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)

Invest with smart knowledge and objective odds

THE DAILY EDGE: 5 JUNE 2019: Jingoism

Fed Puts Interest Rate Cut In Play Powell’s comments suggest central bank is focusing now on whether and when to lower rates

Powell was speaking at the “Conference on Monetary Policy Strategy, Tools, and Communications Practices” in Chicago, “part of a first-ever public review by the Federal Open Market Committee of our monetary policy strategy, tools, and communications (…) to share perspectives on how monetary policy can best serve the public.” Powell is embarking on a crusade to modify the Fed’s inflation target.

For some reasons, he felt he had to begin reiterating the Powell put:

I’d like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.

He went on discussing his topic but that was all the market needed, like a Powell tweet confirming there’s a crew ready to offset whatever damage the guy in the house does. But the market says the damage has already been done and needs immediate remedy:

(…) financial conditions have already tightened by about 50bp, and we attribute some of the weakness in the survey data in late May to the impact of the escalating trade war. On the back of these developments, we are lowering our H2 GDP forecast by about ½pp to 2%. (Goldman Sachs)

image

  • The market’s expectations of rate cuts generally did not overshoot in the past. (The Daily Shot)

Source: @SvendsenAnders

Could it be that right when the FOMC seeks to cut its inflation target, its long-standing 2% goal will be met?

The trade war is likely to become increasingly visible in the inflation numbers. Our new core PCE forecast incorporates a ½pp tariff boost and sees inflation climbing from 1.57% in April to 2% in August and to 2.3%-2.4% in early 2020, before diminishing under our assumption of tariff removal. If all proposed tariffs are implemented, we estimate a peak core inflation boost of +1¼pp! (Goldman Sachs)

image
U.S. Factory Orders Retreat as Durable Goods Orders Backpedal

Manufacturers’ orders declined 0.8% (+1.0% y/y) during April following a 1.3% March gain, revised from 1.9%. Orders in February declined 1.0%, revised from -0.3%. Orders for durable goods fell 2.1% and were unchanged y/y. Transportation equipment orders fell 5.9% (-0.1% y/y), led by a one-quarter decline in civilian aircraft & parts orders. Factory orders excluding the transportation sector improved 0.3% (1.2% y/y). (…)

Order backlogs in the manufacturing sector slipped 0.1% (+2.1% y/y) and reversed the March gain. Transportation equipment backlogs were little changed (1.9% y/y) after a 0.2% rise. Unfilled orders outside of transportation eased 0.1% (+2.7% y/y), the third straight month of slight decline. (…)

 image image

There were huge downward revisions in New Orders for February and March. In effect, New Orders for Q1 suddenly went from +1.7% (+7.0% annualized) to +0.4% (+1.6% annualized), all erased by April’s –0.8%. As a result, backlog declined and inventories accumulated at a 4.0% annualized rate in the last 3 months.

image

Markit’s manufacturing PMI’s preview for May said new orders fell in May on “weak client demand’ and that manufacturers needed to “readjust stock levels in light of softer demand conditions”.

COMPOSITE PMIs
U.S. Services new business expansion eases to slowest since March 2016

The latest survey data signalled only a marginal expansion in business activity across the U.S. service sector in May. The rise was the slowest since the current period of growth began in February 2016, amid softer demand conditions in domestic and foreign markets. A slower rise in input costs and greater competition for new work led to broadly unchanged output charges.

Meanwhile, firms expressed the lowest degree of confidence since mid-2016, with service providers more uncertain with regards to output growth over the coming year. Nonetheless, firms continued to increase workforce numbers at a moderate pace despite unchanged levels of outstanding business.

The seasonally adjusted final IHS Markit U.S. Services Business Activity Index registered 50.9 in May, down from 53.0 in April. The latest headline figure was the lowest since the current sequence of expansion began in February 2016, and signalled only a marginal upturn in business activity. Where a rise in output was reported, panellists linked this to a further increase in new business. Some firms, however, stated that greater competition and softer demand conditions had, in part, driven the slowdown.

image

At the same time, new orders received by service providers increased at only a marginal rate in May. The rise was the softest since March 2016 as firms commonly stated that less robust demand conditions weighed on new business growth. Meanwhile, new export orders were broadly unchanged during May, with the respective seasonally adjusted index posting fractionally above the 50.0 no change mark.

Subsequently, service sector firms registered a lower degree of optimism towards output over the coming 12 months. Business confidence was at its lowest level since June 2016 as service providers highlighted concerns surrounding softer demand conditions and uncertainty around ongoing global trade tensions. The level of positive sentiment was well below the series trend and muted overall.

Less robust client demand put pressure on firms to remain competitive as companies left output charges broadly unchanged in May. The respective seasonally adjusted index dipped below to crucial 50.0 neutral mark for the first time since February 2016, as some companies sought to retain clients through price discounting.

Input prices increased at a softer and only marginal pace in May. The rise in cost burdens was the slowest since September 2016, with firms stating that any increases in purchase prices and wage costs were only slight overall.

