MORE ON INFLATION

• According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.3% (3.0% annualized rate) in March. The 16% trimmed-mean Consumer Price Index rose 0.1% (1.7% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.

• Underlying Inflation Gauge (UIG)

April 2018:

• The UIG derived from the “full data set” increased slightly from a currently estimated 3.07% in February to 3.14% in March.
• The “prices-only” measure increased slightly from 2.21% in February to 2.23% in March.
• The twelve-month change in the March CPI showed a 0.2 percentage point increase from the February reading. The increase partly reflected some transitory factors that had been restraining inflation dropping out of the twelve-month calculation.

The UIG measures currently estimate trend CPI inflation to be approximately in the 2.2% to 3.2% range, with the prices-only measure close to the actual twelve-month change in the CPI. Recent analysis suggests the rise in the full-data-set UIG compared to the prices-only measure is being driven principally by survey measures of manufacturing and nonmanufacturing activity.

• Fed Minutes Signal Greater Confidence in Reaching 2% Inflation

(…) Fed officials last month believed the economy would run hot, or grow faster than its sustainable rate, for the next few years, the minutes said.

In March, “all participants agreed that the outlook for the economy beyond the current quarter had strengthened in recent months,” the minutes said. In addition, “all participants expected inflation on a 12-month basis to move up in coming months.” (…)

The policy makers also noted potential costs: “An overheated economy could result in significant inflation pressure or lead to financial instability,” the minutes said. (…)

Of the 15 Fed officials at March’s meeting, 12 penciled in either three or four rate increases for 2018, and they were equally divided between those two paths. Most officials also penciled in at least three rate increases for 2019. (…)

The “rising inflation” theme is getting more mainstream.

TRANSPORTATION COSTS KEEP RISING

• Cass Truckload Linehaul Index

March’s Cass Truckload Linehaul Index continued the acceleration established over the last four months by posting a 7.2% year-over-year increase (the largest YoY percentage increase since January 2015), to 133.5. After being negative for 13 months in a row (from March 2016 through March 2017), the Cass TL Linehaul Index has not only been positive now for twelve months in a row, but pricing for trucking continues to gain momentum. “Our realized contract pricing forecast for 2018 is 6% to 8%, and current data is signaling that the risk to our estimate may be to the upside,” stated Donald Broughton, analyst and commentator for the Cass indexes. “The current strength being reported in spot rates is leading us to believe contract pricing rates should keep rates in positive territory well throughout 2018.”

  

Trucking capacity challenges (drivers, trucks, demand) are transpiring to other transportation modes such as rail. Shippers’ ability to pass these costs on must be monitored during the Q1 earnings conference calls. If end demand is strong enough, margins may be spared but there is often a lag…or just no lag at all if demand cannot sustain pricing power.

• Cass Intermodal Price Index

The latest data point shows total intermodal pricing (all-in intermodal costs) rose 5.8% YoY in March. The index rose to 143.2 setting a new all-time high. March marked the eighteenth consecutive month of increases and brings the three-month moving average up to 5.4%. Tight Truckload capacity and higher diesel prices are creating incremental demand and pricing power for domestic intermodal.

  

OPEC Cuts Output While U.S. Shale Steams Ahead OPEC said its crude oil output fell last month amid compliance with the oil cartel’s agreement to cut production, even as the world’s total oil supply continued to rise on the back of burgeoning U.S. shale growth.

In its closely watched monthly oil market report, the Organization of the Petroleum Exporting Countries said the group’s total crude output declined by 201,000 barrels a day in March in month-on-month terms, to average 31.96 million barrels a day. The drop was mainly attributable to lower production in Angola, Venezuela, Algeria and Saudi Arabia.

But OPEC said that the world’s total oil supply rose by 180,000 barrels a day last month, mainly as a result of higher output from non-OPEC producers like the U.S., Norway and the U.K.

U.S. shale fracking is one of the primary drivers of non-OPEC production, with tight and shale formations expected to account for 94% of total petroleum liquids growth this year, compared with 90% in 2017, OPEC said in the report. (…)

OPEC raised its global oil demand forecast for this year by roughly 30,000 barrels a day, up from last month’s estimate, with growth expected to average 1.63 million barrels a day and total consumption 98.7 million barrels a day. The revision was mainly the result of robust demand growth in industrialized countries in the Americas and Asia, OPEC said.

OPEC said commercial oil inventories in the Organization for Economic Cooperation and Development—a group of industrialized, oil-consuming nations that includes the U.S.—fell by 17.4 million barrels in February to stand 2.854 billion barrels. That’s just 43 million barrels above the oil-cartel’s target of the last five-year average.

China: Market Opening Isn’t a Concession to Trump Beijing is opening the economy “at its own pace, in its own direction, which is already fixed,” the Commerce Ministry said after President Xi Jinping offered to increase foreign access to China’s markets.

(…) the Commerce Ministry’s Mr. Gao reiterated Beijing’s position that no talks are taking place and that China won’t engage in them under U.S. threats. “The U.S. lacks the sincerity for negotiations,” he said.

When asked by a reporter whether the government would stick to its “teeth-to-teeth” way of response, Mr. Gao reiterated that China isn’t excluding any options and that its “ability and confidence in defending its interests is unquestionable.” (…)

• More Than 100 Trade Groups Oppose China Tariff Plans The business coalition opposing White House plans to levy tariffs against Chinese goods has doubled to 107 trade groups.

• ‘Farmers are more interested in negotiation than mitigation.’ —Davie Stephens, vice president of the American Soybean Association, on potential federal support amid trade tensions. (WSJ)

TECHNICALS WATCH

I normally do not give a big weight to technical analysis but current conditions warrant greater scrutiny of some market indicators. Investors are torn between surging profits and a highly unstable environment (political, monetary, economic…) requiring us to use some key technical trends to assess how and where liquidity is flowing.

