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: 14 AUGUST 2019: The Puppets Show

THE PUPPETS SHOW

So,

  • this data-dependent Fed embarks on a well telegraphed and “transparent” tightening path, only to completely pivot after equity markets tank fearing recession.
  • Data-dependency gives way to pre-emptive easing as FOMC voters fret about the trade war and a possible escalation that might create a recession. The last FOMC minutes used the words “risks” and “uncertainties” 48 times.
  • This pivot also gets justified by the stubborn inflation that, from the Fed’s lens, refuses to even attempt to point towards the magical 2.0% level.
  • The Fed officially cuts by 25 points, telling us that the economy is still humming nicely and that this is merely a “mid-cycle” adjustment, 10 years into the recovery.
  • Investors and Trump both loudly express their disagreement with the Fed’s action and words.
  • For good measure, reading Powell’s trembling lips, Trump goes against his advisors and announces 10% tariffs on an additional $300B of Chinese exports of primarily consumer goods effective September 1.
  • China “retaliates” by stopping to support the renminbi which briefly eases above the so-called 7.0 threshold. Mnuchin immediately declared China a currency manipulator, just 2 few months after the Treasury officially said it was not.
  • Equities sink again and bond prices skyrocket.
  • Somebody must have told Trump that September 1 is the start of the most important period for retailers. Since the U.S. economy only holds by the consumer nails, timing for these new tariffs is not optimal, Mr. President.
  • “The office of the U.S. Trade Representative on Tuesday said it would instead delay the new tariffs on many major categories of items, including smartphones, laptop computers and toys, until Dec. 15. The USTR said some products would be removed from the tariff lists entirely, based on health, safety, national-security and other factors. The list of excluded items includes some of the biggest-ticket items facing tariffs. Cellphones and laptops alone represent about $80 billion of trade.” (WSJ)
  • Only Trump knows why this announcement went untweeted, unlike virtually every other ones, but markets nonetheless took the USTR word for cash and spiked up.
  • The same morning, the BLS releases the July CPI data. Just about every measure is up by 0.3% MoM and 2.0%+ YoY. Even the ever deflating Core Goods have appreciated in price by +0.2% in July after +0.4% in June.

So,

  • the trade war is not escalating after all. Postponing the next hike to “December 15” probably means December 15, 2020, at the earliest.
  • But it’s also not de-escalating and U.S. importers increasingly struggle with the continuing 25% tariffs.
  • Inflation is at, even above, the Fed’s target by many measures and there is increasing evidence that tariffs are being passed on.

What will the Fed do now that there is no escalation but there is apparent inflation in the numbers? Let’s watch Mr. Market. He’s pulling all the strings, from Eccles building to the White House.

Meanwhile, the Chinese totally understand what’s going on and let the puppets perform their act while they can.

But financial markets don’t seem to know much more than the puppets where this economy is going:

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 valug iwm

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Here’s what we do know:

  • The S&P 500 Index is at 19.8 on the Rule of 20 P/E on today’s pre-opening of 2890, only slightly undervalued.
  • The Rule of 20 Fair Value is 2922 based on trailing EPS of $164.25 and inflation of 2.2%.
  • Fair Value peaked at 2952 in June and has declined in each of the last 2 months as trailing EPS have stalled while inflation has crept up.
  • The Q2 earnings season is almost over so trailing EPS are likely to remain stable for 2-3 months.
  • Inflation seems to be creeping up, threatening a third consecutive decline in month-end Fair Value.

Three consecutive monthly declines in the Rule of 20 Fair Value (yellow line) is a rather rare phenomenon. When it has happened, it has generally not been received warmly by equity investors unless inflation quickly receded (e.g.: 01/84, 08/87, 12/89, 02/01, 08/08). Equities do prefer rising earnings and stable or declining inflation.

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As of Monday night, we had 453 S&P 500 company reports in, a 73% beat rate, a +5.6% surprise factor and a blended +2.9% earnings growth rate, bettering the +0.3% expected growth rate on July 1. Earnings are hanging in. Q3 estimates are –1.6%, down from +0.8% on July 1 and Q4 estimates are +5.1%, down from +7.2%. Unless Q3 results beat significantly, trailing EPS will decline over the next 3 months.

