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: 20 AUGUST 2019

Fearing Recession, White House Drafts Plans to Bolster Economy The White House continues to insist that the economy is strong, but advisers are looking at a potential payroll-tax reduction if things worsen.

White House officials have begun preparing options to help bolster the American economy and prevent it from falling into a recession, including mulling a potential payroll tax cut and a possible reversal of some of President Trump’s tariffs, according to people familiar with the discussions.

Mr. Trump continues to insist the economy is “doing tremendously well,” and he and his advisers publicly dismiss any notion of an impending recession. But behind the scenes, Mr. Trump’s economic team is pulling together contingency plans in the event the economy weakens further.

Officials inside the administration have drafted a white paper exploring a payroll tax reduction, which would seek to boost the economy by immediately injecting more money into workers’ paychecks. In 2011 and 2012, the Obama administration employed a two-year payroll tax cut in an effort to stimulate what was a sluggish recovery from the recession that ended in 2009. (…)

A White House official said more tax cuts were on the table, “but cutting payroll taxes is not something that is under consideration at this time.” Another senior administration official cautioned that a payroll tax cut was not under serious consideration. And a third official said that discussions of what tools could be deployed to offset a recession, based on examining what had been done in previous slowdowns, were hypothetical and not being explored with urgency. (…)

Calling for the cuts could give more political ammunition to Mr. Trump, who has already begun to blame Democrats for fanning the flames of a potential recession and could help the president put the onus on his opponents for failing to push through a tax cut if the economy weakens further. (…)

Researchers at JPMorgan Chase said on Monday that tariffs Mr. Trump has already imposed on $250 billion worth of Chinese imports amount to a tax of about $600 annually on an average American household. When the next wave of tariffs is fully in place, in December, the researchers said, that cost will rise to $1,000 per household. (…)

“Tax cuts 2.0, we are looking at all that,” Mr. Kudlow said. “By the way, Senator Rick Scott of Florida, very smart guy, made an interesting idea — a proposal on another network last week. He said, ‘Look, why don’t we take the tariffs from the China trade and turn those back to the taxpayers in the form of tax cuts?’ That’s an idea.” (…)

Recycling the same dollars, back and forth. That’s an idea!

Interestingly, the Washington Post was first on this on Monday. The NYT carried it today but not the WSJ, BB or Reuters.

But the WSJ’s Daily Shot had these great charts this a.m.:

This last chart is intriguing given that the aggregate national claims data have remained very low and manufacturing employment is still rising albeit more slowly. But weekly hours in manufacturing have declined 2.1% YoY to their lowest level since 2011:

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Employment in agriculture and related industries is down 3.3% YoY in July. On a seasonally adjusted basis, ag employment peaked in April 2017 and is down 10.4% since.

China’s economy slows to 4.6% in June

Fathom’s China Momentum Indicator 2.0, our preferred measure of the pace of economic activity in China, slowed to 4.6% in June, the weakest reading since August 2016. Gary Cohn, former chief economic advisor to Donald Trump, argues that this slowdown reflects a strategic decision by China to rebalance the economy at a time when any negative impact on growth can be blamed on US trade sanctions. However, we believe that China was slowing regardless. With the consumer share of total import demand on a downward trend since 2016, we also find little evidence to suggest that China is successfully rebalancing. Instead, policymakers are resorting to their tried and tested playbook, including currency depreciation. Indeed, since the first threat of tariffs in March 2018 the renminbi has weakened by 11% against the US dollar, neutralising what we estimate to be an increase of around 10 percentage points, over the same period, in the average effective tariff imposed by the US on imports from China. This undermines any hopes of rebalancing, while further frustrating trade relations, as evidenced by the US administration branding China a currency manipulator. It also acts as a fiscal transfer from China to the US.