• NDRCMG’s Market Pulse: De-risking in response to market health

(…) The NDRCMGLF Index rebalanced from 100% to 80% equity on April 10, as the model’s composite score is currently under 70 and its directional trend went negative in response to the more recent broader market breakdown. Should the model’s composite score turn up and trend positive, it will reallocate to 100% equity. However, if the negative trend persists, pushing the model’s composite score below 60, for example, it will signal greater market breakdown and a 40% equity allocation (…).

The NDRCMGLF Index’s model measures the overall health of the market through an evaluation of market breadth. In this case, market breadth refers to advancing and declining price trends and countertrends at the GICS industry level. The model computes a robust moving average score daily to capture multi-industry and multi-term trend and countertrend measures to gauge overall market health. It then calculates the score’s directional trend to see if it is improving or declining. Collectively, the score and its directional trend determine the equity allocation of either 100%, 80%, 40%, or 0% − in which case it would be allocated to cash. (…)

Investors can access this equity risk-managed approach through VanEck Vectors NDR CMG Long/Flat Allocation ETF (LFEQ), which was developed to offer guided equity allocation by trading into and out of the market automatically for its investors. This strategy seeks to minimize losses
from potential market drawdowns typical of traditional buy-and-hold or static strategies.

(More on the above here)

• 13/34–Week EMA Trend Chart:

• Yamada: Dow Forming Bearish Technical Pattern

Famed technician Louise Yamada at LY Advisors warns that investors have been selling the rallies since the January peak, leading to a descending triangle formation on the chart, which is typically a bearish sign.

EARNINGS WATCH

Next Up: The Forgotten Earnings Season Only once before have U.S. earnings expectations risen so far, or so fast, as they have this year. Yet, investors couldn’t care less as shares are down. The result is that Wall Street’s favorite valuation measure has fallen at a speed usually only seen in a crisis.

(…) the 12-month forward price/earnings ratio on the S&P 500 has fallen from a 16-year high of 18.6 times adjusted earnings at the end of January to 16.4 times at Tuesday’s close, putting it back to where it stood in 2014, according to Thomson Reuters IBES. Stocks are less obviously expensive—although still above their average since 1985. (…)

The last two times the forward PE ratio tumbled this far, this fast, were the 2010 Greek crisis and the aftermath of the Lehman Brothers failure in 2008; other notable occasions include the dot-com bust, the 1998 collapse of hedge fund Long-Term Capital Management and the 1987 stock-market crash. (…)

Earnings are set to be spectacular, even without the boost from the Trump tax cut. S&P 500 companies are predicted to report earnings per share up 18% in total from a year ago, according to Howard Silverblatt at S&P Dow Jones Indices. The rolling forecast for 12-month ahead adjusted earnings has risen more than 11% since the start of the year—an acceleration surpassed only during the rebound from recession in 2009.

Even better, overall sales are predicted to be up 7%, continuing a rise last year that is the fastest since 2011. Part of the growth is expected to come from the recovery in oil prices, but unlike most of the past decade, there is also a decent chunk from economic growth. We may finally have corporate results that are good not just for investors but for Main Street too: earnings that come from rising revenue and a better economy can in principle be sustained even as higher wages threaten fat profit margins. (…)

Goldman Sachs chief U.S. equity strategist David Kostin points out that much of the fall in share prices since January came during periods when companies were blocked from buybacks. Since corporate buybacks have for years been the biggest source of demand for shares, their absence might leave the market more vulnerable to the selling that comes with bad news. (…)

Let’s set the record straight on forward P/Es. Data since 1993 include the very high P/Es of two bubbles so the current 16x range remains high by historical standards. We are also quite far from levels after previous “crumbles”. In 2010, the forward P/E dropped to 11.5 in August. In 1987: 9.7.

But the current 16x range compares more favorably with the range of the 1960s when inflation was low. Here’s the Rule of 20 chart which incorporates inflation AND uses full 2018 estimated EPS of $158. If we transpose ourselves to April 2019, the current 18.9 Rule of 20 P/E is a lot more reasonable than its January 23.5 level (on trailing EPS) but still does not look as a great bargain. Note also that trailing inflation rose from 1.8% to 2.1% yesterday with the March core CPI numbers which negatively affects the Rule of 20P/E.

James Mackintosh’s article wonders why investors don’t care about the spectacular earnings coming our way. Good question that has no definitive answers. The fact is that equity valuation is a poor timing tool but remains a very useful investment tool to protect portfolios from swings in sentiment by measuring the risk/reward ratio based on the relatively stable Rule of 20 historical valuation 15-25 range using trailing earnings and inflation numbers.

Eventually, earnings do matter and this is why this blog spends so much time focusing on earnings and inflation as well as sentiment. This next chart (using trailing data) shows how the S&P 500 Index (blue) has dropped to the Rule of 20 Fair Value (yellow) which is rising very powerfully thanks to the strong earnings trend (the recent dip is due to the aforementioned rise in inflation). At its current level, the S&P 500 Index registers 20.7 on the Rule of 20 scale, somewhat overvalued versus its 20 median value but offering a more balance risk/reward ratio based on valuation. We shall see if this holds in the current rather unstable environment.

Speaking of earnings, 26 S&P 500 companies have already reported their Q1 results. The beat rate is 73% and fairly broad with a surprise factor of 7.1%. Pre-announcements two weeks after quarter end remain upbeat with 61 positive versus 73 negative. Same time last year: 35:79. Same time during Q4’17: 45:69. The earnings bar has been set very high but so far, so good.

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