Note to subscribers: hopefully the problem has been solved. Today’s email should include links to all posts since Oct.19.
Economy Steams Ahead but Warning Signs Are Emerging Strong consumer spending powered economic growth in the third quarter, helping to offset weak business investment and a drop in U.S. exports.
(…) Gross domestic product grew at a 3.5% annual rate from July through September to $18.7 trillion, adjusted for inflation, the Commerce Department said Friday. That came after a 4.2% growth rate in the second quarter and stands as fresh evidence that growth has picked up from subpar levels closer to 2% that had prevailed for much of the long-running U.S. expansion since 2009. (…)
Defense outlays grew at a 4.6% annual rate in the third quarter, adjusted for inflation, thanks in part to a bipartisan budget agreement reached in February to boost government spending this year and next by nearly $300 billion above limits set in a 2011 law. That included $165 billion more for the military. For the six months between April and September, defense spending rose at its fastest pace since 2009.
Despite those engines of growth, many analysts believe the expansion will slow in the months ahead. The Federal Reserve, for example, projects a growth rate of 2.5% in 2019, 2% in 2020 and 1.8% in 2021. (…)
Business investment grew at a modest 0.8% annual rate. That included a contraction in investment in business structures, which had been running strong for months, thanks to spending on oil and gas rigs driven by rising energy prices. (…)
The central bank’s preferred measure of inflation—a price index tracking the costs of goods and services purchased by consumers—rose at a 1.6% annual rate in the third quarter, less than the Fed’s 2% target. (…)
(…)The price of a gallon of paint is rapidly increasing. Home Depot’s key supplier, PPG Industries Inc., PPG -0.85% raised prices 2% over the summer, while rival Sherwin-Williams Corp. SHW 0.66% is bumping them at least 4%. Both companies will keep raising prices through 2019.
As if on cue, Sherwin-Williams on Thursday noted a slowdown in DIY growth. The company suggested it could be just a blip in a fickle slice of the market. But analysts say it could prove that customers will balk when price tags get too steep. (…)
“I can’t recall any time so many companies say they need to raise prices and to this degree,” said Scott Mushkin, a retail and staples analyst with Wolfe Research. “All they talk about is raising prices, raising prices.”
Companies selling everything from bulldozers to Big Macs say higher prices are the only way to protect margin growth, an important metric to Wall Street during a particularly volatile moment for investors. JetBlue , United Technologies , Unilever , Procter & Gambleand UPS have all signaled they plan to raise prices. And that list barely scratches the surface. (…)
Kimberly-Clark Corp. provided a recent example of how a company can get stung. During the third quarter, it raised the net price of tissue products by 2% to offset raw material costs, and reported a North American sales decline of 5%. “That suggests that the consumer is pretty sensitive to these,” Mr. Mushkin said. (…)
(…) Nearly every industrial company reporting results in October has mentioned tariffs.Caterpillar (ticker: CAT) said the drag of higher input costs due to tariffs was $50 million more than its price increases. That $50 million is about 1.2% of the construction-equipment maker’s third-quarter gross margin. Air-conditioner maker Lennox International (LII) was more positive. It said that the 2.5% price gain it realized in the quarter more than made up for inflation and tariffs.
For now, it appears that many companies are willing to eat the costs, and that could have a big impact on bottom lines. Barclays strategist Maneesh Deshpande’s worst-case scenario is a 25% tariff on all Chinese goods imported to the U.S. Assuming that companies absorb the costs, Deshpande calculates that would shave three percentage points off the projected 10% growth for S&P 500 earnings in 2019.
Of course, if pressure continues to mount, companies may have to raise prices. When Honeywell International (HON) was asked on its earnings call about taking pre-emptive action on any new tariffs—such as price hikes, cost cuts, or alternative sourcing—executives said they were getting ready, but weren’t pulling the trigger just yet. (…)
The main problem with cost-push inflation: uncertainty. Even more so if the cost hits are not the result of fundamental trends but rather come from political diktats targeting specific industries/goods imported/exported from/to specific countries and not others. Prices are no longer defined by demand and supply; industries/companies are impacted very differently and for reasons that have little to do with the economics of the moment.
Pricing and production decisions become very difficult to make under such unstable environments since executives must try to figure out the numerous ramifications that tariffs will have, not only on their costs but also on their competitors’ costs which may be operating in different countries with different tariff impacts.
If, to top it all, nobody knows how long the situation will last, how can you manage, how can you invest?
Very carefully.
