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 FOR OCTOBER 12 2018

DOG DAY

Yesterday, access to the blog was temporarily suspended after my hosting service wanted to verify potential malware issues at their end. Afterward, technical problems prevented a quick resumption. I was assured that everything was good and secure and that there was no risk for anybody. I wish I could also blame it on the Fed. At least, President Trump did not blame the bad markets on this off day for my blog Winking smile.

Fed Officials See Strong Economy Justifying Interest Rate Rises Though the central bank has boosted rates—drawing criticism from President Trump—it sees falling unemployment, economic growth and the return of normal inflation as other factors behind the rise.
‘Crazy’ Tight? Actually, Fed Still Looks Loose by These Measures

Consumer Prices Rise 0.1%, Less Than Forecast

(…) The consumer-price index rose 0.1% in September after rising a seasonally adjusted 0.2% in August, the Labor Department said Thursday. September’s slight increase undershot economists’ expectations of a 0.2% rise.

In the 12 months through September, overall prices rose 2.3%, the smallest year-over-year change since February and down sharply from the near-3% year-over-year increases seen this summer. Excluding the more volatile food and energy components, core prices were up 2.2% on the year in September, the same rate as in August. (…)

In a positive sign for American workers, modest prices increases caused the pace of inflation-adjusted earnings to rise at the strongest rate in six months, according to Thursday’s report. Average hourly earnings rose a seasonally adjusted 0.3% in September. (…)

A relief for bonds and stocks: inflation has been decelerating in the past 2 months (+1.3% annualized). CPI core Goods is especially weak, down 3.7% annualized in 2 months, something likely to continue (see below). The worry, however, is that profit margins may be getting squeezed…

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  • The NY Fed’s Underlying Inflation Gauge “full data set” measure decreased from a currently estimated 3.16% in August to 3.12% in September.
  • The “prices-only” measure decreased from 2.09% in August to 1.95% in September.

Absent severe tariffs impact, inflation is not threatening a big spike at this time.

Business Prices Firmed Up in September Uptick in producer-price index comes after two months of sluggishness

The producer-price index, a measure of the prices businesses receive for their goods and services, increased a seasonally adjusted 0.2% in September from a month earlier, the Labor Department said Wednesday.

The rise in September prices came after two months of sluggishness and was propelled by a hefty increase in transportation prices.

Prices excluding the often-volatile food, energy and trade-services categories were up a robust 0.4% in September, the largest monthly increase since January.

From a year earlier, overall producer prices rose 2.6% in September. Producer-price inflation measured on a 12-month basis peaked at 3.4% in June, but has since weakened each subsequent month.

So-called core prices, though, have been stronger. Excluding food, energy and trade, prices rose 2.9% on the year in September after gradually moving upward this year.

Core PPI (Final demand less foods, energy and trade) has been rising at more than 3.0% annualized all year and is +2.9% in September. What is interesting is that core goods PPI, which was also rising at a 3%+ rate for a while, rose only 0.2% in the last 2 months, a +1.2% annualized rate.

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Digging deeper, one finds that goods inflation in intermediate demand stages has been negative in August and September. Briefly stated, all inflationary pressures there were in the goods pipeline throughout 2018 disappeared in the last 2 months.

Meanwhile, Trade Services PPI, which measures changes in margins received by wholesalers and retailers, turned sharply negative since July. All this when retail sales have been pretty strong.

U.S. Treasury Staff Finds China Isn’t Manipulating Yuan The Trump administration is preparing to issue a closely watched report on foreign currencies.
U.S. Strengthens Controls on Nuclear Tech Exports to China The U.S. implemented heightened controls on nuclear technology exports to China. U.S. officials say the move follows Chinese attempts to illicitly acquire the know-how.
World’s Largest Car Market Faces Historic Drop

Purchases of passenger vehicles by dealerships plunged for a third straight month, an industry group said Friday. With trade ties with the U.S. worsening by the day and car sales barely up for the year already, the industry is now facing the prospect of its first contraction since at least the 1990s. (…)

Surprised smile Passenger-car purchases by dealerships declined 12 percent to 2.06 million units in September, the China Association of Automobile Manufacturers said. That leaves the market up just 0.6 percent for the first nine months of the year, and the association said fourth-quarter comparisons from 2017 are challenging. (…)

General Motors Co., the largest U.S. carmaker, reported a 15 percent drop in China deliveries for the three months ended Sept. 30, its first quarterly report since the trade tensions with the U.S. began escalating in July. Volkswagen AG and Honda Motor Co. also reported declines in deliveries. (…)

Note that this follows a 3.8% fall in August and a 4.0% drop in July. Reuters adds:

“It’s very alarming and is even causing panic among some automakers and suppliers. That’s because the market has been growing non-stop every year for more than twenty years, and those companies make plans based on growth,” he said.