Germany Readying Stimulus Plan as Contingency for Deep Recession

(…) Similar to bonuses granted in the 2009 crisis to prod Germans to buy new cars, the government is studying incentives to improve energy efficiency of homes, promote short-term hiring and boost income through social welfare, the people said. (…)

Signs are mounting that Germany’s rigid adherence to its balanced-budget policy is softening. On Sunday, Finance Minister Olaf Scholz suggested the government would aim to muster 50 billion euros ($55 billion) of extra spending in case of an economic crisis. Last week, Chancellor Angela Merkel said the economy is “heading into a difficult phase” and that her government will react “depending on the situation.” (…)

The hurdles for a stimulus program remain high. The government requires the lower house of parliament to declare a crisis so it can issue debt beyond the normal guidelines allowed during a recession. Without a sense of wide-spread malaise that approval could be difficult to justify, and Germany is still officially predicting an economic recovery before the end of the year. (…)

(Note to Miles: This is dated August 19, 2019 Winking smile)

Japan manufacturers turn pessimistic for first time since 2013: Reuters Tankan

(…) The monthly poll, which tracks the Bank of Japan’s (BOJ) closely-watched tankan quarterly survey, found manufacturers’ mood slid for a third straight month to minus 4 in August from the prior month’s plus 3.

It was the weakest sentiment reading since April 2013, when it was minus 4, dragged down by electric machinery, metals, food processors and transport equipment.

Confidence in the service sector also plunged, to plus 13 from plus 25 in July, due to big drops at wholesalers and retailers. That will raise questions over how much longer domestic demand can remain resilient enough to offset rising external pressures, with a rise in the domestic sales tax set for October.

Private consumption constitutes about 60% of the economy. (…)

A full year into the trade war, we read more of these stories: higher costs passed on or absorbed and more complex logistics.

Apparel Industry Works to Blunt Impact of Tariffs Apparel companies in the U.S. are bracing for squeezed profits and potential store closures as a result of the Trump administration’s pledge to extend tariffs on Chinese imports.

(…) About 40% of all clothing and 70% of shoes sold in the U.S. are made in China, according to the American Apparel and Footwear Association. (…) In all, about $33 billion in apparel, shoes and hats are among the items subject to a 10% tariff on Chinese imports beginning Sept. 1, according to a Wall Street Journal analysis of data from the Office of the U.S. Trade Representative and the Census Bureau. (…)

Jay Sole, a retail and department store analyst at UBS, estimated that if the administration raised tariffs on China to 25%, it could lead to as many as 12,000 stores closing, about 10% of the stores among the 524 retailers UBS tracks. Even the proposed 10% tariff would pressure hundreds of stores throughout the U.S., he added. (…)

Macy’s Inc., which raised prices on some luggage, housewares and furniture when tariffs on such items rose to 25% in May, said it was unlikely to repeat that approach for apparel subject to new tariffs.

“We learned from that experience that the customer had very little appetite for those cost increases,” CEO Jeffrey Gennette said during the company’s earnings call last week. Instead, he said, Macy’s would work with its Chinese partners to absorb the extra costs.

Many apparel companies would find it painful to do the same. Fifteen publicly traded clothing, footwear and accessories retailers tracked by UBS have margins of less than 3%. These companies represent $42 billion in sales, and they operate more than 12,000 stores, UBS said. (…)

At least a few retailers already facing tariffs have been able to raise prices without much consumer backlash. In May, Home Depot said it managed to pass the tariff costs on imported washing machines to its customers. Sales initially sagged, then recovered.

Steven Madden Ltd. , a shoe and fashion-accessory company, said it has already moved some production out of China. If any competitors feel compelled to raise prices after the China tariffs, the company would view that as an opportunity to gain market share.

“We’re making a good chunk of the Steve Madden-branded products in Mexico for fall,” CEO Edward Rosenfeld said on a recent earnings call. He added that some production was moved to Cambodia “and a number of other countries.”

But shifting suppliers isn’t an easy option for most apparel companies. It takes years to build relationships and establish new supply chains. Retailers have built quality-control systems in Chinese factories that can’t be dismantled and reassembled in another country overnight. (…)

WeWork Analyst Warns IPO Filing a ‘Masterpiece of Obfuscation’

WeWork’s IPO prospectus lacks the information needed to create a financial model of the company, according to an analyst who specializes in new listings. (…) “The prospectus is a masterpiece of obfuscation,” he said in an interview. “If the underlying facts were positive, why would a company go to so much trouble to prevent you from understanding them?” (…)

States to Move Forward With Antitrust Probe of Big Tech Firms Investigation would put additional scrutiny on an industry already under a federal spotlight

(…) The effort involving state attorneys general is expected to be formally launched as soon as next month, the people said. It is likely to focus on whether a handful of dominant technology platforms use their marketplace powers to stifle competition.

