. This is the highest level since the Equity Put/Call ratio reached 1.13 on December 21, 2018, Historically, readings above 1.0 have been associated with levels where the market is near a point where it turns higher. This potential set up to a move higher is on top of the 21% gain achieved year to date.

  • Thumbs down Participation Problem

Among all common stocks trading on the NYSE, fewer than 50% of them have moved above their 200-day averages. For a time when the S&P had climbed to within 1% of a former high, this is an abnormally low figure. On average, 63% of NYSE stocks are in bull markets when the S&P nears an old high. (…)

Better returns came when participation was not at an extreme, when between 50% – 70% of NYSE were in bull markets as the S&P approached a prior high. That could still happen in the days ahead if a bunch of stocks suddenly move above their 200-day average. As it stands, it looks to be a modest, but inconsistent, negative. (Sentimentrader)

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  • Thumbs up Lowry’s argues that “much of this drop in the percentage of New Highs can be attributed to a rotation in market leadership, as buying has moved away from momentum stocks towards stocks that have been market laggards. (…) much of the improvement in the Small Cap percentage has occurred over the past seven weeks, largely concurrent with the rotation among market leaders. Relative to their Sept. 5 levels, (…) the percentage of OCO Small Cap stocks near their highs has climbed, from 7.75% to 11.51%, suggesting an increased focus on small cap stocks. Since small caps are typically among the weakest performers prior to and during the formation of a major market top, recent strength in this segment also suggests the market’s sideways movement should be resolved through a breakout rally to new highs.”
  • Thumbs down Lastly, short interest is at a low:
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Confused smile High five But watch the fundamentals. Valuations are high when earnings are weak. And the equity-market-watcher-in-chief is embroiled with a Thumbs down Congress, a huge foreign policy mistake in the Middle-East, a not-so-easy-to-win trade war with China and an economy hanging on the consumer nails, one year away from the elections. So, while “after he wakes up and coifs his hair in the mirror, he wonders what his administration can do to drive stocks higher”, he may come short of answers…other than to eventually sign something, anything, with President Xi.

EARNINGS WATCH

The facts from Refinitiv/IBES:

Through Oct. 18, 73 companies in the S&P 500 Index have reported earnings for Q3 2019. Of these companies, 83.6% reported earnings above analyst expectations and 4.3% 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 4.3% 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, 61.6% reported revenues above analyst expectations and 38.4% 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 -3.1%. If the energy sector is excluded, the growth rate improves to -0.6%.

The estimated revenue growth rate for the S&P 500 for 19Q3 is 3.1%. If the energy sector is excluded, the growth rate improves to 4.3%.

Pointing up Actual earnings growth for the 73 companies having reported is –0.9% on revenue growth of +2.9%.

By comparison, after 79 reports during Q2, the beat rate was 77%, the surprise factor +5.3% and the blended growth rate +1.0%, up from +0.3% on July 1. Actual earnings growth for the 79 companies having reported was +9.0% on revenue growth of +2.8%.

In effect, in spite of a strong beat rate and a decent surprise factor, earnings growth for the early reporters is negative compared to +9.0% during Q2. Meanwhile, analysts keep revising downward across the board:

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The estimated earnings growth rate for the S&P 500 for 19Q3 is -3.1% which is a worsening from the –2.2% estimated on October 1. At the same time last July, estimates for Q2 were improving from +0.3% to +1.0%.

The estimated earnings growth rate for the S&P 500 for 19Q4 is 2.7% (was +4.1% on Oct. 1, +7.2% on July 1). If the energy sector is excluded, the growth rate improves to 5% (5.9%).

In all, this, so far, is not a typical, market lifting earnings season. Earnings from 6 sectors are being revised downward from -6.7% on average on Oct. 1 to -9.3%. Average growth for the other 5 sectors is only being upped from +1.3% to +1.7%.

Trailing EPS are now $162.66, down 0.4% from their level at about the same stage during Q2 and –1.0% from the end of September. Look at the yellow line below: headwinds which, if not reversed, need a strong valuation push to take equities higher.

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Still early but not a great earnings season so far. Some of the reasons

Thorough analysis of the impact of tariffs on prices/margins for both importers and exporters from and to China. This is the conclusion:

A rich literature theoretically characterizes the motivations behind enacting tariff policies and the potential implications they carry. Relatively little is known, however, about how economies in practice respond to tariffs, particularly when these trade policies involve large countries that have the potential to influence prices. (…)

We find that tariffs passed-through almost fully to US import prices, implying that much of the tariffs’ incidence rests with the United States. In these same data, we find far lower rates of passthrough from exchange rate shocks into import prices. Furthermore, despite this rapid increase in the total cost of importing goods, we find more mixed evidence regarding retail price increases, which suggests that many US retailers reduced the profit margin on their sales of the affected goods.

