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: 23 JANUARY 2019

Home Sales Sank 6.4% in December

(…) December capped the weakest year for home sales in three years. Existing-home sales fell 6.4% in December from the previous month to a seasonally adjusted annual rate of 4.99 million, the National Association of Realtors said Tuesday. Compared with a year earlier, sales in December declined 10.3%. (…)

The decline in December sales was broad, with Seattle, Portland, much of California, Denver, Maryland, Delaware and the Philadelphia area experiencing double-digit declines, according to an analysis of local multiple-listing service data by Lawler Economic and Housing Consulting. (…)

The median sale price for an existing home in December grew 2.9% from a year earlier—the smallest increase since March 2012, when the market was still depressed from the housing crash. (…)

The Commerce Department isn’t expected to release December’s data due to the government shutdown, but an analysis by Redfin found that new-home sales dropped 10.3% in the South in December, 13.4% in the West and more than 16% in the Northeast. (…)

Mortgage rates have also come down in recent weeks, easing concerns that a long era of cheap housing credit was about to end. Rates nearly hit 5% about two months ago, but average rates for a 30-year, fixed-rate mortgage dropped to 4.45% last week, according to Freddie Mac. Purchase mortgage applications grew 9% for the week ending Jan. 11 from a week earlier to the highest level since April 2010, according to a Mortgage Bankers Association index. (…)

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Here’s a scary chart (@MikaelSarwe)

This will help some:

Los Angeles Teachers, School District Announce Deal to End Weeklong Strike Union members vote to approve agreement that includes 6% raise, additional staffing

(…) LAUSD Superintendent Austin Beutner said the agreement included a 6% raise, additional staffing at schools, and a reduction to class sizes, covering the union’s major demands. He said the nation’s second-largest school district agreed “to invest every nickel we have in our classrooms while maintaining the fiscal solvency of Los Angeles Unified.”

The deal includes $403 million to be spent through 2022 to add nurses, counselors and librarians at schools and to reduce class size. It doesn’t address health-care and other retiree benefits, which the district has cited as a major strain on its finances. (…)

“So far it seems like we got everything we wanted, most importantly that we are taken seriously,” teacher Julia Guzman said. (…)

In the last year, teachers in states including North Carolina, Arizona and West Virginia have gone on strike to demand higher pay and other changes, winning average pay increases of between 5% and 20%.

The trend could continue as teachers unions in Denver and Oakland, Calif. are currently locked in disputes with their districts and threatening to strike within the next month.

Truckers See Momentum Slowing Heading Into 2019

(…) “We see more evidence pointing to a potential freight recession in 2019 similar to 2015/16,” Morgan Stanley analysts Ravi Shanker and Diane Huang wrote in a Jan. 16 research note. “With net inventory levels reaching another all-time high and ordering levels falling, the risk of a destocking event in 2019 is high.” (…)

An index of U.S. domestic freight volumes slipped 0.8% last month compared with December 2017, the first annual decline in two years, according to Cass Information Systems Inc., which processes freight bills.

Trucking rates on the spot market, where shippers book last-minute transportation, also fell in December for the first time in several years, according to online freight marketplace DAT Solutions LLC. The average price to hire the most common type of big rig dipped to $2.07 per mile, a penny lower than the prior month and 5 cents below the level in December 2017.

The first quarter is typically a slower period for freight, although factory production ticked up at the end of last year, suggesting consumer demand could make up for a pullback in exports.

But analysts say trucking companies could face an even steeper drop-off in shipping demand this year because some manufacturers and retailers pulled imports forward in 2018 to avoid tariffs expected to take effect around March.

The impact “will likely be seen most in February after the impacts of an earlier Chinese new year leave the market somewhat naked to difficult  [year-over-year] comparisons,” Cowen & Co. transportation analyst Jason Seidl wrote in a Jan. 14 research note. Factor in falling spot rates, and “the data would suggest that much of the spot pricing gains from mid-2018 that strongly benefited carriers could be erased in 1H19, with the advantage in contract negotiations reverting back toward the shippers.”

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China Risks Real Hard Landing This Time Beijing’s crackdown on shadow banking has gone overboard. Some backtracking looks necessary.

(…) Chinese credit growth has continued to decelerate, despite nine months of significant central bank easing. If it doesn’t turn back up soon, producer-price inflation could turn negative—causing big problems in the heavily indebted industrial sector.

The mushrooming of Chinese shadow banking was an unfortunate, but necessary, byproduct of a banking system that has grown more state dominated since 2010. Private companies account for about two-thirds of the economy but receive only about a third of net new lending. It’s little wonder they have turned increasingly to unofficial channels to get loans. (…)

Despite several big reserve ratio cuts and sharply lower benchmark interbank rates, growth in net nonfinancial fundraising had declined to 9.8% in December, its lowest in more than a decade.

In other words, in the past year, banking-system liquidity has risen by about a fifth, but net credit growth has fallen by about a third. The reason is clear. Shadow finance outstanding fell by a full 10% in 2018—by far the sharpest contraction on record. (…)

  • Shadow banking was cut sharply last year, with shadow loans outstanding down by almost 11% YoY as of December, in contrast to a rise of 15% through December of 2017. Total credit rose by about 10% last year, but the composition of the new flow changed: traditional bank loans accounted for 81% of new credit, up from a 51% share in 2013 as shadow banking was curbed. There was a similar clampdown on peer-to-peer lending. While these changes are good for the long-term health of the financial system, they created short-term pain for many private firms, who were among the largest recipients of shadow credit. (Andy Rothman)

  • The SMI report from World Economics shows further softening in China’s economic activity in January. (The Daily Shot)

EARNINGS WATCH

We have 61 reports in with an aggregate 20.0% earnings growth rate, a 79% earnings beat rate with a low +1.7% surprise factor (+0.7% for Financials). The revenue beat rate is 57% (42% for Financials).

The blended growth rate for Q4 is 14.1% (12.2% ex-Energy), down from 15.8% on Jan. 1. Q1’19 estimates now show earnings rising 2.7%, down sharply from 5.3% on Jan. 1. with only 3 sectors expected to report good growth: Financials (+5.3%), Health Care (+8.7%) and Industrials (+8.2%). The remaining 8 sectors’ earnings are seen down 0.5% on average in Q1’19.

Trailing EPS are now $162.05. The Rule of 20 P/E is at 18.4.

ODD ODDS

There are many ways to skin a cat, and so many ways to forecast a recession. There’s this old saying that markets have forecasted 9 of the last 5 recessions and economists none of them. David Rosenberg plays the odds in his own many ways:

You don’t need to have the S&P 500 decline 20% to have a recession – we had an official downturn in 1990-91 without that happening (…). And we have had periods in the past when the stock market corrected more than 22% (1961, 1966, 1987) and there was no recession. But (…) declines in the S&P 500 of 20% or more typically does foreshadow recessions around 80% of the time. Nothing is truly infallible, but I’ll take those odds.

We don’t need a 20% beating and we have had bears greater than 22% without recessions but 20% or more typically does foreshadow recessions 80% of the time. Only President Trump can make some sense out of these numbers. Recessions without bear markets, bear markets without recessions but bear markets which, typically, do foreshadow recessions 80% of the time. I never thought I could use “typically” with “does” and 80% odds.

And about those 80% odds: there have been only 11 official recessions since WWII. Pretty small sample to derive solid statistics, especially if you also had recessions without a bear and bears without recessions. But there is a key to this:

The real key is whether the September high in the S&P 500 of 2,930 was indeed the peak of the cycle. This has nothing to do with the severity of the decline. Just a simple fact, which is that every post-WWII peak in the stock market was followed by a peak in the real economy. This is not 9 out of 5; it is 9 out of 9.

The real, real key in all this is what is actually a peak in the stock market? Obviously, if one waits long enough, there will be a peak close enough to a recession…Look at these charts from Ed Yardeni and try to make solid odds out of them. Confused smile

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THE DAILY EDGE: 22 JANUARY 2019: Tail End Earnings Risk

U.S. Manufacturers Ramp Up Production Despite Flagging Exports Factory production surged at the end of last year amid broad-based gains in output, signaling U.S. consumer demand may be making up for a pullback in exports.

Industrial production, a measure of overall factory, mining and utility output, increased a seasonally adjusted 0.3% in December from the prior month, the Federal Reserve said Friday. Output at U.S. factories, which accounts for the bulk of the nation’s total industrial output, grew 1.1% last month, the biggest gain since February 2018.

Manufacturers in a variety of categories produced more last month, with vehicle and car-parts makers leading the way. Production of appliances, clothing, and paper items also ramped up.

Mining output picked up despite recent energy-price volatility, while utility production declined a stark 6.3% from November, largely due to “warmer-than-usual temperatures,” which lowered the demand for heating, according to the Fed’s report. (…)

From a year earlier, overall industrial production rose 4% in December, while capacity utilization, which reflects how much industries are producing compared with what they could potentially produce, rose by 0.1 percentage point to 78.7% in December. This was the highest reading in about four years. (…)

Manufacturing output has ben fairly steady quarter to quarter…

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…with a strong finish:

  • The number of manufacturing sub-sectors that were contracting was the lowest since 2010. (The Daily Shot)

Source: @GregDaco

Markit’s December U.S. Manufacturing PMI was reasonable strong with still solid new orders:

Following a slight pick up in November, new order growth eased in December. Though strong, the pace of expansion was the weakest since September 2017. Although some firms stated that the upturn was driven by new order inflows from newly acquired clients, others cited concerns surrounding a drop in client demand compared to earlier in the year.

Conversely, new export business grew at an accelerated pace in December. New orders from abroad increased for the fifth successive month and at the fastest rate since January amid stronger foreign client demand.

Markit will release its flash PMI Thursday.

From Haver Analytics’ table, we see that Manufacturing of consumer goods has stalled in Q4. Probably a good thing, to keep inventories in shape. But Biz equipment and construction supplies have been very strong, also a good sign going into the first half of 2019 amid all this political uncertainty. Mining as well in spite of lower oil prices.

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Government Shutdown, Trade Tensions Weigh on U.S. Households The latest University of Michigan index is a sign that Americans could pull back on discretionary spending

An index of U.S. consumer sentiment fell to its lowest level in more than two years in January, the University of Michigan said Friday. (…) The consumer sentiment index also fell the last time the government shut down in 2013 but recovered once the government reopened, said Jim O’Sullivan, chief U.S. economist at High Frequency Economics. (…)

Consumer sentiment are coincident indicators but because the U.S. economy is currently crucially in need of steady consumer spending, let’s spend time on this latest survey thanks to The Daily Shot:

  • This index hasn’t experienced such a sharp decline in years.

  • The expectations component tumbled.

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“Tumbled” sounds overly negative for such a volatile series. For better perspective of the tumbling, here’s a 50 year chart:

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These are the two scary charts, but we knew that already:

  

In spite of the above, the consumer has continued to consume…

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Ghost This is the scary chart: were Americans to decide to save again, income growth would not support spending growth. Confidence is at work here.

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China’s growth slowed by service, farm sectors, despite construction rebound  Weakness in the service and farm sectors slowed China’s economic growth in the fourth quarter, despite a strong pickup in construction activity, official data showed on Tuesday.

Services grew 7.4 percent from a year earlier, slowing from 7.9 percent in the third quarter, while growth in agriculture slowed to 3.5 percent from 3.6 percent, the National Bureau of Statistics (NBS) said. (…)

The services sector accounted for almost half of gross domestic product in the quarter by value as China continued to transition towards a service-oriented economy, while agriculture contributed about 10 percent, according to Reuters’ calculations based on the latest data.

Growth in real estate services slowed to 2 percent year-on-year in the fourth quarter from 4.1 percent a quarter earlier, as government tightening measures to curb speculation and skyrocketing prices subdued overall demand. The sector contributed 6.4 percent to GDP in the quarter.

The retail and wholesale sector slowed to 5.5 percent from 6.2 percent as consumption of physical goods lost momentum. Auto sales in the world’s biggest car market shrank for the first time in 2018 since the 1990s.

Though retail sales growth picked up marginally in December to 8.2 percent, the consumer strength gauge is around the weakest in 15 years. (…)

Having been a stellar performer benefiting from supportive policies, the tech sector still grew at double-digit rate but growth slowed to 29.1 percent in the fourth quarter compared with 32.8 percent in the third. It accounted for about 3 percent of GDP in the fourth quarter. (…)

The [construction] sector – accounting for 8 percent of the economy – grew 6.1 percent in the fourth quarter, accelerating from the previous quarter’s 2.5 percent growth.

But in a surprising remark, Fang Xinghai, vice-chairman of China’s Securities Regulatory Commission, told a seminar in Davos that he expected economic growth to slow to 6 percent this year from 6.6 percent in 2018, stressing China’s slowdown won’t be a “disaster”.

China’s Xi Warns Party of ‘Serious Dangers’ as Risks Mount

(…) The meeting was held on the same day that China reported its slowest quarterly economic growth since the depths of the global financial crisis in 2009. The data underscored concerns that the decades-long economic expansion that helped the ruling party outlast most other communist regimes may be running out of steam. (…)

IMF Lowers 2019 Global Growth Forecast New projection largely reflects poor economic performance out of Europe

The IMF cut its forecasts for world economic growth in 2019 to 3.5%, down from 3.7% forecast in October and 3.9% expected in July.

In its earlier predictions, the IMF had characterized growth as “plateauing” but now has conceded that the “global expansion has weakened.”

A global recession isn’t around the corner, the IMF’s Managing Director Christine Lagarde told reporters at the World Economic Forum’s annual meeting in Switzerland on Monday. “But the risk of a sharper decline in global growth has certainly increased.”

She cited in particular the threat of higher tariffs, which have already weakened financial markets globally. (…)

Germany’s growth forecast for 2019 was cut 0.6 percentage points due to weak consumption and industrial production data; Italy was cut by 0.4 points due to weak domestic demand and high government borrowing costs and France was cut by 0.1 points due to the impact of ongoing street protests. (…)

The forecast was unchanged for the world’s two largest economies, the U.S. and China. But the IMF had previously forecast that both economies would slow—each by 0.4 points—in 2019 compared with the previous year. (…)

Forecasts were raised slightly for two major economies, India and Japan, and many of the sources of concern are self-inflicted wounds from political dysfunction, such as trade tensions between the U.S. and its trading partners, the U.S. shutdown, the U.K.’s Brexit and Europe’s domestic strife.

“The main shared policy priority is for countries to resolve cooperatively and quickly their trade disagreements,” the IMF said.

The IMF assumes Britain will leave the European Union with a deal that smooths the transition. A “no deal Brexit” is a “major risk” to the outlook, Ms. Gopinath said.

The fund also assumes the U.S. will impose further tariffs on China. If it doesn’t, following the negotiations under way between the countries, that would represent a positive risk to the outlook, Ms. Gopinath said.

Central Banks Struggle With Policy Settings ECB outlook reflects a global shift in central banking

(…) “The narrow window in which the ECB could have lifted its key interest rate from emergency, negative levels, has closed,” said Simon Wells, an economist with HSBC in London. (…)

The ECB outlook reflects a global shift in central banking. Federal Reserve officials—unsettled by market turbulence and slowing global growth—have said they would be patient before moving rates up again, meaning they’ll pause after a series of rate increases last year and before.

The Bank of Canada has also made a notable about-face. In early December, the Canadian central bank pointed to a weaker-than-anticipated housing market and the rapid decline in oil prices in signaling a pause in rate rises.

“We have to do our work in order to understand the shock better and what its magnitude actually is,“ Governor Stephen Poloz said last month. “We need some time.”

ECB President Mario Draghi is expected to acknowledge the darkening outlook after the bank’s policy meeting Thursday. Speaking at the European Parliament in Strasbourg earlier this month, Mr. Draghi admitted that recent data had been weaker than expected, although he argued that the eurozone probably would avoid recession. (…)

Much of the turnaround is due to weaker demand for eurozone exports. There are problems closer to home as well. Holdups at Germany’s key automobile factories pushed Europe’s largest economy to the brink of recession in the final six months of last year. Italy may not have avoided that fate, following a jump in borrowing costs as investors fretted over the government’s plans to add to an already large debt load.

In France, President Emmanuel Macron is wrestling with rolling mass protests aimed at derailing his economic reform plans. And the U.K.’s Parliament is deeply divided over how to manage the country’s planned divorce from the European Union, barely two months before it is due to depart. (…)

Figures released Thursday show the core inflation rate—which excludes volatile prices such as those charged for energy and food—was unchanged at 1% in December.

ECB officials are mindful of the bank’s past tendency to raise interest rates at the wrong time. It increased key rates in 2008 and then again in 2011. In both cases those moves were followed by recession. (…)

“The uncomfortable truth is that there may not be a whole lot the ECB can do to offset a moderate slowdown,” said Mr. Wells.

EARNINGS WATCH

From Factset:

Overall, 11% of the companies in the S&P 500 have reported earnings to date for the fourth quarter. Of these companies, 76% have reported actual EPS above the mean EPS estimate, 2% have reported actual EPS equal to the mean EPS estimate, and 22% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year (77%) average but above the 5-year (71%) average.

In aggregate, companies are reporting earnings that are 3.2% above expectations. This surprise percentage is below the 1-year (+6.0%) average and below the 5-year (+4.8%) average.

In terms of revenues, 56% of companies have reported actual sales above estimated sales and 44% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is below the 1-year average (72%) and below the 5-year average (60%).

In aggregate, companies are reporting revenues that are equal (0.0%) to expectations. This surprise percentage is below the 1-year (+1.4%) average and below the 5-year (+0.7%) average.

The blended, year-over-year earnings growth rate for the fourth quarter is 10.6% today, which is slightly above the earnings growth rate of 10.5% last week. The blended, year-over-year revenue growth rate for the fourth quarter is 6.0% today, which is slightly above the revenue growth rate of 5.8% last week.

Refinitiv reports that the 55 companies having reported so far showed 21.0% earnings growth. The blended growth rate for Q4 stands at 14.2% from Refinitiv’s lower than Factset’s base. Capital IQ’s even lower base allows them to expect a 19.1% YoY growth rate in Q4. Pick your base ‘cause they all end up at the same earnings level.

Factset continues:

At this point in time, 6 companies in the index have issued EPS guidance for Q1 2019. Of these 6 companies, 6 have issued negative EPS guidance and 0 have issued positive EPS guidance.

Analysts continue to trim estimates for 2019, particularly for the first quarter:

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Q1 earnings are now expected up 3.0% (3.3% ex-Energy), down from 5.3% on Jan.1 with only 3 sectors sporting comfortable growth rates. Compared with 3 months ago, the revisions are very significant in Consumers, Energy, Materials and Technology. These sectors were expected to grow Q1’19 earnings 12.9% on average last Oct. 1 (+6.7% ex-E). Now: zero (+1.1% ex-E)!

Half the sectors get little or no earnings lift during the next several months, making them more susceptible to sentiment swings. In effect, while equities are cheap in aggregate, fundamental support is waning for 5 of the 11 sectors. Furthermore, all S&P 500 sectors but one (Utes) currently have a negative earnings revisions index and a negative revenues revisions index according to Ed Yardeni. The same is true for S&P 600 sectors (all sectors have negative NERI) and S&P 400 sectors.

The numerous uncertainties surrounding trade, the shutdown, Brexit and China are obviously influencing analysts to be more cautious. So far, their cautiousness is concentrated in Q1 as Q2 earnings are seen up 4.9% (6.5% on Jan. 1) and the full year is at +6.0% (from 7.3%) thanks to the hopeful Q4 expected at +11.3%, barely down from 11.5% on Jan. 1. Fingers crossed Talk about tail end risk!

Trailing EPS are now $162.06 per Refinitiv’s calculations and the Rule of 20 P/E is 18.64, down from 23.6 one year ago but up from 16.6 last December 26. The Rule of 20 Fair Value (yellow line in chart) is still rising (2885 currently) and if analysts estimates for the full year ($171.34) materialize, it will rise 5.7% to 3050 one year from now. Equity markets are generally better sustained when fundamentals (earnings and inflation) are rising.

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Needless to say, navigating the current environment is more like rafting than yachting!

SENTIMENT WATCH
Investors’ Cash Dash Adds to Stock Market’s Vulnerability Investors are increasing their cash holdings at the fastest pace in a decade, highlighting doubts about the durability of the stock market’s rebound.

(…) An estimated 13% of investment portfolios now include cash, up from 12% for 2018, which was one of the lowest figures in the Goldman data. Besides pressuring stock returns, a rush toward cash could also signal a looming economic downturn, Goldman data show, as allocations tend to rise continuously in the 12 to 15 months preceding a recession. (…)

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Silicon Valley’s Optimism Turns Into ‘Shame of Being Suckered’ Startup investors and company founders warn that the unchecked growth of the past several years could be hitting a limit. A rout of publicly traded tech companies is fostering newfound restraint.

“The unbridled optimism that inhabits our world,” said startup investor Sunny Dhillon, “is getting a shot of realism.” (…)

Yet a worrying sign is the shrinking of so-called seed deals, essentially the earliest investments in startups. The number of these deals has fallen steadily, dropping to 882 in the fourth quarter from more than 1,500 three years earlier, PitchBook says.

(…) U.S. venture-backed companies raised a record $131 billion last year, topping the previous high of $105 billion set in 2000, according to researcher PitchBook. The influx of money from investors at home and abroad has cushioned startups with shaky business models. (…)