Finally, pressure on capacity at service providers was subdued in May as backlogs of work remained the same as those seen in April. Nevertheless, a sustained increase in new work drove firms to employ greater workforce numbers. The rise in staffing levels was stronger than that seen in April and moderate overall.

The Composite PMI Output Index registered 50.9 in May, down from 53.0 in April. The slowdown in private sector growth was driven by a softer service sector output expansion. The overall rise in business activity was the slowest since May 2016 and only marginal overall.

image

Similarly, the upturn in new business across the service sector eased for the fourth successive month to a marginal rate. Alongside a contraction in manufacturing new orders, less robust demand in the service sector led to the slowest overall expansion since March 2016. Foreign demand was lacklustre, with manufacturers registering a fall in new export orders, and service providers signalling broadly unchanged new business from abroad.

Manufacturing and service sector employment growth was moderate overall, with the rate of job creation accelerating in the latter. At the same time, backlogs of work were unchanged across the private sector. On the price front, input price inflation eased further in May and was subdued in the context of the series history. As such, manufacturers raised their factory gate charges only slightly, and service providers noted broadly unchanged charges.

Finally, business confidence dipped to its lowest since June 2016 amid concerns about global trade tensions and less robust demand conditions.

Chris Williamson, Chief Business Economist at IHS Markit:

The final PMI data for May add to worrying signs about the health of the US economy. With the exception of February 2016, business reported the weakest expansion for five and a half years as a trade led slowdown continued to widen from manufacturing to services.

Inflows of new business showed the second-smallest rise seen this side of the global financial crisis as the steepest fall in demand for manufactured goods since 2009 was accompanied by a further marked slowdown in orders for services.

The survey data indicate a deterioration of annualised GDP growth to just 1.2% in May, down from 1.9% in April, putting the second quarter on course for a 1.5% rise.

Employment growth has come off the boil in line with weaker than expected sales and gloomier prospects for the year ahead, albeit still showing some resilience. The survey data are running at a level broadly consistent with around 150,000 jobs being added in May.

The slowdown has also seen inflationary pressures fade rapidly. Despite upward pressure on prices from tariffs, the rate of increase of average prices charged for goods and services barely rose in May, in marked contrast to the strong rises seen earlier in the year, as increasing numbers of companies competed on price amid weak demand.

As with manufacturing, the biggest change in recent months has been a sharp deterioration in growth of orders and output at larger companies, linked in part to worsening export trends, trade war worries and rising geopolitical uncertainty.

Eurozone private sector growth remains subdued during May

May saw the continued expansion of the euro area private sector, albeit at a modest pace. After accounting for seasonal factors, the IHS Markit Eurozone PMI® Composite Output Index rose to 51.8 in May, up from April’s 51.5 and slightly better than the earlier flash reading (51.6). The latest index reading was the highest for three months, and extended the current period of continuous growth to just under six years.

image

In line with the recent trend, it was the service sector that provided the impetus to overall growth during May, expanding at a solid pace. In contrast, manufacturing output fell for a fourth successive month, albeit at the slowest pace since February.

imageBy country, Germany saw growth improve to a three-month high and, despite recording its weakest expansion for five-and-a-half years, Spain continued to expand solidly. In France, output increased modestly, but Italy remained just inside contraction territory for a second successive month.

Modest growth of the private sector economy occurred at a time when levels of incoming new business were rising only slightly for the third month running. With activity increasing solidly, firms were subsequently able to reduce their overall backlogs of work for a third consecutive month.

Companies were also able to keep on top of their workloads thanks to the continued expansion of the private sector workforce. May’s survey indicated a solid rise in staffing levels, albeit a slower pace than in April. All nations covered by the survey registered employment gains. Germany remained a strong performer, though overall job creation purely reflected a strongly performing services economy as manufacturing jobs continued to fall.

May’s survey signalled that firms continued to face higher operating expenses, although inflation eased since April to its second-weakest in the past two-and-a-half years. Output charges were also increased at a slower rate, with the degree of inflation easing to its weakest level since November 2016.

Finally, business confidence, undermined by ongoing worries over Brexit, US-China trade and European political instability, fell in May to its lowest level since the start of the year. German companies signalled by far the lowest level of confidence about activity over the coming year.

May’s IHS Markit Eurozone PMI® Services Business Activity Index signalled ongoing growth of the euro area’s service sector. After accounting for seasonal factors, the index recorded 52.9, a little higher than April’s 52.8 and better than the earlier flash reading of 52.5.

Solid growth occurred in spite of a slowdown in the rate of new business expansion to a three-month low. Germany and Spain both recorded notably weaker gains in new work, whilst there was a decline seen in Italy. May’s survey data nonetheless indicated some pressure on capacity as signalled by a slight increase in backlogs of work for the first time in three months.

This encouraged companies to continue to take on additional staff. Employment in the service sector continued to rise markedly over the month, extending the current run of continuous expansion to over four-and-a-half years. Jobs continued to be created at the sharpest rate in Germany. Demand for staff led to further upward pressure on wages, and this was a key component behind a sharp increase in overall service sector costs.