But there is also the rising inflation risk. This Cleveland Fed table gives the trends:

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The sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 3.4% annualized in July, following a 3.0% increase in June. On a year-over-year basis, the series is up 2.5%. The core sticky-price index rose 3.4% annualized in July, and its 12-month percent change was 2.5%.

The flexible cut of the CPI—a weighted basket of items that change price relatively frequently—jumped 6.4% annualized in July, and is up 0.3% YoY.

The Atlanta Fed also has a wage growth tracker. Breaking out?

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China’s Growth Struggles Mount China reported a raft of weak economic data, adding to evidence that the world’s second-largest economy is slowing further as it remains locked in a trade war with the U.S.

(…) Industrial production rose at its slowest pace since the beginning of 2009, increasing 4.8% in July from a year earlier compared with a 6.3% rise in June, the National Bureau of Statistics said Wednesday. (…) Retail sales—a gauge of consumption—rose 7.6% in the period, down from a 9.8% increase in June, as car dealers finished unloading inventories ahead of new emissions standards. (…)

Urban unemployment shot up to 5.3% in July, matching a record high in February, data from the statistics bureau showed. (…) China International Capital Corp. said in a research report in July that the nation’s industrial sector has lost five million jobs in the past year, attributing 1.8 million to 1.9 million jobs losses to the trade war with the U.S. (…)

There are a lot more stats in this Reuters’ piece. Some charts from Bloomberg via Zerohedge:

U.S. to Back More Condo Loans Aimed at First-Time Buyers The Trump administration is vastly expanding the scope of condominium purchases eligible for lower-down-payment loans.

(…) The FHA now insures a million home loans made by banks and other private lenders, the vast majority of which are for single-family homes. With the new rules, the agency estimates it could insure as many as 60,000 additional condo loans each year, on top of the 16,000 condo loans it backed in 2018. (…)

“FHA is already a higher risk program,” Mr. Stevens said. “Layer that on top of a higher-risk product called the condominium and you definitely have to prepare yourself for the fact that in the next correction you’re going to take more losses at FHA than anywhere else.”

Mr. Stevens said condos are a dicier proposition because units in a building can be turned into rentals, which tend to be less-well-maintained. A single foreclosure in a condo building can affect other units as windows aren’t washed, balconies aren’t painted and maintenance dues aren’t paid. (…)

THE DAILY EDGE: 13 AUGUST 2019: …flation, more In… than De…

Small Business Optimism Continues to Defy Expectations

The Optimism Index rose 1.4 points to 104.7, an exceptional reading. Seven of the 10 components advanced, two fell, and one was unchanged. This is confirmation that small business owners remain very optimistic about the economy despite all the talk about “slowing.”

Expectations for business conditions, real sales, and expansion posted solid gains. Plans to create new jobs and make capital outlays also advanced. Plans to order new inventories posted a solid gain, although there were lingering signs of the excess inventory built in the second quarter. Earnings trends improved, supported by a solid improvement in sales trends. Few owners credited price change (up or down) for changes in earnings. After surging last month, reports of higher average selling prices stabilized, no evidence of a pickup in inflation.

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Sales are hanging in:image

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CPI for all items rises 0.3% in July as gasoline, shelter indexes increase

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in July on a seasonally adjusted basis after rising 0.1 percent in June, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.8 percent before seasonal adjustment.

Increases in the indexes for gasoline and shelter were the major factors in the seasonally adjusted all items monthly increase. The energy index rose in July as the gasoline and electricity indexes increased, though the natural gas index declined. The index for food was unchanged for the second month in a row, as a decline in the food at home index was offset by an increase in the food away from home index.

The index for all items less food and energy rose 0.3 in July, the same increase as in June. The July rise was broad-based, with increases in the indexes for shelter, medical care, airline fares, household furnishings and operations, apparel, and personal care all contributing to the increase. The index for new vehicles was one of the few to decline in July.

The all items index increased 1.8 percent for the 12 months ending July, a larger increase than the 1.6-percent rise for the period ending June. The index for all items less food and energy rose 2.2 percent over the last 12 months, slightly more than the 2.1-percent increase for the period ending June. The food index rose 1.8 percent over the last year while the energy index declined 2.0 percent.

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Core CPI is up 0.3% two months in a row, a 3.6% a.r. following +1.4% in the previous 5 months. Core Goods is also up 3.6% a.r. in June-July vs –1.0% in the previous 5 months. Something just changed…and seemingly not in a transitory fashion… Core Services keep inflating at a steady rate well above 2.0%. So total CPI is up 1.8% YoY when Energy is down 2.0%. Last 3 months, total CPI is up 2.0% a.r. when Energy is down 6.5% a.r..