As part of the probe, the states are likely to issue civil investigative demands, similar to subpoenas, to tech companies and other businesses, the people said.

The new investigation could dovetail with plans by the Justice Department, which last month announced its own antitrust review that will focus on tech companies includingAlphabet Inc. ’s Google unit and Facebook Inc., the people familiar with the plans said.

The specific number of states that might join the investigation couldn’t be learned, though one person familiar with the effort said up to 20 or more may participate. (…)

“The attorneys general involved have concerns over the control of personal data by large tech companies and will hold them accountable for anticompetitive practices that endanger privacy and consumer data,” said a spokesman for New York Attorney General Letitia James, a Democrat. (…)

The expected state investigation would add a third major layer of scrutiny for the tech sector. In addition to the Justice Department probe, the Federal Trade Commission is investigating antitrust concerns at Facebook, including the company’s acquisition of nascent tech companies, as well as competitive issues elsewhere in the tech industry.

The involvement of state attorneys general could add to complexity and cost for the companies. These officials were a driving force in the landmark joint state-federal antitrust case against Microsoft Corp. two decades ago. Microsoft agreed to an array of conditions, including making the Windows platform more accessible to third-party software developers.

But the states eventually splintered over whether to accept a settlement. Some experts say their involvement expanded and extended the legal battle, at times significantly. (…)

In case you missed this link a few weeks back. Really worth the 16 min.: https://www.youtube.com/watch?v=WQMuxNiYoz4

THE DAILY EDGE: 19 AUGUST 2019

Trump Cites Hong Kong Concerns in Talks With China President speaks hours after administration officials confirm new round of trade negotiations

(…) Over the weekend, administration officials said they would give Huawei Technologies Co. more time to work with U.S. customers and said the White House was laying the groundwork for a new round of trade talks with Chinese officials in Washington, D.C.

Those moves, combined with last Tuesday’s delay in tariffs on $156 billion of Chinese goods, suggest an effort by the White House to dial back trade hostilities following a week of market swings. A 10% tariff on another $111 billion of imported goods will go into effect Sept. 1 as planned. (…)

“I’m making a decision tomorrow,” he said. “Ultimately we don’t want to do business with Huawei, for national security reasons.” (…)

Mr. Trump also said Sunday he was evaluating the effects of tariffs on tech company AppleInc., whose chief executive, Tim Cook, he had dinner with on Friday. The president said Mr. Cook told him that tariffs on imports from China give a competitive advantage to Apple rival Samsung Electronics Co. “And I thought he made a very compelling argument so I’m thinking about it,” Mr. Trump said.

The vast bulk of Apple’s products are made in China, while Samsung manufactures most of its goods elsewhere. (…)

Earlier in the day, Mr. Kudlow said American and Chinese trade negotiators will be holding one or more teleconference calls in the next week or two to set ground rules and discuss topics for new high-level trade talks. (…)

CEO Chuck Robbins

…what we’ve seen is in the state-owned enterprises anymore, we’re just being we’re being uninvited to bid. We’re not being allowed to even participate anymore. So those are the enterprises that’s where the large impact was this past quarter, so it was just a much faster decline of what we candidly expected. – (The Transcript)

Backing for Free Trade Up, Support for Trump Down in New Poll

(…) Almost two-thirds — 64% — see free trade as good for the U.S., an all-time high for the survey series. Support was up 7 percentage points from the previous time the question was asked, in 2017, and up from a bare majority of 51% in December 2015. Only 27% now believe free trade is bad, citing a negative impact on key industries. (…)

Costly Tariff Spat Masks Deeper Trade Problems The fight between the U.S. and China is the public face of the global slide toward protectionism

(…) “What we have is a change of direction for the U.S.” in terms of free trade, said Rob Martin, an economist at UBS. (…) UBS calculates the blossoming trade conflict has kept the U.S. economy around 0.75% smaller than it would have been had tariffs stayed where they were. (…) UBS says the world economy is around 0.4% smaller than it otherwise would have been. The damage will rise to 0.7% if Mr. Trump pulls the trigger on all threatened tariffs. (…)

Mr. Evenett, who oversees the Global Trade Alert project that tracks developments in trade policy, estimates that in 2019 around 73% of global trade will be affected by some trade-distorting measure. That compares with 35% a decade ago.