Competitive pressures, however, meant that firms could only pass on a modest fraction of their higher operating expenses. Latest data showed that output charges rose at the weakest pace since August 2017.

Finally, business sentiment remained subdued in May, falling to its weakest level for four months. Firms operating in Germany were the least confident of a rise in activity in the coming year.

Chris Williamson, Chief Business Economist at IHS Markit:

The final eurozone PMI for May came in higher than the flash estimate, indicating the fastest growth for three months, but the overall picture remains one of weak current growth and gloomier prospects for the year ahead. While the service sector has seen business conditions improve compared to late last year, growth remains only modest, in part reflecting a spill-over from the trade led downturn in the manufacturing sector.

Despite output at goods and service providers collectively rising at a slightly faster rate in May, the survey data are merely indicating a modest 0.2% rise in GDP in the second quarter. Furthermore, there seems little prospect of any immediate improvement: new orders barely rose in May, painting one of the gloomiest pictures of demand seen over the past six years, and companies’ expectations of growth over the coming year likewise fell to one of the lowest in six years.

The survey also brought further signs that companies are having to increasingly compete on price to sustain sales growth, dampening inflationary pressures to the lowest for two-and-a-half years. (…)

image
Chinese business activity expands modestly in May

The Caixin China Composite PMI™ data (which covers both manufacturing and services) showed that business activity in China rose for the thirty-ninth month running in May. The rate of expansion was moderate overall, as signalled by the Composite Output Index edging down from 52.7 in April to a three-month low of 51.5.

The lower headline index reading was partly driven by a softer increase in service sector activity. The seasonally adjusted Chinese Services Business Activity Index fell from April’s recent high of 54.5 to a three-month low of 52.7 in May. Nonetheless, the reading was consistent with a strong rise in output overall amid reports of firm client demand. At the same time, manufacturing output was broadly stable, following a three-month sequence of expansion.

image

Total new business received by services companies also rose at a softer, but still solid, rate during May. According to panellists, new product launches and promotional activities supported a further increase in sales. Factory orders meanwhile rose at a slightly faster, albeit still marginal, pace. At the composite level, new orders expanded at a moderate rate that was the least marked for three months.

New orders received from abroad rose slightly across both the manufacturing and service sectors in China during May. For services companies, this marked a notable slowdown from the sharp rate of growth seen during April. However, this signalled a renewed increase in export sales for manufacturers following a slight reduction in the previous month.

On the employment front, services companies continued to add to their workforce numbers, but manufacturers registered a further decline. Job creation in the service sector was generally linked to rising business activity, though the rate of payroll expansion eased to a marginal pace. Manufacturers meanwhile cut their staffing levels only slightly. Consequently, composite employment fell for the first time in three months, albeit at a fractional rate.

Higher staff numbers and efforts to reduce outstanding business underpinned a further fall in backlogs of work at service providers. That said, the rate of backlog depletion remained marginal overall. At the same time, unfinished workloads at goods producers continued to expand slightly in May. As a result, the level of work-in-hand (but not yet completed) at the composite level remained broadly unchanged.

Services companies registered a solid increase in operating expenses during May, despite the rate of inflation easing since April. According to panel members, greater costs for labour and raw materials pushed up input prices in the latest survey period. Average cost burdens rose only slightly for manufacturing companies. Measured across both sectors, average input prices rose at a modest pace that remained weaker than the historical average.

Efforts to remain competitive and attract new business limited the overall pricing power of Chinese companies during May. Notably, services companies raised their output charges marginally, despite a strong rise in input costs. Factory gate prices were meanwhile unchanged from the previous month, thereby ending a three-month sequence of inflation.

Latest survey data indicated that overall confidence towards the year ahead weakened to the lowest on record, which was primarily driven by weaker sentiment at manufacturers. Furthermore, expectations at goods producers were the least upbeat since the series began in April 2012, while services firms registered the lowest degree of confidence since July 2018. Subdued expectations were often linked to the ongoing China-US trade dispute and relatively subdued global demand conditions.

Global Economy Cools Faster Than Expected as Trade Tensions Rise, World Bank Says Global growth forecast for 2019 lowered to 2.6%, from 2.9% in January forecast

With nearly half a year of data under its belt, the World Bank lowered its global growth forecast to 2.6% from 2.9% in January—and cut its forecast for growth in trade to 2.6% from 3.6%.

“There’s been a tumble in business confidence, a deepening slowdown in global trade, and sluggish investment in emerging and developing economies,” World Bank President David Malpass told reporters. “This is worrisome because subdued investment weakens the foundations for sustained growth.” (…)

Forecasts for the U.S. and China, which already incorporated a sharp slowdown, were unchanged in the latest update. The U.S. is forecast to slow to 2.5% in 2019 from 2.9% in 2018, while China is expected to slow to 6.2% from 6.6%.

Thus the surprise in the World Bank’s forecast wasn’t the damage the world’s two largest economies are doing to each other in their trade conflict—but the extent of international fallout from that rift in trade and withering of global business confidence.

