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: 19 JUNE 2019: Let’s Make A Deal! Recession Watch!

Trump and Xi Plan Trade Talks at the G-20 Summit President Trump and Chinese President Xi Jinping agreed to meet in Japan next week, lifting financial markets and spurring hopes for a trade truce that could stave off a fresh round of tariffs.

In a Twitter message on Tuesday, Mr. Trump said he had a “very good” telephone conversation with Mr. Xi, setting the stage for a summit on the sidelines of the Group of 20 leading global economies meeting in Osaka.

“We will be having an extended meeting next week at the G-20 in Japan,” the president tweeted. “Our respective teams will begin talks prior to our meeting.” (…)

According to Chinese state media, Mr. Xi told Mr. Trump in their conversation Tuesday that China hopes “the U.S. will treat Chinese companies fairly,” in what was widely seen as a reference to Huawei. (…)

The proposed $300 billion in tariffs are now the subject of public hearings held by the U.S. Trade Representative in Washington. If Mr. Trump and Mr. Xi fail to get talks restarted in Japan, those levies could be imposed as early as next month.

On Monday, the first day of the hearings, 47 of the 50 speakers asked that their industry be spared the tariffs; only two business representatives spoke in support of the Trump administration’s plan. (…)

Left hug Right hug It took me some digging but I was very curious to know who initiated the call after Trump threatened to tax China even more if Xi refused to meet him next week. Trump himself uncharacteristically did not mention who requested the call which made me believe he asked for it. No surprise, Xinhua, the Party’s news agency, disclosed Trump made the first move (my emphasis):

Chinese President Xi Jinping held a telephone conversation with his U.S. counterpart, Donald Trump, on Tuesday at the latter’s request.

Trump said he looks forward to meeting Xi again during the upcoming Group of 20 (G20) summit in the Japanese city of Osaka later this month, and conducting in-depth discussions on bilateral ties and issues of common concern.

The U.S. side, he added, values its economic and trade cooperation with China, and hopes that the teams on both sides can conduct communication, and find a way to resolve the current dispute as soon as possible.

Trump said he believes the entire world hopes to see the United States and China reach an agreement.

For his part, Xi said some difficulties have recently occured in China-U.S. relations, which is in the interests of neither side.

Reiterating that both countries gain from cooperation and lose from confrontation, Xi said the two sides should, in accordance with the consensus he has reached with Trump, push forward the China-U.S. relationship featuring coordination, cooperation and stability on the basis of mutual respect and mutual benefit.

As the world’s two biggest economies, China and the United States should jointly play a leading role in pushing for positive outcomes at the G20 Osaka summit, so as to inject confidence and vitality into the global market, added Xi.

The Chinese president said he stands ready to meet Trump in Osaka to exchange views on fundamental issues concerning the development of China-U.S. relations.

On economic and trade issues, Xi stressed, the two sides should solve their problems through dialogue on an equal footing, with the key being to accommodate each other’s legitimate concerns, adding that China hopes the U.S. side can treat Chinese firms [meaning Huawei] in a fair manner.

Xi said he agrees to have the two countries’ trade teams maintain contact on how to solve the dispute.

This is significant as it suggests that Trump is very anxious to make a deal.

Apple explores moving 15-30% of production capacity from China: Nikkei

Apple Inc has asked its major suppliers to assess the cost implications of moving 15%-30% of their production capacity from China to Southeast Asia as it prepares for a restructuring of its supply chain, according to a Nikkei Asian Review report on Wednesday. (…)

The countries being considered include Mexico, India, Vietnam, Indonesia and Malaysia. India and Vietnam are among the favorites for smartphones, Nikkei said (…)

Devil Trump Suggests He Could Consider Demoting Fed Chairman ‘Let’s see what he does,’ Trump said of Fed Chairman Jerome Powell ahead of major interest-rate decision

(…) “Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA. They have been getting away with this for years, along with China and others,’’ he tweeted. Later, he added: “German DAX way up due to stimulus remarks from Mario Draghi. Very unfair to the United States!’’ (…)

U.S. Housing Starts Fell in May May’s 0.9% drop is new sign of weakness in the housing market; residential building permits rose.

(…) Residential building permits, which can signal how much construction is in the pipeline, rose 0.3% from April to an annual pace of 1.294 million. That was the strongest monthly rate of growth since December. The pace of starts in April was revised higher, another positive sign. (…) Starts were down 4.7% from May last year. (…)

You need a very sharp eye to notice May’s rise in permits:

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Here’s a close-up!image

Starts are down 32.4% and 33.1% YoY in the Northeast and the Midwest respectively. Down 0.5% in the West and up 8.1% in the warmer South.