Efforts to revive economies weakened by the financial crisis have driven the shift, he said, and while the U.S. isn’t innocent of such practices itself, it is often on their receiving end. Nearly 59% of U.S. imports this year are subject to some trade-distorting measure. But in China, it is 75%. (…)

RECESSION WATCH
One County’s RV Industry Points to Recession Around the Bend Multiyear drops in recreational-vehicle shipments to dealers—many from the Elkhart, Ind., region—have preceded the last three recessions. Shipments have fallen about 20% so far this year, after a 4.1% drop last year, according to data from the RV Industry Association

(…) “The RV industry is better at calling recessions than economists are,” said Michael Hicks, an economist at Ball State University, in Muncie, Ind. Mr. Hicks says softening consumer demand for RVs coupled with rising vehicle prices due to tariffs suggests the economy is either in a recession or soon headed for one. (…)

Unemployment in Elkhart County, which has a population of 200,000, was 3% in June, below the national rate of 3.6%, according to federal data. But it is up from a low of 2.1% in April 2018. Weekly hours worked fell by half a percent in June. (…)

RV manufacturing giant Thor Industries Inc., based in Elkhart, said it was cutting back production of RVs and shifting its staff to a four-day workweek. LCI Industries , another Elkhart manufacturer, consolidated some of its facilities to address the slowdown.

Baird analyst Craig Kennison said he estimates based on proprietary data that retail sales of RVs this year are down mid-to-high single digits and expects a similar decline next year. (…)

Still, shipments remain historically strong. Executives say they expect inventory levels to balance out by the end of the year. The RV Industry Association is forecasting a 2.5% increase in shipments to dealers for 2020.

Bill Murnane, chief executive of LazyDays Holdings Inc., a national dealership based in Tampa, Fla., doesn’t think 2020 will bring the relief some manufacturers anticipate. He said consumer demand began to weaken last fall and he didn’t see it recovering soon. (…)

Divya Brown, the president of Houston.-based TAXA Outdoors, a small RV manufacturer, said her company bought most of its parts from Elkhart. Her suppliers are raising their prices to account for the hit they are taking from imported goods such as aluminum and steel. Ms. Brown said the company saw a 22% jump in the cost of steel and a 9% jump in the cost of aluminum.

“When our suppliers are having price increases, we’re seeing price increases,” she said. (…)

Bundesbank Warns German Economy Could Enter Recession

Also, from Charles Schwab:

The manufacturing downturn weighing on Germany is being felt around the world—with more than 75% of global manufacturing PMIs below 50. Thus, Germany is not a leading indicator but rather a reflection of what is happening broadly around the globe.

EARNINGS WATCH

From IBES/Refinitiv:

Through Aug. 16, 463 companies in the S&P 500 Index have reported earnings for Q2 2019. Of these companies, 73.0% reported earnings above analyst expectations and 18.8% 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, 76% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 5.5% 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, 56.9% reported revenues above analyst expectations and 43.1% reported earnings below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 63% of companies beat the estimates and 37% missed estimates.

In aggregate, companies are reporting revenues that are 1.1% 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 1.0%.

Q2 earnings are seen up 2.9% (3.6% ex-Energy) with 3 strong and 3 weak sectors:

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Revenues are expected up 4.7% (5.1% ex-E), thanks to a 57% beat rate and a +1.1% surprise factor led by Financials (+3.3%), Energy (+2.6%) and Health Care (+1.6%).

Pre-announcements for Q3 are roughly in line with what they were at the same time during Q2 but substantially worse than Q3’18:

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Revisions were weaker last week, particularly for smaller caps:

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Q3 estimates are –1.6% (-0.1% ex-E) from +0.8% on July 1. Q4: +5.0% from +7.2%. It is worth nothing that Refinitiv estimates that buybacks will boost EPS by 2.6% in Q3 and 2.7% in Q4 from 2.4% and 1.9% in Q1 and Q2 respectively.