“They don’t know what to do and worry about survival.” (…)

China’s broader economic woes have led to a particular slowdown in the demand for cars in smaller, lower-tier cities across China, some car makers have said, which until now were the engine of growth for the country’s auto industry.

Zhang of Automotive Foresight said that several factors had combined to cause this, including high gas prices this year which had stymied growth in lower-tier cities. (…)

Sales of new-energy vehicles – a category comprising electric battery cars and plug-in electric hybrid vehicles – remained strong, up 54.8 percent in September, slightly faster than a month earlier.

That took new-energy vehicle sales in the first nine months of this year to 721,000 vehicles, up 81.1 percent from the same period a year earlier.

BMW to Take Control of China Joint Venture The deal comes as Beijing plans to eliminate a limit on foreign ownership of automotive ventures by 2022, the year the $4.1 billion deal is set to close.

Beijing has said it plans to phase out a limit on foreign ownership of automotive ventures by that year. (…)

Under the deal, the German car maker intends to increase production capacity at the venture’s existing plants in Shenyang. Investment of more than €3 billion in new and existing facilities in Shenyang is planned over the coming years, according to the company’s statement.

The total annual production capacity of automobiles at the venture’s plants will increase to 650,000 starting in the early 2020s, creating 5,000 new jobs, BMW said. (…)

Left hug Right hug Trump and Xi Plan to Meet Amid Trade Tension The White House is moving ahead with plans for President Trump to meet with Chinese leader Xi Jinping at a summit in November, to try to devise a way out of the countries’ trade battle.

In a toughly worded commentary, the official Xinhua News Agency said Sino-U.S. relations were at a crossroads. The piece said “relentless and groundless China-bashing rhetoric” showed that Washington wanted a “a full-scale face-off.” It called on the U.S. to stop its attacks and work with China to find a solution to their differences. (…)

The Xinhua piece, which made no mention of U.S. President Donald Trump, cited Chinese President Xi Jinping as saying there were “a thousand reasons to make the China-U.S. relationship work, and no reason to break it.”

“As to Washington, it is high time that it stopped its calumny campaign against China, abandoned its antiquated confrontational mindset, and worked with Beijing to steer their relationship out of the rough patch as soon as possible,” the article said.

Nafta Rewrite Won’t Boost U.S. Growth, Economists Say The new U.S. trade pact with Canada and Mexico is unlikely to boost economic growth or manufacturing employment, according to most economists surveyed by The Wall Street Journal.
Canada Announces New Steel Quotas and Tariffs, Refunds for Firms

Canada is applying quotas and a 25 percent tariff on steel imports from China and other countries to avoid becoming a dumping ground for steel in the face of metal levies imposed by U.S. President Donald Trump. (…)

The “targeted relief” for Canadian firms includes refunds of import tariffs paid to date on steel and aluminum products that Canada is facing shortages of, for certain firms. Those whose claims are accepted will be refunded tariffs paid so far, and also won’t have to pay them going forward — either until the end of this year, or indefinitely, depending on how severe the shortage. (…)

Rush to Beat Tariffs Fuels Record China Trade Surplus With U.S.

Exports in dollar terms rose 14.5 percent in September compared to the same period last year, the customs administration said Friday, defying expectations for a slowdown to 8.2 percent. Imports climbed 14.3 percent, leaving a trade surplus of $32 billion. (…)

Growth in exports to the U.S. accelerated to 14 percent from a year earlier in U.S. dollar terms, up from August’s 13.2 percent rate. Imports from the U.S. contracted 1.2 percent, the first decline since February. (…)

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The surge won’t last, which will hurt everybody:

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IEA Lowers Oil-Demand Growth Forecasts Global oil demand will grow at a slower pace than expected this year and next amid economic risks stemming from trade tensions and higher oil prices, the International Energy Agency said.

In its closely watched monthly oil-market report, the Paris-based organization lowered its oil-demand growth forecasts for 2018 and 2019 by 110,000 barrels a day to 1.3 million barrels a day and 1.4 million barrels a day, respectively.