  • High five If new home sales remain at current levels, residential construction will have to improve. (The Daily Shot)

Source: Pantheon Macroeconomics

RECESSION WATCH
Economic Outlook from Freight’s Perspective

(…) With the -6.0% drop in May, we see the shipments index as going from “warning of a potential slowdown” to “signaling an economic contraction.” (…)

May’s drop is significant enough to raise the question, “Will the Q2 ’19 GDP be negative?”

The weakness in spot market pricing for many transportation services, especially trucking, is consistent with the negative Cass Shipments Index and, along with airfreight and railroad volume data, strengthens our concerns about the economy and the risk of ongoing trade policy disputes. Weakness in commodity prices and the decline in interest rates have joined the chorus of signals calling for an economic contraction.

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Beyond our concern that the Cass Freight Shipments Index is negative on a YoY basis for the sixth month in a row:

  • We are concerned about the severe declines in international airfreight volumes (especially in Asia) and the ongoing swoon in railroad volumes, especially in auto and building materials;
  • We see the weakness in spot market pricing for transportation services, especially in trucking, as consistent with and a confirmation of the negative trend in the Cass Shipments Index;
  • As volumes of chemical shipments have lost momentum in recent weeks, our concerns of the global slowdown spreading to the U.S., and the trade dispute reaching a ‘point of no return’ from an economic perspective, grow.

Bottom line, more and more data is indicating that this is the beginning of an economic contraction. If a contraction occurs, then the Cass Shipments Index will have been one of the first early indicators once again. (…)

Asian airfreight volumes were essentially flat from June to October 2018 but have since deteriorated at an accelerating pace (November -3.5%, December -6.1%, January – 5.4%, February -13.3%, March -3.6%, -10.2% in April, and the preliminary May -8.1%). If the overall volume wasn’t distressing enough, the volumes of the three largest airports (Hong Kong, Shanghai, and Incheon) are experiencing the highest rates of contraction. Even more alarming, the inbound volumes for Shanghai have plummeted. This concerns us since it is the inbound shipment of high value/low density parts and pieces that are assembled into the high-value tech devices that are shipped to the rest of the world. Hence, in markets such as Shanghai, the inbound volumes predict the outbound volumes and the strength of the high-tech manufacturing economy. (…)

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HOW ABOUT RAIL

The slowdown in trucking gets even more troubling when considering that truck tonnage has strongly outperformed rail intermodal since 2016

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From the Association of American Railroads:

You have to look pretty hard to find good news in May’s rail traffic data, but disappointing news is easy to find. Total U.S. rail carloads were down 2.1% in May 2019 from May 2018, their fourth straight monthly decline. In May, six of the 20 carload commodities the AAR tracks had carload gains.(…) Ongoing trade disputes aren’t helping intermodal. In May, intermodal volume was down 5.9%, thanks in part to the trade disputes and tariffs that have been applied to imports in recent months. For the first five months of 2019, intermodal was down 2.4% from last year. (…) Approximately half of U.S. rail intermodal consists of imports or exports, so everything that’s going on from a political standpoint regarding trade — tariffs and threats of tariffs, retaliation for tariffs that get implemented, etc. — will impact intermodal.

I look at rail volume excluding coal, grain and oil to get a better sense of what’s happening in the economy: the 6-wk m.a. is down 5.4% in May, back to the 2017 level.

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U.S. IP could drop significantly in coming months:

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Warning Lights Are Flashing in China’s Money Market

On Sunday, the country’s securities regulator convened a meeting asking big brokerages and funds to support their smaller peers, according to a meeting summary circulated among industry participants Monday. The briefing cited rising risk aversion in money markets after defaults in the bond repurchase market. Some interbank lending rates have moved sharply higher in recent weeks.

China’s short-term lending market for banks and other financial institutions has for years operated under the assumption that Beijing wouldn’t allow big losses in the event of defaults or insolvencies. That confidence has been shaken by regulators’ unusual public takeover of a small, troubled bank in northern China last month—and the even more unusual public admission by the central bank that not all of Baoshang Bank’s liabilities would necessarily be guaranteed. (…)

Worryingly, problems appear to be migrating from the relatively small market for negotiable certificates of deposit (NCDs)—used primarily by small banks—into the much larger bond repo market. Although key one-day and seven-day weighted average borrowing rates remain low, thanks to huge central bank cash injections, longer tenors have marched sharply higher.

Seasonal cash demand ahead of the quarter-end is probably playing a role. But small banks, squeezed out of the market for NCDs, may also be trying to replace a portion of three or six-month NCD funding in the repo market. Since Baoshang’s takeover on May 24, the one-month repo rate has nearly doubled from 2.9% to 5.2%. (…)

THE DAILY EDGE: 18 JUNE 2019: Trade War, Rates War, Currency War!

ECB Signals Possible Rate Cut, Bond-Buying Extension European Central Bank President Mario Draghi signaled that the bank could cut interest rates or expand its giant bond-buying program as soon as its next policy meeting in July, sending stocks higher and the euro lower against the dollar.

The comments, delivered at the ECB’s annual research conference outside Portugal’s capital, represent a clear statement of intent from Mr. Draghi, who is wrestling with the fallout from international trade tensions on Europe’s critical manufacturing sector and stubbornly low inflation.

In a sign of the headwinds Europe faces, exports from the eurozone to the rest of the world fell 2.5% in April compared to March, according to the European Union’s statistics agency Tuesday. Meanwhile, Germany’s ZEW index, a gauge of sentiment in the financial markets, fell by 19 points to minus 21.1 in June. (…)

A slew of central banks in the Asia-Pacific region, including New Zealand and Australia, have already reduced interest rates in recent weeks. The Federal Reserve could signal on Wednesday that it is preparing to cut short-term interest rates, with bond markets pricing in two rate cuts this year.

The ECB is in a trickier position because its key interest rate is minus 0.4%, almost three percentage points lower than the Fed’s.

Mr. Draghi said ECB policymakers would consider “in the coming weeks” how to adapt its policy tools “commensurate to the severity of the risk” to the economic outlook.

In particular, the ECB could tweak the parameters of its €2.6 trillion bond-purchase program, known as quantitative easing or QE, to create room for fresh purchases, Mr. Draghi said. (…)

Mr. Draghi also called for support from governments in the shape of fiscal spending, as well as more progress on a common budget tool for the eurozone “of adequate size and design” that could help guard against downturns.

FOMC FEEDSTOCK:

Via The Daily Shot:

  • Empire State vs. the US industrial production:

Source: Deutsche Bank Research 

  • Recently, a sharp cutback in construction spending has been signaling a potential slowdown in the economy.

Source: Piper Jaffray 

  • And here is the Morgan Stanley Business Conditions Index.

Source: Morgan Stanley, @DriehausCapital

U.S. Home Builder Sentiment Declines

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Mortgage refinancing activity surging amid lower interest rates

Data published last week by the Mortgage Bankers Association showed a sharp acceleration in mortgage refinancing applicants in the first week of June. As today’s Hot Chart shows, while the number of applicants remains at present below levels registered in recent refinancing waves (2016 and 2012-2013), the average amount being refinanced is much higher. This means that the total amount refinanced (number of applicants x average amount) is now approaching that observed in the two prior episodes. That’s good news for consumers, who will benefit from a decline in debt service costs. For the bond market, this wave of refinancing may have ended up amplifying downward pressures on yields. Indeed, a rise in the amounts of refinancing means MBS holders face greater-than-expected prepayments (lowering the weighted average duration of their portfolio). In order to offset this unwanted impact on their portfolio, money managers have to buy long duration Treasuries. (NBF)

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Buying American Isn’t an Option, Some U.S. Companies Say With public hearings on the Trump administration’s China tariff plan set to begin Monday, the U.S. trade representative’s office has already been flooded with letters from companies saying they have few options besides China.

(…) Items to be hit by new tariffs include 273 categories of goods—such as consumer fireworks, fishing reels and electric blankets—for which China accounts for more than 90% of imports. Last year, $66.3 billion worth of these items were imported from China. (…)

Vietnam can handle orders for wood products and textiles but “has very weak infrastructure in metal fabrication,” officials at the Minnesota company said in a letter. In general, factories couldn’t match China’s prices or keep up with production demands.

“It was NOT even close,” they wrote. (…)

In a letter to Mr. Trump on June 13, tariff opponents, including Walmart, Target Corp. and Costco Wholesale Corp. , said current and proposed tariffs would raise costs to a family of four by an average of $2,000 a year.

China – falling into the same long-term rut as Japan?

(…) Fathom’s measure of economic activity in China, the China Momentum Indicator (CMI), slowed to 4.9% in April, down from 5.1% in the twelve months to March, hitting a new two-and-a-half-year low. As highlighted in the chart, this has resulted in a widening of the gap between Fathom’s measure of growth and the official measure, which was a steady 6.4% in the first quarter of the year.

(…) in an attempt to arrest the slowdown in underlying growth, China has resorted to its old tried-and-tested growth tactics of credit-fuelled investment. Problematically for Beijing, these efforts to cushion the economy will only exacerbate existing domestic and global imbalances.

Indeed, weaker trend growth is attributable in part to the astronomical expansion of credit observed in China in recent years, which has led to allocative mistakes at the macro level. That misallocation is evidenced by China’s non-performing loan problem, which, as Fathom detailed in a recent note to clients, is estimated to be a large and rising 28–38% of domestic GDP.

With China’s current policy mix suffering not only diminishing returns but allocative inefficiencies too, Fathom’s central scenario sees China falling into the same kind of long-term rut as Japan. In this world, despite the evergreening of bad loans and perennially low interest rates, China’s economy will slow to around 4% by 2021.