Finally, we show how the response of US exporters to foreign retaliatory tariffs was not symmetric to the response of foreign exporters to US import tariffs. Foreign tariffs targeted undifferentiated goods exported by the United States, and US exporters significantly reduced their ex-tariff export prices on these goods, particularly on shipments to China. (…)

We offer some evidence that importers to some extent front-ran the recent changes in trade policy and document clear trade diversion away from China. These non-price margins of adjustment suggest that so far, we may have only seen the short-run response to tariffs.

Third-quarter earnings season has just begun, but at least 16 companies in the S&P 500, including Delta Air Lines Inc., Johnson & Johnson and General Mills Inc., have already blamed a strong currency for denting profits, according to company earnings calls.

That number is likely to grow in the weeks ahead as technology companies, consumer staples and others that get a significant portion of their sales from overseas report.

The WSJ Dollar Index, which tracks the dollar against 16 other currencies, rose to its highest level since 2017 last month. It is up nearly 1% so far this year after rising 4.3% in 2018. (…)

Companies, especially multinationals, have been blaming the dollar for hurting profit margins all year. A stronger dollar generally makes U.S. products less competitive overseas and raises the costs of converting foreign revenue back into local currency. The S&P 500’s technology sector makes more than half its revenue overseas, leaving it most exposed to a burgeoning dollar, followed by materials firms, energy companies and consumer staples. (…)

“It’s a pretty modest driver” of weaker earnings, [UBS] Mr. Lefkowitz said of the dollar. He estimates the dollar will shave about 0.5% from S&P 500 earnings versus the same period a year ago. The impact was bigger earlier this year, erasing 1% from profits in the first and second quarters, he added. (…)

(…) Abbott Laboratories, a manufacturer of health-care products, reported a 4% hit on sales from foreign exchange rates in key emerging markets such as India, Brazil, Russia and China. Johnson & Johnson, meanwhile, reported sales in markets outside the U.S. were 2.8% lower because of currency effects.

Philip Morris’s net revenue was reduced by $115 million because of currency effects in the third quarter, resulting in a foreign-exchange impact of $931 million since the beginning of the year. “Currency is something that is very hard to predict,” Chief Financial Officer Martin King said in an interview Thursday. The company hedges against movements in some currencies, including the Japanese yen, he said.

During the second quarter, North American companies listed on the New York Stock Exchange and Nasdaq recorded currency-related losses of $21.01 billion, down from $23.39 billion in the first quarter, according to Kyriba. Exchange rate-related losses at these companies have exceeded $20 billion for three consecutive quarters.

European companies listed on the FTSE 100 and Euronext reported a decline in foreign-exchange effects to $1.55 billion in the second quarter, down from $3.31 billion in the first quarter of 2019, Kyriba said.

If Kyriba’s numbers are right, currency losses represent 6-7% of quarterly earnings on the S&P 500 Index.

Credit-rating firms raise more alarms about the weakest corporate borrowers

S&P Global Ratings said its list of “weakest link” companies reached a 10-year high in September of 263, the most since November 2009, during the credit crisis when defaults soared to 10.5% globally for speculative-grade companies.

That doesn’t mean defaults in the roughly $1.2. trillion “junk bond” market are now at crisis levels, but it shows that S&P thinks hundreds of companies could flounder if conditions worsen. (…)

“The default rate of weakest links is nearly eight times greater than that of the broader speculative-grade (rated BB+ or lower) segment, and the weakest link tally may signify higher default rates ahead,” a team of S&P analysts led by Nicole Serino wrote.

Moody’s Investors Service on Thursday said that U.S. corporate defaults were still a low 3.2% in September among speculative-grade companies, but warned that downgrades and defaults could swell when the credit cycle turns.