Trailing EPS are now $164.29, up from $163.88 at the end of May and +7.5% YoY. This week, we get 19 of the remaining 37 companies to report. Eleven of these are consumer-centric and 9 IT, among the weakest sectors this season. Refinitiv calculates that 67% of 152 retail/restaurant companies it tracks beat estimates in Q2 but that their blended growth rate is 2.0% on a 4.9% revenue growth rate.

Refinitiv says that retailers generally are “discussing China tariffs and warning us not to expect much from them in the upcoming quarters.”

STOXX 600 EARNINGS

Refinitiv reports that of the 227 STOXX 600 companies having reported so far, 52% beat estimates with a surprise factor of +1.1% leading to a blended growth rate of –1.6% on a +3.0% revenue gain. On July 1, earnings were expected to increase 2.3%. Full year 2019 earnings are now seen up 1.8% vs +4.3% on July 1.

TECHNICAL WATCH

From my lens, Lowry’s Research’s last weekly analysis is trying hard to remain positive amid all this volatility: “With the rally on Aug. 16, the market appears to have made a good start on providing evidence of the strong Demand needed for a sustained rally as Up Volume was about 88% of total NY Up/Down Volume.” More such strong days are needed to reverse the rise in Selling Pressure seen throughout the month of August.

Moving averages for major equity markets are still rising but the recent weaker behavior of the equal-weight S&P 500 Index is worrisome:

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Note also that trends in smaller caps (S&P 600 and Russell 2000) remain very weak.

Lower-Rated Bonds Benefit as Big Companies Slash Debt Debt reduction at AT&T, Anheuser-Busch InBev and other companies is contributing to a surprising development: The lowest group of investment- grade bonds is outpacing other tiers.

(…) Over the past decade, triple-Bs have grown from roughly 40% of the investment-grade market to about half of it as companies bulk up on debt in an era of low interest rates. (…)

Corporate officers got the message last year when the Fed tightened. They are using the “easing window” ( and the rising equity market) to deleverage amid all the recession calls around.

The Most Fascinating Standoff in Corporate America: The Accountant Who Exposed Madoff vs. GE
Business Roundtable Steps Back From Milton Friedman Theory CEO group urges firms to remember obligation to society, widening focus beyond shareholder value

The Business Roundtable said Monday that it is changing its statement of “the purpose of a corporation.” No longer should decisions be based solely on whether they will yield higher profits for shareholders, the group said. Rather, corporate leaders should take into account “all stakeholders”—that is, employees, customers and society writ large. (…)

In 1970, Mr. Friedman spelled out their views in his article “The Social Responsibility of Business is to Increase its Profits.”

“The businessmen believe that they are defending free enterprise when they declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers.” Mr. Friedman wrote. “In fact they are—or would be if they or anyone else took them seriously—preaching pure and unadulterated socialism.”

Life expectancy in America has declined for two years in a row That’s not really meant to happen in developed countries

An American baby born in 2016 can expect to live on average 78.6 years, down from 78.9 in 2014. The last time life expectancy was lower than in the preceding year was in 1993. The last time it fell for two consecutive years was in 1962-63.

Other statistics suggest that this alarming trend is caused by the epidemic of addiction to opioids, which is becoming deadlier. Drug overdoses claimed more than 63,000 lives in 2016. Two-thirds of these deaths were caused by opioids, including potent synthetic drugs such as fentanyl and tramadol, which are easier to overdo by accident and are becoming more popular among illegal drug users. (…)

The steepest rise in mortality was among 25- to 34-year-olds. In that age group deaths per 100,000 people from any cause increased by 11% from 2015 to 2016. Mortality from drug overdoses in the same age group shot up by 50% from 2014 to 2016. (…)

A continued decline in life expectancy would leave America trailing even farther behind other rich countries. Lives in America are already two years shorter than the average in the OECD group of 35 rich and soon-to-be-rich countries: life expectancy is closer to Costa Rica’s and Turkey’s than to that of Britain, France and Germany. If the administration cannot reverse this then—at least when it comes to longevity in the Western world—its policy might be described as America Last.