India tariff hike shows vulnerability of US trade strategy. India has struck back after the US withdrew its preferential tariff schedule

India has decided to impose long-awaited tariffs on 28 product groups after the US said it would roll back a duty-free imports scheme for approximately $6 billion worth of imports from India. The tariffs came into effect on Sunday. These retaliatory measures show the vulnerability of the high pressure strategy characterised by the current US trade policy. Not all countries will give in so easily to US demands as, for example, Mexico did. Countries that are less dependent on trade with the US will resist, with the risk of escalating tit-for-tat tariff fights. If it pushes too far in negotiations with India, Japan, the EU, and China, the US could end up being the biggest loser of all. This is because it would then face tariffs with all its trading partners involved in the disputes while the EU and the other counties would face higher tariffs only at the US border. (…)

The 28 products affected include agricultural products, with tariffs being raised by up to 120%. The measures are reportedly expected to raise about $217 million of tax revenues. Assuming that the average increase is about 50%, the tariffs will affect 1% to 2% of total Indian merchandise imports from the US. Although this is only a small fraction of US – Indian trade, it further inflames tensions between the two countries. (ING)

Saudis to Push for OPEC Cuts, Despite Tanker Attacks Saudi Arabia is set to push for OPEC to cut oil output in the second half of the year, as signs of slowing global demand for crude outweigh threats of war and worries about supply disruptions in the Middle East.
SENTIMENT WATCH

(…) Equity allocations saw the second-biggest drop on record, while cash holdings jumped by the most since the 2011 debt-ceiling crisis, the June poll showed. Concerns about the trade war, a recession and “monetary policy impotence” all contributed to the bearish sentiment, Bank of America said. (…)

Global growth expectations collapsed, Bank of America said, with half of the surveyed fund managers forecasting weakness over the next 12 months. The surge in cash levels set off the strategists’ contrarian buy signal for stocks, even as the poll showed relative exposure to equities over bonds narrowed to the tightest level since May 2009. (…)

The survey conducted between June 7 and 13 showed a rotation into fixed income, cash, utilities and staples and away from banking, tech and euro-area shares. (…)

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Is this the capitulation that the contrarian in you is dying for? Nope! Watch the II for that as Ed Yardeni illustrates:

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EARNINGS WATCH

Two weeks left to the second quarter. The number of negative pre-announcements has been stable in recent weeks and is in line with Q1’19 at the same time. However, positive pre-announcements have declined significantly.

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Tech looks vulnerable as this Broadcom announcement last Friday suggests (my emphasis):

Let me [Hock E. Tan, Broadcom Inc. – CEO] address the current business environment and our outlook for the remainder of the year. We have, as I indicated, performed very much to plan in the first half of fiscal ’19. And in the second half, we had expected a recovery. However, while enterprise and mainframe software demand remained stable, particularly in North America and Europe, with respect to semiconductors, it is clear that the U.S.- China trade conflict, including the Huawei export ban, is creating economic and political uncertainty and reducing visibility for our global OEM customers. As a result, demand volatility has increased and our customers are actively reducing inventory levels to manage risks. This leads us to believe the second half of 2019 will be more in line with the first half as opposed to the previously expected recovery. We now anticipate fiscal 2019 semiconductor solutions segment revenue of $17.5 billion, which translates into a year-over-year decline in the high single digits.

Analysts have been busy reducing estimates. Last week, 89.2% of IT company revisions were down. Industrials: 80%. We’ll soon see if this is corporate positioning or real.

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Last week, Factset noted that for companies that generate more than 50% of sales inside the U.S., the Q2 estimated earnings growth rate is 1.4%. For companies that generate less than 50% of sales inside the U.S., the estimated earnings decline is -9.3%.

At the sector level, the Information Technology is expected to be the largest contributor to the earnings decline for S&P 500 companies with more global exposure in Q2. Overall, this sector is predicted to report the highest earnings decline of all eleven sectors in Q2. This sector also has the highest international revenue exposure of all eleven sectors in the index.

FYI:

FYI:

Experts: Spy used AI-generated face to connect with targets

(…) The Katie Jones profile was modest in scale, with 52 connections. But those connections had enough influence that they imbued the profile with credibility to some who accepted Jones’ invites. The AP spoke to about 40 other people who connected with Jones between early March and early April of this year, many of whom said they routinely accept invitations from people they don’t recognize.

“I’m probably the worst LinkedIn user in the history of LinkedIn,” said Winfree, the former deputy director of President Donald Trump’s domestic policy council, who confirmed connection with Jones on March 28.

Winfree, whose name came up last month in relation to one of the vacancies on the Federal Reserve Board of Governors, said he rarely logs on to LinkedIn and tends to just approve all the piled-up invites when he does.

“I literally accept every friend request that I get,” he said. Confused smile

Good judgement!!! Fit for a Fed governor job?