All six global regions of emerging and developing economies tracked in the forecast—East Asia and the Pacific; Europe and Central Asia; Latin America and the Caribbean; Middle East and North Africa; South Asia; and sub-Saharan Africa—saw their growth prospects wither in the first half of the year.

The forecast, however, doesn’t incorporate the effects of the U.S. threat to apply 25% tariffs to an additional $300 billion of Chinese goods, which could begin later this month—nor its threat to apply tariffs that could rise to 25% against Mexico’s $350 billion of imports, which could begin next week. (…)

Washington’s Anti-Growth Turn Policies matter, and they’re changing for the worse in both parties.

(…) But as he focuses on re-election, Mr. Trump is returning to the issues that marked the worst moments of his 2016 campaign. He is restrictionist on immigration, increasingly protectionist on trade, and more interventionist in regulating business. He favors price controls on drugs, a mandate for paid family leave, and his regulators are revving up what looks like it could become the largest federal antitrust campaign since the 1970s.

Meanwhile, House and Senate Democrats are advancing their own election agenda that includes higher taxes and new regulation on finance and industry. The only pro-growth measure that could pass would be Mr. Trump’s renegotiated Nafta deal, but that is in greater jeopardy after last week’s tariffs on Mexico. Gridlock will probably prevail through 2020, but investors will have to start discounting the chance that Democrats could implement much of their agenda in 2021. (…)

Mr. Trump seems to believe the Federal Reserve can make everything great again by cutting interest rates, and he may get the rate cuts he wants this year. (…) But the Fed can’t offset bad trade policy by itself. (…)

Mr. Trump campaigned in 2016 on reviving the economy, and the surge of growth has helped to offset his personal unpopularity. Bad policies operate at the margin and their effect is cumulative. The initial tariffs were dwarfed by the growth effects of tax reform and deregulation, but the damage from tariffs will rise if they increase in severity and are imposed impulsively. Sooner or later bad policies always exact a high economic and political cost.

Trump warns ‘foolish’ Republican senators in rare clash over Mexico tariffs Lawmakers in president’s own party voice firm opposition to threat over Mexico

(…) But with the tariffs set to start next Monday, and Trump declaring them “more likely” than not to take effect, fellow Republicans in Congress warned the White House they were ready to stand up to the president. (…)

At a lengthy closed-door lunch meeting at the Capitol, senators took turns warning Trump officials there could be trouble if the GOP-held Senate votes on disapproving the tariffs. Congressional rejection would be a stiff rebuke to Trump, even more forceful than an earlier effort to prevent him from shifting money to build his long-promised border wall with Mexico.

“Deep concern and resistance” is how Senator Ted Cruz of Texas characterized the mood. “I will yield to nobody in passion and seriousness and commitment to securing the border, but there’s no reason for Texas farmers and ranchers and manufacturers and small businesses to pay the price of massive new taxes.”

Ron Johnson of Wisconsin, who was among the senators who spoke up, said: “I think the administration has to be concerned about another vote of disapproval … I’m not the only one saying it.” (…)

Fingers crossed “By what we have seen so far, we will be able to reach an agreement,” the foreign minister, Marcelo Ebrard, said during a news conference at the Mexican embassy in Washington. “That is why I think the imposition of tariffs can be avoided.”

Trump, during a press conference in London, offered mixed messages.

“We’re going to see if we can do something,” he said on the second day of his state visit to Britain. “But I think it’s more likely that the tariffs go on.” He also said he doubted Republicans in Congress would muster the votes against him. “If they do, it’s foolish.” (…)

“The Trump Administration last year recognized the importance of rare earths elements – albeit as an after-thought – when it pulled them off a list of Chinese imports to be hit with US tariffs. China mines about 80% of the 17 elements that appear on the Periodic Table, and has a lock on about 90% of rare earth processing.”
Source: “How the US lost the plot on rare earths” – a good primer on rare earths, at http://www.mining.com/web/us-lost-plot-rare-earths/ .

The Trump trade war expansion has reached a new and higher risk threshold. It is not just about China and rare earths; China’s threat to play the rare-earths card could mark a turning point.

In addition to complicating the China dispute, the Mexico round has intensified the adverse reactions among Republicans in the US Senate to Trump’s trade-war jingoism. Grassley is now a critical person. We shall see how these politics unfold.

Meanwhile, Mexico’s retaliation is likely to target US agriculture and add to what is certainly a shock to bilateral US-Mexico trade. Launching a tariff war with Mexico while simultaneously attempting to ratify the USMCA is incomprehensible. Many are labeling it a colossal Trump blunder. News reports infer Mnuchin and Lighthizer recommended against Mexico tariffs.

Our view from the perspective of portfolio management is that we must focus on the global rise of protectionism and nationalism and the use of jingoistic weapons. Trump has already changed the global paradigm. Diplomats had a code of negotiation behavior. It is destroyed.

The history of jingoistic rhetoric and behavior is not encouraging. Here’s what the Encyclopaedia Britannica has to say about the origins of jingoism:

“Jingoism, an attitude of belligerent nationalism, the English equivalent of the term chauvinism. The term apparently originated in England during the Russo-Turkish War of 1877–78 when the British Mediterranean squadron was sent to Gallipoli to restrain Russia and war fever was aroused. Supporters of the British government’s policy toward Russia came to be called jingoes as a result of the phrase ‘by jingo,’ which appeared in the refrain of a popular song:

We don’t want to fight, yet by jingo, if we do,
We’ve got the ships, we’ve got the men,
And got the money, too!”

(Source: https://www.britannica.com/topic/jingoism)

Now jingoism has become a term relevant to portfolio management. This is true in America, China, Mexico and elsewhere. Jingoism raises risk premia.

TECHNICALS WATCH

Lowry’s Buying Power Index crossed back above the Selling Pressure Index yesterday. The S&P 500 shot back up above its declining 200-d m.a.. Same with Nasdaq and the Wilshire 5000. Smaller caps also bounced but remain well below their 200-d m.a.

At today’s opening of 2823:

image

President Trump Says There’s ‘Always a Chance’ of War With Iran Trump prefers to talk, but war can’t be ruled out.
Brussels warns Italy it is in breach of EU budget rules Censure from European Commission risks sparking fresh row with anti-establishment government

THE DAILY EDGE: 4 JUNE 2019

U.S. Light Vehicle Sales Rebound

The Autodata Corporation reported that sales of light vehicles during May increased 6.2% (1.2% y/y) to 17.40 million units (SAAR) and reversed April’s 6.1% decline.(…) Light-truck sales increased 8.0% (6.7% y/y) last month to a 12.38 million unit rate and reversed the 6.5% April decline. (…) Auto sales improved 1.6% (-10.2% y/y) to a 5.02 million annual unit pace following a 4.8% April decline. (…)

Trucks’ share of the U.S. vehicle market rose to a record high of 71.1%. The share rose from 68.2% last year and a low of 47.3% in 2009.

Imports share of the U.S. vehicle market eased last month to 22.5% but has been trending upward since 2015. Imports’ share of the passenger car market surged to 30.1%, nearly a six-year high. Imports share of the light truck market eased to 19.5%., but remained up from the 11.8% low in April 2014.

 image image

Still trending weak. Americans don’t seem to be rushing out to buy cars ahead of potential import tariffs.

U.S. Construction Spending Unchanged in April

“Unchanged” but only because public construction jumped 4.8% (+15.1% YoY!). Private construction declined 1.7% (-6.0%).

 image image

USA: Manufacturing PMI drops to lowest since September 2009 

May survey data signalled only a marginal improvement in the health of the U.S. manufacturing sector. The headline PMI fell to its lowest level since September 2009 as output growth eased and new orders fell for the first time since August 2009. Weak demand conditions and ongoing trade tensions led firms to express the joint-lowest degree of confidence regarding future output growth since data on the outlook were first collected in mid-2012. At the same time, employment rose at the slowest rate since March 2017 and backlogs of work were unchanged. Meanwhile, inflationary pressures eased further, with both input costs and output prices increasing at softer rates.

The seasonally adjusted IHS Markit final U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) posted 50.5 in May [flash PMI was 50.9), down from 52.6 in April. The latest headline figure signalled only a slight improvement in operating conditions, with the latest reading the lowest since September 2009. The data for the second quarter so far have indicated a distinct slowdown in the manufacturing sector compared to the first three months of 2019.

image

A key factor weighing on the headline reading was the softest expansion of output since June 2016. May data signalled only a marginal rise in production that was often linked to clearing backlogs of previously-placed orders. At the same time, manufacturers signalled the first decline in new orders since August 2009. Though only fractional, survey respondents stated that weak client demand drove the fall. Some firms also noted that customers were postponing orders due to growing uncertainty about the outlook. Similarly, new business from abroad contracted for the first time since July 2018, albeit at a marginal rate.

Consequently, manufacturers exhibited a lower degree of confidence towards output over the coming year. Expectations for growth dipped to their joint-lowest since the series began in July 2012, as firms highlighted concerns surrounding ongoing trade tensions and a growing trend of customers postponing new orders, especially among large clients.

On the price front, cost burdens increased at only a modest rate in May. The rise was the slowest since July 2017, with reports of tariffs driving costs higher being countered by increased competition among suppliers. Subsequently, firms increased their factory gate charges only marginally amid efforts to remain competitive.

Meanwhile, firms signalled a further increase in employment in May. The upturn was commonly linked to the replacement of voluntary leavers and retirees. Nonetheless, the expansion was the slowest since March 2017 amid tight labour market conditions.

Finally, purchasing activity was broadly unchanged in May as firms indicated greater efforts to use current inventories for production and increased efforts to readjust stock levels in light of softer demand conditions.