The IEA said higher oil prices have dented consumer appetite, particularly in emerging markets, while the trade dispute between China and the U.S. threatens global economic growth with knock on effects for oil demand. (…)

The IEA said Iranian supply fell to a 2½-year low in September as buyers continued to reduce their purchases before the Nov. 4 deadline. Crude production fell by 180,000 barrels a day month-on-month, to stand at 3.45 million barrels a day last month, the agency said. (…)

OPEC crude output rose by 100,000 barrels a day in September, to 32.78 million barrels a day, with the biggest increase coming from Saudi Arabia, where supply climbed to 10.52 million barrels a day. That is roughly on par with OPEC’s own estimate provided in its monthly oil-market report that was published on Thursday.

Output from Russia climbed by roughly 160,000 barrels a day to reach a record 11.36 million barrels a day in September, the IEA said. (…)

Those increases, combined with surging U.S. and Canadian oil production, mean the “oil market is adequately supplied for now,” the IEA said.

But the agency said reductions in Iranian output, combined with threats of further supply disruptions in Libya and Venezuela, suggest the market “is clearly signaling its concerns that more supply might be needed.” (…)

Still, in the mid-to-long term, the IEA said there is “no peak in sight” for global oil demand. “The drivers of demand remain very powerful, with petrochemicals being a major factor,” the report said.

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SENTIMENT WATCH
Trump Says Blame ‘Loco’ Fed, Not China Trade War, for Sell-Off

(… “They’re so tight. I think the Fed has gone crazy,” the president said.(…) “The Fed is going wild. They’re raising interest rates and it’s ridiculous.” (…)

(…) While higher rates haven’t interrupted U.S. stocks’ broad uptrend so far, they may have crossed a threshold where they’re starting to weigh on pricey stocks and make equities less attractive. (…)

More companies are speaking up about the trade conflict’s impact on their business. Trinseo SA on Wednesday became the second chemicals maker this week to warn of disappointing results, partly due to trade uncertainty. Industrial supplier Fastenal Co. said new U.S. tariffs on Chinese goods are hurting customers. (…)

(…) “It’s going to come down to earnings. The big concern isn’t really what third-quarter earnings numbers are, but really what the outlook for the fourth quarter and first quarters are,” said Oliver Pursche, vice chairman and chief market strategist at Bruderman Asset Management in New York. (…)

Cost pressures for companies are mounting, Lori Calvasina, RBC Capital Markets head of U.S. equity strategy, wrote in a note on Tuesday, adding that more than a third of S&P 500 companies have seen full-year margin expectations shrink since June.

Calvasina said she’s been factoring in “back half deceleration” in 2018 margins and also a stronger dollar, but expects those issues have not been “fully baked into bottom up consensus estimates yet.”

She and other strategists pointed to wage inflation as a key risk to profit margins, while companies already have cited worries about costs related to tariffs and the strengthening dollar. (…)

“It’s Not Such A Crazy Idea”: The Hunt For Another Red October “The elements of a narrative that finds a parallel between the alarming sell-off in equities over the last few days and the epic disaster that was the Black Monday crash of October 19, 1987, do exist.”

Hmmm…not really. See below.

TECHNICALS WATCH

The MSCI World Index is now down 10.5% and testing another resistance (!) level.

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The SPY has lost 7.3% from its September 20th peak and has traversed its (still rising) 200dma.. Mid and Small caps are through their respective 200dma, both still rising, but with a rapidly declining slope…

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The Nasdaq 100 is down 8.9% from its Oct. 1 peak.

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But its equal weight index is off 9.7%. Valuations don’t matter…until they do:

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Overall, selling has been “intense”.

EARNINGS WATCH

Last but certainly far from least. Profits always matter.

We now have 24 companies in with Q3 results and the beat rate is 88% with a +3.2% beat factor. Revenues are beating by +0.4%. Blended earnings for Q3 are seen up 21.3%, virtually unchanged from +21.6% on Oct. 1 (+18.4% ex-Energy). Q4 earnings: +20.0% (+17.4% ex-E), also virtually unchanged.

Estimates for 2019 are +10.3%. They were +10.2% on Oct. 1 and +9.7% on July 1. Analysts may be worried about costs but are not reflecting them in their estimates, so far.

Trailing EPS are now $155.56 and full year estimates are $161.82. On that basis, the Rule of 20 P/E is 19.3 using this morning’s opening of 2762. It is 20.0 is we use actual trailing EPS but these miss the tax reform impact on Q4’17 earnings which would add about $2.50 to trailing 4 quarters results. On $158 pro forma, the Rule of 20 P/E is 19.7.