Corporate guidance will become very iffy for a while. A few more examples gleaned here and there:
- Correct Craft Inc., a recreational boat maker based in Orlando, Fla., is “getting squeezed on both ends,” Chief Executive Bill Yeargin said in an interview. Alongside tariffs on exports that pose “significant headwinds” to its international business, tariffs on components imported from China have given domestic suppliers cover to raise prices, too, he said. “Fortunately, the domestic market’s been very strong,” Mr. Yeargin said. (WSJ)
- [Chipotle] reported third-quarter results after the market’s close on Thursday, turning in a 4.4% same-restaurant sales increase that made for its best number of the year—and best of newish CEO Brian Niccol’s tenure. The shares were up about 1% to $428 on Friday morning. Higher menu prices, management said, led to most of the increase; that, along with restaurant openings, helped revenue go up 8.6% year-over-year. They also helped profit margins. The price increase and cheaper avocados meant food, beverage and packaging costs were a lower percentage of sales even as meat, paper and packaging costs rose; restaurant operating margins also widened as the company cut marketing and promotional costs. Now, Chipotle says, it may not wait as long to boost prices again—particularly as it looks to offset rising labor costs. “We‘re open to the idea of doing smaller, more regular increases,” CFO Jack Hartung told Barron’s in a Friday morning interview, saying that labor costs have risen for years and Chipotle wants to attract quality employees in the face of that growth. “We’re going to pay more than fair value” for talent, Hartung said.
These are good times to raise prices, courtesy of President Trump’s fiscal largesse, but if everybody does it, the good times will quickly become tough times for consumers, the FOMC and the economy, meaning essentially everybody. Inflation is the key to future sales, profits, interest rates and stock prices
INFLATION/MARGINS WATCH
Shorter term, the Cleveland Fed’s Inflation Nowcasting sees core inflation dropping below the 2.0% level in October. Consumers and the Fed will like that.
Apart from labor, inflationary pressures are not too strong so far suggests the Atlanta Fed Inflation Dashboard:
But corporate execs see inflation accelerating somewhat in 2019…
Business Inflation Expectations Rise Slightly to 2.3 Percent – October 2018
…because their costs are rising…
…and they want to protect margins which are back to 2017 levels…
…especially if sales growth reverts to “about normal” levels…
…as experienced by smaller companies:
By roughly what percent are your firm’s unit sales levels above/below “normal,” if at all?
Large companies’ margins are still up in Q3:
Equities’ erratic behavior is certainly not because of poor Q3 earnings as Factset explains:
To date, 48% of the companies in the S&P 500 have reported actual results for Q3. Companies are outperforming recent averages on the earnings side and performing in line with recent averages on the revenue side. In terms of earnings, the percentage of companies reporting EPS above the mean EPS estimate is equal to the 1-year (77%) average but above the 5-year (71%) average.
In aggregate, companies are reporting earnings that are 6.5% above the estimates. This surprise percentage is above the 1-year (+5.4%) average and above the 5-year (+4.6%) average.
In terms of revenues, 59% of companies have reported actual sales above estimated sales and 41% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is below the 1- year average (73%) but equal to the 5-year average (59%).
In aggregate, companies are reporting sales that are 0.8% above expectations. This surprise percentage is below the 1-year (+1.3%) average but above the 5-year (+0.7%) average.
The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report), year-over-year earnings growth rate for the third quarter is 22.5% today, which is above the earnings growth rate of 19.4% last week. (…)
The blended, year-over-year sales growth rate for the third quarter is 7.6% today, which is above the sales growth rate of 7.4% last week.
While investors are getting spooked by corporate earnings calls expressing rising uncertainty on costs and margins, sell-side analysts keep revising their estimates upwards, especially on large cap companies (smaller caps’ up revisions were 49.5% last week (44% the previous week):
And corporate guidance is not getting worse than usual as Factset reveals:
At this point in time, 41 companies in the index have issued EPS guidance for Q4 2018. Of these 41 companies, 26 have issued negative EPS guidance and 15 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 63% (26 out of 41), which is below the 5-year average of 70%.
Actually, IBES data show S&P 500 earnings rising 25.2% in Q3 (22.3% ex-Energy), up nicely from +21.6% expected on Oct. 1. Q4 earnings are seen +19.5%, down slightly from +20.1% on Oct.1. Looking into 2019, estimates are a little softer at +7.9% for Q1 (was +8.1%) and +9.0% for Q2 (9.2%).
Trailing EPS are now $156.17 or about $158.70 pro forma the tax reform for 12 months. Full year 2018 earnings are now seen reaching $162.00.
At 2662, the S&P 500 Index is selling at 16.8x trailing pro forma EPS and 16.4x the 2018 estimate. In early 2016, the S&P 500 Index bottomed at 16.2x trailing EPS even though earnings only troughed in July.
In January 2016, the Rule of 20 was 18.3 which would be 2555 on current trailing pro forma EPS. The low last Friday was 2623.
Tempting?
Continued strong earnings and stable or even somewhat weaker inflation could bring a good bounce. The problem is the declining 200-day moving average which has morphed itself from a support to a resistance.
I am always wary when the 200dma is declining as it denotes a major trend change requiring another major trend change as this Yardeni.com chart shows:
In mid-2010, it took only 70 days after the 16% correction. In 2011, we spent half of the year in volatility, as even cheap equities can get cheaper when inflation rises strongly. In 2015 and 2016, two corrections hit back to back as earnings declined and inflation rose from 1.7% to 2.3%. The S&P 500 troughed at 19.5 on the Rule of 20 when inflation went back down to 1.7% and earnings growth resumed.
Lowry’s Research says that its history of major market tops shows that “in no case did a bull market end under conditions that existed at the time of the Sept. 20th
high in the S&P 500. (…) put simply, at the time of the Sept, 20th high there was little evidence of the deteriorating breadth and rising Supply that has marked major market tops over the past 93 years.”
Lowry’s also warns about the changed market structure that began in the early 2000’s and which helped cause the unusually high number of corrections in this bull market. “A partial list of these changes includes the end of the “up-tick” rule, the replacement of specialists with electronic exchanges, high frequency trading, algorithmic trading and the proliferation of Exchange Traded Funds. All contribute, to one degree or another, to price volatility and the sharp, intense market declines over the past 9 years. Thus, absent clear signs a major market top is forming, investors should be wary of assigning too much significance to these sharp declines, which have, thus far, all been followed by a resumption of the bull market to new highs.”
Valid points. But for me, this correction can only be blamed on uncertainty created by Trumpism and trade wars. And this changed market structure makes me seek further validation for a resumption of the bull, especially given the high uncertainties at the macro level. Trumpism has created a highly volatile world daring even the best forecasters to bet with a lot of chips on the table.
Credit-Card Spending Limits in Focus as Issuers Grow Cautious Two of the biggest credit-card issuers are tightening lending standards, an unusual move in a strong economy that may signal longer-term concerns about consumers’ financial health.
That’s the signal from a Bloomberg Economics gauge aggregating the earliest-available indicators on business conditions and market sentiment. The government effort to stabilize the mood among executives and investors hasn’t been effective yet. (…)
(…) “Failure of any nation to adhere to international norms and the rule of law undermines regional stability at a time when it is needed most.” (…)
The uproar amounts to one of the biggest foreign policy tests of Mr. Trump’s presidency. Billions of dollars of arms deal agreements between the U.S. and Saudi Arabia are potentially at stake as well as American support for the Saudi-led war in Yemen. Congress members and other critics have questioned whether the U.S. should redefine its relationship with Riyadh, a primary ally in the region and the anchor to the West’s strategy to counter Iranian influence. (…)
Conservative’s Win Signals Sharp Rightward Turn in Brazil Jair Bolsonaro, a firebrand ex-army captain, won Brazil’s presidential election, putting him in position to join the growing ranks of populists across the world and shift Latin America’s largest nation sharply to the right.
It’s signed by the artist: min G max D Ex[log(D(x))] + Ez[log(1-D(G(z)))].
A portrait created by artificial intelligence fetched $432,500 at Christie’s in New York on Thursday, the first time a computer-generated artwork was offered by a major auction house.
The print on canvas, titled “Edmond de Belamy, from La Famille de Belamy,” depicts a blurry and unfinished image of a man. Displayed in a gilded wooden frame, it was estimated to fetch $7,000 to $10,000 and offered as the final lot at Christie’s auction of prints and multiples.
The work was the brainchild of Obvious Art, a Paris-based collective, with help from an algorithm known as GAN (Generative Adversarial Network).
“We fed the system with a data set of 15,000 portraits painted between the 14th century to the 20th,” collective member Hugo Caselles-Dupre told Christie’s.
The piece sparked a bidding war among five parties that lasted about seven minutes, with an anonymous phone buyer prevailing, said Christie’s spokeswoman Jennifer Cuminale.
“It is an exciting moment and our hope is that the spotlight on this sale will bring forward the amazing work that our predecessors and colleagues have been producing,” the collective said in a statement. “We are grateful to Christie’s for opening up this dialogue in the art community and honored to have been a part of this global conversation about the impact of this new technology in the creation of art.”
Min G max D Ex[log(D(x))] + Ez[log(1-D(G(z)))] is no Leonardo just yet!
ART: “the expression or application of human creative skill and imagination, typically in a visual form such as painting or sculpture, producing works to be appreciated primarily for their beauty or emotional power”
Analysis: Are Price Increases Painting Companies Into a Corner?