Chris Williamson, Chief Business Economist at IHS Markit:

While tariffs were widely reported as having dampened demand and pushed costs higher, both producers and their suppliers often reported the need to hold selling prices lower amid lacklustre demand. While this bodes well for inflation, profit margins are clearly being squeezed as a result. (…)

While companies of all sizes are struggling, the biggest change since the strong growth seen late last year is a deteriorating performance among larger companies, where surging order book growth just a few months ago has now turned into contraction, the first such decline seen in the series’ ten-year history

In Canada, the U.S. main trading partner:

Canada’s manufacturing sector saw operating conditions worsen again in May. Production continued to contract amid the sharpest drop in new orders since December 2015. (…)

The headline seasonally adjusted IHS Markit Canada Manufacturing Purchasing Managers’ Index® (PMI®) dropped from 49.7 in April to 49.1 in May, signalling a second successive monthly deterioration in business conditions. The latest PMI reading was the lowest in nearly three-and-a-half years, albeit still indicating only a slight downturn.

(…) Output contracted at the most marked rate since the end of 2015. Panellists linked this to falling new orders and subdued global trade conditions. (…)

Tariffs from the US also inflated cost burdens, which firms then passed on to customers through a solid uptick in output charges. (…) Ontario registered the sharpest downturn in manufacturing performance during May, partly reflecting a survey-record decline in new export sales. (…)

In Mexico, the other North American trading partner:

Mexico’s manufacturing industry continued to stutter in May, with the headline PMI showing no change in the health of the sector following a fractional improvement in April. Output growth was reinstated amid a renewed rise in exports and back-to-back increases in total sales, but in all three cases respective rates of expansion were lackluster. Challenges in securing meaningful volumes of new work in recent months translated into further job shedding and another cutback to input purchasing, with the contractions the fastest registered since the survey started in April 2011 as some companies faced cashflow issues and focused on cost reduction measures.

Also testing factories’ financial resources was a further increase in cost burdens parallel to limited pricing power amid demand weakness. (…)

Let’s recap the status of the manufacturing industry in North America:

  • USA: “new orders fell for the first time since August 2009” on “weak client demand” and “postponed orders due to growing uncertainty about the outlook”. “New export business contracted for the first time since July 2018”. “Tariffs are driving costs higher” but “firms increased their factory gate charges only marginally amid efforts to remain competitive”.
  • CANADA: “the sharpest drop in new orders since December 2015. (…) Output contracted at the most marked rate since the end of 2015” on “falling new orders and subdued global trade conditions. Tariffs from the US also inflated cost burdens”. Ontario saw a survey-record decline in new export sales.”
  • MEXICO: “rates of expansion were lackluster” and new work so weak that corporate demand contracted at “the fastest rate registered since the survey started in April 2011” limiting “pricing power amid demand weakness”.

In fewer words: new manufacturing orders, domestic and foreign, are falling throughout North America amid generalized weak demand and uncertainty. This weak overall demand fuels increasing competition, limiting pricing power, preventing passing on cost increases and therefore squeezing margins.

This is a worldwide trend as the J.P. Morgan Global Manufacturing PMI reveals:

imageGlobal PMI surveys signalled that manufacturing downshifted into contraction during May. Business conditions deteriorated to the greatest extent in over six-and-a-half years, as
production volumes stagnated and new orders declined at the fastest pace since October 2012.

The trend in international trade continued to weigh on the sector, with new export business contracting for the ninth month running. Business optimism fell for the second month in a row and to its lowest level since future activity data were first collected in July 2012. (…)

The downshift in growth in the US was the main driver of the slowdown in global manufacturing, as the US PMI slipped to its lowest level in almost a decade (September 2009). (…)

Efforts to maintain competitiveness led to the weakest rise in selling prices since September 2016 (…)

image

Most American media and commentators report on the ISM manufacturing survey. The ISM PMI declined 0.7 to 52.1 in May but remains well into expansion territory while Markit’s PMI flirts with contraction readings. Markit compared its survey results with others last month:

Charting the data highlights how the ISM and the aggregated regional surveys correlate closely, but that both overstated actual manufacturing growth for much of late 2016- to late 2018, an overstatement which is not observed in the IHS Markit data. (…)

The outperformance of the IHS Markit data relative to the ISM is likely a consequence of ISM only surveying large companies while the IHS Markit survey covers small, medium and large companies in the correct proportions, as defined by the official data.

The IHS Markit survey is also the only survey to incorporate a national weighting system for its survey responses based on company size and sector contribution to total manufacturing output, ensuring each company’s response contributes appropriately to the survey index each month.

image
Trade Risks Prompt Growing Predictions for Fed Rate Cuts Economists are projecting that uncertainty created by the Trump administration’s actions on tariffs will prompt the Fed to cut rates later this year.

(…) If trade tensions persist, “we could end up in a recession in three quarters,” said Morgan Stanley chief economist Chetan Ahya in a report Sunday. Recent conversations with investors “have reinforced the sense that markets are underestimating the impact of trade tensions.” (…)

“It feels as if the market is internalizing the fact that President Trump may not be solely focused on the health of financial markets,” said Roberto Perli, an analyst at Cornerstone Macro, in a report Monday.

Mr. Perli said Friday’s market expectations of the Fed’s future interest rate path over the following eight months posted the largest one-day drop since June 2016, when British voters approved a referendum to leave the European Union. The move was larger than all but 19 other such declines since 2008, with all of those declines occurring during the financial crisis in 2008.

“A change this big did not happen even at the time of the 2015-16 China scare, during which many investors thought the economy was definitely headed for recession,” Mr. Perli said. (…)

St. Louis Fed President James Bullard said the inverted yield curve and a perceived shift in the Trump administration’s prospects to achieve near-term trade agreements warranted the move.

“The narrative on global trade has darkened,” Mr. Bullard told reporters after a speech in Chicago on Monday.

“Monetary policy looks too restrictive in this environment,” Mr. Bullard said, referencing the inverted yield curve. “That’s usually been a bad sign for U.S. economic prospects.” (…)

Fed Chairman Jerome Powell is set to speak at a research conference in Chicago on Tuesday morning. (…)

image

Consumer prices rose 1.2% in May, dropping back to the lowest in more than a year, from an Easter-boosted 1.7% pace in April. The core inflation rate fell to 0.8%, with both figures coming in below the median estimates of economists. (…)

Euro-area inflation eased more than expected in May

Yuan Watchers Say 7 Is No Longer a Sticking Point for China

(…) In the four days since ex-governor Zhou Xiaochuan dismissed the importance of 7, at least six analysts published reports laying out why the People’s Bank of China is likely to tolerate a weaker yuan. They say policy makers are more likely to prioritize supporting economic growth amid a worsening standoff with the U.S. over trade. (…)

China Warns Citizens Against U.S. Travel, Citing ‘Frequent’ Shootings “Recently, U.S. law enforcement agencies have repeatedly harassed Chinese citizens visiting the U.S.,” a report said.

SENTIMENT WATCH
Druckenmiller Piled Into Treasuries on Trump’s China Tweet

(…) “When the Trump tweet went out, I went from 93% invested to net flat, and bought a bunch of Treasuries,” Druckenmiller said Monday evening, referring to the May 5 tweet from President Donald Trump threatening an increase in tariffs on China. “Not because I’m trying to make money, I just don’t want to play in this environment.” (…)

“So I think if you’re confident in your long-term view and ability to make money, this is not a great environment to be going and betting the ranch. Not short, not long,” Druckenmiller said.

Liz Ann Sonders shows a NDR Research chart that I am not allowed to display here but can be seen on her post linked above.

(…) The table above shows the contrarian nature of sentiment at extremes, with market returns being weakest when investors are most optimistic. The contrary has an interesting wrinkle though. Also seen in the table above, the best zone for stocks is not while sentiment remains in the “extreme pessimism” zone, but when it has clawed its way out of that zone and moves up into the neutral zone. In other words, we may have to experience more market downside to trigger a better reading on this model.

Much of what is shown above represents attitudinal measures of sentiment; but there are also behavioral measures. A couple of them are captured in the CSP—the put/call ratio and Rydex flows—but there are others that I track as well.

One that is a perennial favorite among readers is ST’s “Smart Money” and “Dumb Money” Confidence readings (see their definitions in the footnote below the chart shown below). As of May 1, Dumb Money Confidence hit a high rarely seen in history; yet shortly thereafter—in keeping with the rollover in stocks—the spread between Dumb Money and Smart Money started to converge. The market’s decline since late-April was enough to finally push Smart Money above Dumb Money as the two groups are changing their mentality from hedging to covering (the Smart Money); and from being extremely long to reducing their exposure (the Dumb Money).

Smart Money Crosses Above Dumb Money

060319_SmartDumbMoney

Source: Charles Schwab, SentimenTrader, as of May 31, 2019.

The cross seen above marked the first occurrence in four months. That’s one of the longer streaks over the past 20 years according to ST. The longest streaks historically were typically during the starts of bull markets however—not typically this long into an existing bull market. 

With one major exception, these crosses were mostly good signals for stocks, although continued weakness tended to be concentrated in the subsequent month. The exception was in 2000, when it triggered right at that cycle’s peak, leading to more than a 30% loss over the next year. The sooner we see Dumb Money retreat closer to 30%, the less likely further major losses will occur according to historical precedent (although past performance is no guarantee of future results).

Finally, there are two other behavioral measures of investor sentiment—fund flows and households’ positioning in equities. On the former, the latest data from the Investment Company Institute (ICI) shows that equity mutual funds suffered an outflow of more than $42 billion in April alone—one of the largest losses ever for a single month. What’s especially notable according to ST is that while investors were yanking those funds out of stocks, stocks were still rising at the time and the S&P 500 was firmly above its 12-month moving average.

The near-term results for stocks after prior occurrences like this were mixed; with a couple of notable times when investors’ contrary sense paid off: in July 2011, and more recently in January 2018. Both times, stocks struggled immediately and continued to suffer hefty pullbacks. But those were the exceptions; and looking at the subsequent one-year returns for the S&P 500 after 19 prior signals since the mid-1980s, 95% of the time, returns were higher. (…)

In sum, we are beginning to see signs of a ramping of pessimism tied to the latest market weakness and concerns about recession. It may not be enough yet to suggest a contrarian case for a near-term bottom, but it may not take much additional weakness to get there given the heightened sensitivity toward even mild pullbacks. Longer-term though, an objective look at households’ exposure to equities suggests the likelihood of the next 10 years looking as good as the past 10 years is fairly low.

The Big Challenge for Policy Makers: Policing American Tech Giants  Amazon, Apple, Facebook and Google don’t fit neatly into old monopolistic formulas that would signal harm to consumers

(…) On the surface, Google and Facebook—as well as Amazon.com Inc. and Apple Inc. —have traits that would traditionally raise concerns about stifled competition squelching choices for consumers. They all have dominant market shares in their sectors—from search to social media, e-commerce, online advertising and smartphone apps—and are protected by practices and conditions that make it hard for new rivals to challenge them.

And yet they don’t fit neatly into the old formulas that signal harm from such power: higher prices and less choice for consumers. On the contrary, these companies offer many of their core products to customers for no charge. And they have vastly expanded the ability of consumers to search, compare and buy a newly broad range of products from all over the world with a quick click, search, or download. (…)

Many economists say consumers do pay for all of these services, not with cash but by providing the tech companies with valuable information about their personal lives as well as shopping and search habits. Those companies in turn convert that data into big profits by selling it to advertisers and other users. These economists say that in a more competitive market, the real free-market price could be lower than it is. Consumers, they suggest, might be paid for that data. (…)

The report also suggests that data-privacy concerns—a nonmonetary “cost” borne by consumers using digital platforms—might be better addressed with more competition, if different companies tried to lure customers by offering tighter protections.

The huge share of the digital advertising market controlled by Google and Facebook also means they can charge more for those ads than they could in a more competitive market—costs that may be passed on to consumers with higher prices for the goods they buy online, the reports say. They add that the prominent placement of ads associated with those platforms also degrades the quality of the user experience for consumers. (…)

The Chicago report says that, with digital platforms, the “competition in the market” shaping most industries is replaced by “competition for the market,” meaning that once a firm has won the battle to control a sector, it faces little challenge from other rivals. (…)

The reports all recommend tougher antitrust policies toward the big digital platforms. That could include more active investigations of practices used to curb competition, as well as a more aggressive stance in blocking any future acquisitions by those firms of potential competitors, like Facebook’s purchase of Instagram and WhatsApp.

But the studies also say there are limits to what antitrust authorities, like the Justice Department, can do about Google or the other big tech firms given that technology leads to single-firm dominance and moves so quickly.

Both the Chicago and U.K. studies conclude that governments will need new powers to foster more competition.

Druckenmiller:

(…) the future of an economic war with China will be fought with artificial intelligence and the U.S. should be helping, not hurting related companies.

He said China started easing up on its private sector last autumn and has been highly supportive of its own tech sector. “What are we doing? Oh, we’re saving, steel, coal, aluminum. What are we doing with our leading tech companies? We’re throwing sand in the gears and making their life miserable.” (WSJ)

An Ethanol Sop to Farmers The EPA allows E15 blends in the summer to offset tariff damage.

Americans will pay for President Trump’s tariffs in many ways, and on Friday we learned one more. The Environmental Protection Agency released a final rule allowing gasoline to be blended with up to 15% ethanol year-round. The result will be smoggier air and costlier road trips.

The EPA has long restricted E15 sales in the summer. The concern is—or at least was—that the combination of sun, heat and the organic compounds released by ethanol blends would result in much more smog. The Clean Air Act allows the EPA to issue a waiver and allow sales of 10% ethanol blends between June 1 and Sept. 15, but the law includes no such carve-out for E15.

Despite dubious legal authority, the Trump Administration has now granted E15 this pass to pollute during peak smog season. (…)

Compared to pure gasoline, ethanol has about 33% less energy content, so drivers get fewer miles per gallon. Unless an engine is specially built to accommodate high-ethanol blends, anything over 10% is corrosive. (…)

The EPA uses credits called “renewable identification numbers,” or RINs, to enforce these ethanol quotas. The credits are created when ethanol and gasoline are mixed, but independent refiners usually aren’t blenders. They can’t create RINs, so they’re forced to buy them.

Big oil and corn producers and speculators have cornered the market for the credits, driving up prices. When the East Coast’s biggest refinery, Philadelphia Energy Solutions, filed for Chapter 11 bankruptcy in 2018, it blamed RINs. By 2017 the credits had cost twice as much as the company’s payroll.

The new regulations do little to prevent manipulation of the RINs market. Gone are earlier proposals that would have barred hoarding the credits and required speculators to sell promptly. The new rule does mandate more transparency, but that doesn’t change the basic incentives in this artificial market. Mark it down as another example that one bad economic policy leads to many more.