During the last 5 years, equity routs stopped at 19.0 on the Rule of 20 P/E (2725, yesterday’s close!) except in January 2016 when it slid to 18.3 (2600).

FYI, before the 1987 crash, the Rule of 20 P/E reached 23.1 (normal P/E 18.8) while inflation was accelerating sharply from 1.1% in December 1986 to 4.5% in October 1987. Profits were rising 7-8% YoY.

The slower CPI trend should help support valuations given the strongly rising Rule of 20 Fair Value (yellow line), unless companies start scaring investors during their Q3 conference calls. Banks report today, then we get into high gear.

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THE DAILY EDGE (10 Octobre 2018)

Small Business Optimism Continues Historic Trend

The Index fell slightly from August’s survey record breaking high of 108.8 to 107.9. Six of the ten Index components declined, three advanced and one was unchanged, exactly reversing last month’s gain. Most of the decline came in the “hard” components of the Index (down 14 points) but still registered as the second highest reading since 1998, partially offset by some improvement in the expectations components (up 3 points). (…)

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  • Flattening sales against rising expectations:

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  • Record boom in job openings:

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  • Accelerating comps at already high level:

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  • Typical margin squeeze…

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  • …more to come:

Source: Pantheon Macroeconomics (via The Daily Shot)

  • …offset by tax cuts, this year:

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  • Flat capex at not so high level:

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IMF Warns of Possible Emerging-Markets Crisis A new IMF study projects emerging economies will muddle through recent market turbulence without a severe shock to their financial systems, but flags an outside chance of a crisis.

(…) While all three countries face vastly different challenges, their crises share a common element: the flip side of a strengthening dollar has been a weakening of their currencies. Capital has flooded out of their economies, and into the U.S., enticed in part by the Federal Reserve’s campaign of rising interest rates. (…)

Though the scenario isn’t inevitable, vulnerabilities are high. The IMF’s measure of government-debt distress—in part a function of overall borrowing—is rising. Over 45% of low-income countries were at high risk of debt distress or already experiencing it, the IMF said, compared with only about 25% five years ago. (…)

Meanwhile, China is busy trying to protect its economy from the trade war with America which also aims at breaking up the complex China-centered supply chain web. Chinese entrepreneurs are understandably investing in other Asian countries to reduce their business risk. Meanwhile, Beijing has allowed its currency to decline against most other currencies to counter tariffs but it also seeks to control the outflow of money. How these interacting trends will eventually play out throughout the various emerging markets is anybody’s guess at this point. Beware of the known unknowns, but also of the unknown unknowns.

(…) The CKGSB Business Conditions Index, compiled by the Cheung Kong Graduate School of Business, dropped to the lowest level in its seven-year history in September as the U.S. and Chinese governments imposed new rounds of tariffs on each other’s exports, escalating the trade war. (…) The respondents represent around 300 privately-owned small and mid-sized enterprises across several sectors of the economy. (…)

Probably reflecting conditions for smaller businesses.

Pence Unloaded on China; Here’s Why That’s Important Vice president’s blunt speech could be inflection point in Washington-Beijing relations

(…) In surprisingly blunt terms, Mr. Pence accused China of abusing its economic power, stealing American technology, bullying the very American companies that have helped in its economic rise, intimidating its neighbors, militarizing the South China Sea and persecuting religious believers at home.

“America had hoped that economic liberalization would bring China into a greater partnership with us and with the world,” Mr. Pence said. “Instead, China has chosen economic aggression, which has in turn emboldened its growing military.”

In his most headline-grabbing assertion, he also charged that China is attempting to interfere in the 2018 midterm elections and laying the groundwork to try to defeat President Trump’s quest for re-election. (…)

He asserted that the Chinese have embarked on a governmentwide effort to “interfere in the domestic policies of this country.” In this concerted program, he charged, China seems to expand its influence by “rewarding or coercing American businesses, movie studios, universities, think tanks, scholars, journalists, and local, state, and federal officials.”

This isn’t a casual accusation. For months, a team of national-security officials has been compiling a study on the many ways China uses money, power and rewards to affect the way it is viewed in the U.S. The study was intended in part, say those familiar with it, to shame American institutions that the administration believes are being used by China.

In a key passage, Mr. Pence declared: “Beijing provides generous funding to universities, think tanks, and scholars, with the understanding that they will avoid ideas that the Communist Party finds dangerous or offensive. China experts in particular know that their visas will be delayed or denied if their research contradicts Beijing’s talking points.” (…)

The Trump administration sees Chinese practices not merely as an attempt to gain an economic upper hand, but as a part of a kind of broad struggle over global dominance, in which the Chinese are pulling every lever at their disposal in a quest to prevail. (…)

Unlike during the Cold War, when the U.S. and the Soviet Union had few economic ties to bind them together, the U.S. and China still are in an economic embrace that gives both sides ample reason to coexist peacefully.