(…) Average prices for consumer goods rose 2.3% in the first six months of 2019, according to data tracker Nielsen, the fastest pace in several years. Walmart said it saw “modest” inflation in the first quarter, but it has heated up lately, and a Walmart shopping trip was 5.2% more expensive in June compared with a year earlier, according to Gordon Haskett Research Advisors. (…)Price CheckRising Tide

10% Tariffs Were Manageable. At 25%, Businesses Are Squirming. An importer of vinyl flooring spends “nearly 100% of my energy” trying to defray the cost of Washington’s levies on Chinese products. How these decisions get made, across the economy, will help determine how higher costs get distributed and their effects on sales.

Good WSJ piece on the chaos stemming from tariffs.

Germany confronts growing risk of economic slowdown Fears that manufacturing dip will hit jobs and services prompt stimulus debate

(…) The Chinese market is the most important market for the majority of German car manufacturers. In 2018, almost one-quarter of all cars sold in China were German. BMW and Daimler sold more than one-third of their total car sales in China. For Volkswagen, the share is even bigger at 40%.

Looking ahead, things aren’t looking too good for German car manufacturers. New car sales in China have fallen for 13 months in a row, a slump that started in the second half of 2018 when the trade war between China and the US began to heat up. (…)

Given that some German car manufacturers actually export US-produced cars to China, there has been a clear and direct impact of the trade conflict on the German car industry. Having said that, the larger impact seems to be coming indirectly from lower Chinese consumer confidence. According to media reports, BMW and Mercedes car exports from the US to China have suffered due to the tariff hikes, which is probably why BMW has started to manufacture locally in China.

Another factor, which is well known in Europe and has probably weighed more heavily on sales in recent months, is the switch to the new emission standard. By July 2020, all light vehicles in China need to comply with the China 6a emission standard, based on European and US regulations. But many provinces rushed ahead and made the new standard mandatory a year earlier to comply with environmental protection campaigns.

In Europe, the impact of adopting this new standard placed a huge strain on the passenger car market last year such that new passenger car registrations fell more sharply (in absolute terms) than during the global financial crisis. 

In China, although car dealers substantially discounted prices for China 5-standard vehicles before the deadline, consumers were reluctant to make purchases, probably waiting for passenger cars with the new emission standard instead. Automotive retail sales saw a surge only in June, with car dealers offering heavy price reductions. The destocking of China 5-emission standard vehicles might be responsible for lower orders from dealers too. But with the new standard now in place, a rebound in car sales might be round the corner. (…)

Alongside cyclical developments, there are also structural changes in the Chinese automotive market affecting German car sales. China is already the largest ride-hailing market in the world, with over 459 million customers and a turnover of around US$ 53 billion. In the US, there are currently 66 million users generating US$ 49 billion in turnover. To put things into perspective, one-third of the Chinese population already uses alternative mobility solutions, while in the US the figure is around 20 percent and in the EU it is just 18 percent – a trend that is likely to grow in the coming years. Admittedly, it’s impossible to tell whether users are exclusively using ride-hailing or whether it is complementary to owning a car.

To date, forecasts of the Chinese car market have assumed that low ownership rates offer sufficient growth potential in the coming years, but it’s quite possible that this growth potential will be impaired by ride-hailing and/or car-sharing.

Another structural change is the transition towards electric car production and sales, which the Chinese government is supporting. Indeed, sales of electric cars in China are still going strong, increasing by 50 percent in the first half of 2019 compared to 1H18, but the subsidies in this segment will be phased out between 2020 and 2021.

Related:

FIBER: Industrial Commodity Prices Post Broad-Based Declines

The Industrial Materials Price Index from the Foundation for International Business and Economic Research (FIBER) declined 3.1% during the last four weeks. The price index was down 13.0% y/y and has fallen to the lowest level since June 2016. Prices declined broadly amongst product categories. (…)

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Reuters’ Exclusive: Google’s jobs search draws antitrust complaints from rivals Google’s fast-growing tool for searching job listings has been a boon for employers and job boards starving for candidates, but several rival job-finding services contend anti-competitive behavior has fueled its rise and cost them users and profits.