The credit-rating firm isn’t forecasting that to happen in the next 12 months, but said defaults could “easily exceed the last cycle” peak of 14% if conditions deteriorate, largely due to the record volume of B3-rated debt that risks falling into Caa territory. (…)

The search for yield seems to be holding high yield spreads down. Moody’s multi-variable regression model (r-square statistic of 0.89) “now generates an estimated midpoint of 475 basis points for the composite high-yield bond spread. By contrast, the actual high-yield bond spread closed at 432 bp on October 16, which left its October-to-date average at 458 bp.” Moody’s goes a few steps further to warn us:

Of the many readily available macroeconomic variables that might explain the high-yield bond spread, the moving three-month average of the Chicago Fed’s NAI shows the strongest correlation of -0.82 with the high-yield bond spread. (…)

The NAI provides valuable insight regarding both the underlying quality of business activity and the risk of persistently rapid price inflation. On the inflation front, the Chicago Fed notes that a rising risk of an accelerating rate of consumer price inflation has been associated with a moving three-month average for the NAI of at least 0.70 points. (…)

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Moody’s Analytics estimates EDF metrics for publicly-held firms. For any issuer, the EDF, or the probability of default within one year, will be greater, the lower is the issuer’s market value of net worth and the higher is the volatility of the market value of the issuer’s business assets. If debt outruns the firm’s market value, the market value of net worth declines.

Moody’s Investors Service’s one-year high-yield default rate for U.S. issuers has been highly correlated with the average one-year EDF for eligible North American high-yield issuers of nine to 12 months earlier. For example, the high-yield default rate’s correlations are 0.88 with the high-yield EDF of nine months earlier and 0.79 with the high-yield EDF of 12 months earlier. (…)

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Prospect of President Warren Spooks Energy Investors Of all the market-moving tweets these days, one in particular from Democratic presidential hopeful Sen. Elizabeth Warren is sending shivers through the oil industry.

“On my first day as president, I will sign an executive order that puts a total moratorium on all new fossil fuel leases for drilling offshore and on public lands,” she tweeted on Sept. 6. “And I will ban fracking—everywhere.”

Outlawing a technique that energy producers use to blast oil and gas from shale formations would require legislation and spur a torrent of opposition from companies, investors and probably even state governments.

Substantial as those hurdles may be, they haven’t stopped analysts from running the numbers for investors and energy executives to see what might happen, if hydraulic fracturing were banned.

They are particularly focused on Ms. Warren’s threat to choke off drilling on federal lands. (…)

Entire oil-field service companies would become obsolete. Pipeline owners would suffer without replenishment, as existing wells peter out. The winners would be Canadian shale drillers and big global operators like Exxon Mobil Corp. and Chevron Corp. , for which higher energy prices would offset losses on U.S. assets. (…)

A spokeswoman for the Warren campaign said that motivating investors to move money from the oil-and-gas business is the aim. (…)

Analysts with Piper Jaffray’s Simmons Energy heard enough about Ms. Warren from money managers recently that they parsed her energy and infrastructure policy proposals in a note sent to clients last week. Though the presidential hopeful’s policies threaten the U.S. oil-and-gas business, they wrote, “her proposals would also result in continued downward impetus for renewable energy’s cost of capital and a likely step-change increase in renewable energy investment and rate of growth.”

Reuters’ Exclusive: Huawei in early talks with U.S. firms to license 5G platform – Huawei executive

Blacklisted Chinese telecoms equipment giant Huawei is in early-stage talks with some U.S. telecoms companies about licensing its 5G network technology to them, a Huawei executive told Reuters on Friday.

Ninja  How TURBINE PANDA and China’s Top Spies Enabled Beijing to Cut Corners on the C919 Passenger Jet

Rarely in the infosec industry do cyber investigators get the luxury of knowing the full scope of their adversary’s campaign—from tasking, to actual operations, all the way to completion. The oft-repeated mantra “Attribution is hard” largely stands true. Short of kicking down the door just as a cyber actor pushes enter, it is frustratingly hard to prove who is responsible for cyber attacks with 100% certainty. However, a series of recent U.S. Department of Justice (DoJ) indictments released over the course of two years, combined with CrowdStrike Intelligence’s own research, has allowed for startling visibility into a facet of China’s shadowy intelligence apparatus.

In this blog, we take a look at how Beijing used a mixture of cyber actors sourced from China’s underground hacking scene, Ministry of State Security (MSS/国安部) officers, company insiders, and state directives to fill key technology and intelligence gaps in a bid to bolster dual-use turbine engines which could be used for both energy generation and to enable its narrow-body twinjet airliner, the C919, to compete against western aerospace firms. What follows is a remarkable tale of traditional espionage, cyber intrusions, and cover-ups, all of which overlap with activity CrowdStrike Intelligence has previously attributed to the China-based adversary TURBINE PANDA. These operations are ultimately traceable back to the MSS Jiangsu Bureau, the likely perpetrators of the infamous 2015 U.S. Office of Personnel Management (OPM) breach. (…)