Still, Mr. Pence has signaled that the coexistence is, and may remain, a tense one.

China’s Huawei Seeks to Chip Away at Silicon Valley’s AI Supremacy Huawei unveiled two new computing chips aimed at powering artificial-intelligence applications, marking the Chinese telecommunications giant’s first major push into high-end technology dominated by U.S. chip giants.

(…) With the AI chips, Huawei, the world’s biggest maker of telecommunications equipment and a major smartphone vendor, is challenging American companies like Nvidia Corp. , Intel Inc. and Qualcomm Inc.

The new components align with broader efforts by China to reduce its dependence on advanced U.S. technologies and develop such products domestically. Under Beijing’s Made in China 2025 development plan, semiconductors and AI have emerged as key areas that authorities want to develop at home. (…)

Last month, e-commerce giant Alibaba Holdings Ltd. announced plans to launch an AI chip next year, while Chinese startups like Bitmain Technologies Ltd and Cambricon Technologies Corp. are also working on such components. (…)

The AI effort follows success for Huawei in its mobile-phone business, which earlier this year overtook Apple Inc. as the world’s No. 2 vendor of smartphones after Samsung Technologies Co.

At the same time, Huawei is weathering increased scrutiny this year from authorities in the U.S., where its telecom gear has been banned due to security concerns. Such fears led Australia to bar Huawei from its fifth-generation wireless rollout, while officials in Japan are studying similar moves. Huawei has long said it isn’t a security threat and that it is owned by its employees and operates independently of Beijing.

The big wake-up call for Beijing was when the U.S. denied access to American chips to ZTE earlier this year. More recently, the Administration said it was considering “enhanced” export controls to limit China’s access to U.S. chips and chip making tools in order to protect the U.S. supremacy on technology and slow down China’s growth in electronics which remains highly dependent on imported chips.

China got the message and is speeding up efforts to reduce its vulnerability, making huge sums of money available to the industry to invest and attract foreign engineers. China has long been the center of production for semiconductor-based goods. It has also become the center of consumption (AMERICA CURSED) and the scale and know-how of its domestic manufacturers make it inevitable that it will rapidly develop a highly competitive semi business.

The race to smaller and smaller chips can be an elusive challenge for China but some experts say that future demand growth will be driven by less sophisticated chips thanks to the “internet of things” market which will not require the most advanced chips to easily and effectively connect to the coming 5G mobile standards.

The Battery Boom Has Created a New Lithium Superpower in China

Ganfeng and Tianqi, both Chinese, now control 29% of the lithium market. Ganfeng’s 17% share of the total market underrepresent its 25% share of “battery-grade lithium hydroxide, the material that’s now most sought after by automakers, the researcher’s data shows.”

German government cuts growth forecasts for 2018 and 2019 – document The German government has cut its forecasts for growth this year and next in Europe’s largest economy and sees an escalation in the global trade dispute as the main risk for the future, a document seen by Reuters on Wednesday showed.

(…) The government – due to present its updated forecasts on Thursday – slashed its 2018 and 2019 growth forecasts to 1.8 percent, compared with its previous predictions of 2.3 percent and 2.1 percent respectively, the document showed. (…)

Hmmm…

Source: @Not_Jim_Cramer (via The Daily Shot)

BTW, the MSCI China Index is down 28% since January 26. The Emerging Markets Asian Index Fund is down 22%. The Core MSCI Europe: –14%. The S&P 500 is up 1.0%.

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Watch these:

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iwm
sly

Selling the less liquid stocks first?

McDonald’s Franchisees Weigh Push on Profit, Cash Flow McDonald’s franchisees are considering making a push to urge the company to help improve profit and cash flow at their restaurants.

(…) One franchisee said his cash flow is shrinking while he is also taking on debt to remodel restaurants in line with new specifications from McDonald’s executives. (…)

KKR’s McVey on Trade Wars, Tech Wars, and Margins

I like Henry McVey. He knows China and he is a one-handed economist with concise reasoning. He also understands that tariffs are boosting the U.S. and Chinese economies in Q3 and that very strong profits have been driving U.S. equity markets this year. A lot of things will change in 2019, not necessarily for the better. Click on headline for the 10 min. video.

Also worth your time: