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 March 2018): “The art of the deal” vs “The art of war”

China Fires Warning Shot at U.S. Over Import Tariffs China unveiled plans for tariffs against $3 billion in American goods and said it is readying more actions against the U.S.

A Commerce Ministry spokesman accused the U.S. of “setting a vile precedent” and warned that China was prepared to defend its interests.

“If somebody imposes a trade war on China, we’ll fight to the end,” Chinese Ambassador to the U.S. Cui Tiankai said on state television.

Measures the Chinese Commerce Ministry rolled out Friday target $3 billion in U.S. goods, from fruit and pork to recycled aluminum and steel pipes that would be subject to higher tariffs. The ministry said the penalties are being imposed in response to new U.S. tariffs on Chinese steel and aluminum products, which the Trump administration announced earlier and which took effect Friday.

Missing from Friday’s list are big-ticket U.S. exports to China such as soybeans, sorghum and Boeing airplanes. The absence of those key goods showed that the Chinese government is leaving itself room to escalate—or negotiate. (…)

Specific actions won’t occur for at least one month, as U.S. officials compile a formal list of proposed tariffs and American businesses then get 30 days to comment on the measures. During that time, the Trump administration hopes China will make concessions to avoid a substantial cutoff in trade.

Similarly, China’s response is calibrated. In announcing its response Friday prior to the U.S. actions on steel and aluminum, the Commerce Ministry didn’t give a specific time for imposing the tariffs on U.S. goods and said Chinese companies have until the end of the month to make comments.

(…) “the Chinese side hopes not to fight a trade war, but is definitely not afraid of fighting one.” (…)

  • China Started the Trade War, Not Trump President Trump’s China crackdown is risky, but it’s on firmer legal, political and economic ground than many of his other trade complaints, Greg Ip writes.

(…) the collateral damage of a trade war, and thus the risks of Mr. Trump’s strategy, are also much greater. The breadth of his action elevates the potential harm to American consumers, supply chains and exporters.

Mr. Irwin says it isn’t clear that Mr. Trump’s strategy is right. Taking China to the WTO might be a less dangerous approach. But he adds: “No one is saying we shouldn’t do anything.”

(…) China ignored the U.S.’s latest move. Instead, it focused on previously announced U.S. steel and aluminum tariffs coming into effect Friday. Chinese data shows steel and aluminum product exports to the U.S. have been $3-4 billion annually over the last two years: accordingly, China announced it is targeting $3 billion of U.S. agricultural and miscellaneous other exports.

In other words, China is providing exactly what President Trump says he wants: reciprocity. China, which now depends far less on U.S. trade for growth than in the mid-2000s, will likely take a similar approach to the planned tariffs on $50 billion of its exports to the U.S.—respond in kind, but not escalate.

So it’s “the art of the deal” against “the art of war”. Good grief!

Going to war against its main lender may have unintended consequences:

Money Markets Are Messed Up, With Real Consequences Banks are paying more to borrow money now than during the 2012 euro crisis, a sign of trouble ahead

(…) The danger signals at the moment are coming from the money markets, where banks are having to pay a bigger premium to borrow than during the 2012 euro crisis. Savers are directing their money to the U.S. Treasury rather than the banks, just as they did in the past two major crises.

The cause this time isn’t a panicked flight to safety. Yet, the money-market stress comes amid a transition to a new phase of the financial and economic cycle. It is a time when those who fail to prepare can be exposed—and in the past such shifts have led to the collapse of hedge funds and banks, and even sovereign defaults.

(…) the money markets are being distorted by a combination of vast U.S. government borrowing needed for the deficit-financed tax cut and companies shifting offshore money from corporate bonds into cash ready to spend. Regulatory restrictions on balance sheets limit banks’ ability to step in and even out the distortions. (…)

The U.S. Treasury is crowding out short-term financing for the private sector, while the huge cash piles that companies built up are no longer available to finance other companies’ bonds.

The result is that the trillions of dollars of loans tied to Libor cost more than they otherwise would, while high-quality, short-term corporate bond yields are up, albeit from low levels. The effect is similar to the Fed having raised rates twice this week, rather than once. (…)

The change in the regime is big: from dovish to hawkish, midcycle to late cycle, fearing deflation to fearing inflation. Hopefully the victims of the shift this time won’t be big enough to shake the entire system.

Known unknowns…or unknown knowns! Thankfully, the Ted Spread is quiet.

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Bond Investors See Air Coming Out of the Inflation Trade Yield on 10-year Treasury note remains below 3% as wagers of a sharp pickup in inflation moderate

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(…) Yet recent data have suggested inflationary pressures are still relatively muted—something that could help cap a rise in bond yields for now. A gauge of consumer prices rose less than expected in February, while wage growth slowed from the previous month and the annual wage gain in January—one element behind the selling in stocks and bonds earlier in the year—was revised downward. (…)

Hmmm…

Again, the facts:

  • Total CPI: Last 7 months annualized: +3.8%. Last 4 months a.r.: +3.6%. Last 3 months a.r.: +3.6%. Last 2 months a.r.: +4.3%.
  • Core CPI: Last 7 months annualized: +2.2%. Last 4 months a.r.: +2.4%. Last 3 months a.r.: +2.8%. Last 2 months a.r.: +3.0%.

  • 16% trimmed-mean CPI: last 3 months annualized: +2.4% vs +2.0% during the previous 3 months. Median CPI: +2.8% vs +2.8%.

  • U.S. Producer Prices Continue Upward Trend Core PPI rose 0.4% in each of the last 2 months and is up 2.7% YoY. Core Goods PPI has gained 0.2% in each of the last 3 months (+2.1% YoY). Prices for intermediate demand goods strengthened 0.7% (4.8% y/y). This is the seventh consecutive month of gains of 0.5% or greater. Goods have been in deflation for years but seem clearly set to add to inflation in 2018.

  • U.S. import prices rise more than expected in February Import prices ex-petroleum jumped 0.5% in each of the last 2 months.

  • And now this:

The White House is putting together a package of 25% tariffs on Chinese imports, and Mr. Trump’s advisers said they had targeted 1,300 product categories. The president said that action could affect imports of “about $60 billion,” but his advisers, speaking earlier, said that it was more likely to be $50 billion, or roughly 10% of the more than $500 billion the U.S. imported from China last year.

Leading Economic Indicators Index Rose in February

The Conference Board Leading Economic Index rose 0.6% to 108.7. (…) The index rose 0.8% in January and 0.7% in December.

The index rose despite a downturn in the stock market and weakness in February housing construction metrics. (…)

The board’s coincident index, designed to reflect current economic conditions, rose 0.3%. The lagging index increased by 0.4%.

The 6 and 12-month rates of change have usually been declining prior to recessions as the Doug Short charts illustrate.

Smoothed LEI

SENTIMENT WATCH

Bespoke’s charts reveal that the crowd suddenly got a lot less bullish…but not more bearish, going neutral instead which means “dunno!”:

The S&P 500 closed yesterday right on its 100-day m.a. and 2.1% above its still rising 200-d m.a. (2582) which was successfully tested on Feb. 9. At 2582, the S&P 500 would sell at 20.5 on the Rule of 20 (using pro forma Q1’18 EPS to reflect tax reform after Q1).

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The earnings backwind will remain strong in April-May as we get into the Q1’18 earnings season with forecasts for +18.3% EPS growth. We are almost at quarter end and pre-announcements remain quite positive.

The risks to valuations are thus inflation and interest rates. The risk to sentiment is Trump vs China.

THE DAILY EDGE (22 March 2018)

Fed Raises Interest Rates, Signals More Aggressive Path

The Fed voted unanimously to raise its benchmark federal-funds rate by a quarter-percentage point to a range between 1.5% and 1.75%. Officials said they expected to lift it another two or three times this year, and three times next year.

New forecasts show officials project faster economic growth, higher inflation and lower unemployment in coming years.

They indicated they expect they will need to tap on the monetary brakes, raising rates in 2020 to a level that would mark the first time in more than a decade that interest-rate policy was deliberately restrictive. (…)

Most Fed officials still expect to raise rates no more than three times this year. But more central bankers said they now anticipate increasing rates four times this year; seven of 15 penciled in four rate increases, up from four of 16 in December.

Most Fed officials expect to lift rates at least another three times in 2019, followed by another two times in 2020. At the December meeting, officials projected around two increases would be needed in both 2019 and 2020.

The projected moves would leave the fed-funds rate in a range between 3.25% and 3.5% by 2020. (…)

The Fed has a poor record of trying to cool the economy without triggering a recession.

“It’s a risky thing to do, but they might feel they have to do it because this fiscal stimulus is coming at the wrong time,” Mr. Perli said. (…)

The fact that officials didn’t revise their interest-rate path higher is significant, Mr. Perli said, because it shows officials will tolerate inflation that runs slightly above the target. (…)

  • Fed’s Mission Improbable: Lift Unemployment—but Avoid Recession The Federal Reserve is attempting in the next few years something it has never accomplished before: guide unemployment up without causing a recession. It faces high odds of failure—and little alternative path.

    • (…) To sustain such growth, the Fed projects employers will have to dig deep into a diminishing supply of workers. That will cause unemployment, already at a 17-year low of 4.1%, to sink to 3.6% by the fourth quarter of 2019, a level last seen in the 1960s. That’s well below the “natural rate” of 4.5%, which is the rate Fed officials and many economists think the economy can sustain without eventually producing inflation. (…)

    In theory, unemployment will eventually have to go back to 4.5%, or inflation will head even higher. Yet since records begin in 1948, unemployment has never risen by 0.9 points, except in a recession. (…)

    Both the 2001 and 2007-2009 recessions were driven more by collapsing asset prices than by higher interest rates. (…)

  • Chair Powell downplayed inflation concerns, saying “there is no sense in the data we are on the cusp of” accelerating inflation.

Meanwhile, in the real world, divergent trends are increasingly hitting investors:

General Mills GIS -8.85% shares fell nearly 9% Wednesday after the company lowered operating-profit guidance for its full fiscal year ending in May. The maker of Cheerios cereal, Yoplait yogurt and Progresso soups now forecasts adjusted earnings-per-share growth of zero to 1% for the period, down from its earlier guidance of 3% to 4% growth.

The company cited higher commodity prices—including grains, nuts and dairy—as well as rising logistics and freight costs. On a conference call, management was contrite for not catching the trend of accelerating inflation earlier, and it outlined plans to respond by cutting costs, reconfiguring logistics networks and raising some prices. (…)

  • ‘We are moving urgently’ to address cost inflation, CEO says (Bloomberg)

(…) General Mills is the latest company to cite higher shipping costs as a major headwind in 2018, joining Hershey Co., Tyson Foods Inc., Kellogg Co. and others. Higher fuel costs and a trucker shortage have driven up expenses across industries. Amazon.com Inc., the e-commerce titan, has been raising fees on some of its suppliers in a bid to protect margins, while Walmart Inc. has said that higher prices to move goods has weighed on margins. (…)

Freight costs neared a 20-year high in February, General Mills said. The company has been forced into the spot market for about 20 percent of its shipments, compared with a historical average of about 5 percent. The costs on those orders can be as much as 60 percent higher. (…)

  • February’s Cass Truckload Linehaul Index continued the acceleration established in November, December, and January (up 6.3%, 6.2%, and 6.5% YoY respectively) by posting another 6.5% YoY increase to 131.3 in February. (…) “In just the last seven months, our pricing forecast [for 2018] has improved from -1% to 2%, to 6% to 8%, and we now have reason to believe 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 into 2018.” 

  • The latest data point shows total intermodal pricing (all-in intermodal costs) rose 5.4% YoY to 137.9 in February, marking the seventeenth consecutive month of increases, and pricing momentum is strengthening. Tight truckload capacity and higher diesel prices are creating incremental demand and pricing power for domestic intermodal.

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The no-frills carrier said Wednesday that it expects revenue for each seat it flies a mile, a key industry gauge of how much airlines can charge for a seat, to be flat compared with the first three months of 2017. The airline had previously expected a revenue increase of 1 to 2 percent. (…)

Competitor United Airlines‘aggressive growth plan to expand service 4 to 6 percent might be having an impact, said Cowen & Co. That plan spooked investors when it was announced, sparking fears of a fare war.

“We suspect the [Southwest guidance] reduction is a direct result of United’s domestic capacity expansion plans,” it said in a note. (…)

(…) during a presentation to analysts last month Marianne Lake, the [JP Morgan’s] chief financial officer, suggested that retail deposit rates would be on the rise before long, driven in part by “improved technology . . . [allowing] customers to move money more easily and therefore to be more price sensitive.” (…)

U.S. Existing Home Sales Rose Robustly in February

Existing-home sales increased 3% in February from the previous month to a seasonally adjusted annual rate of 5.54 million, the National Association of Realtors said Wednesday. Compared with a year earlier, February sales were up 1.1%. (…)

The national median existing home price rose 5.9% in February compared with a year earlier to $241,700.

Rising mortgage rates are compounding the affordability problem. The average rate nationwide for a 30-year, fixed-rate mortgage climbed nearly half a percentage point to 4.43% by the beginning of March from 3.95% at the beginning of January, according to mortgage-finance giant Freddie Mac (…)

Sales of homes in the $500,000 to $750,000 range increased 11.9% in February from a year earlier. Meanwhile, sales in the $100,000 to $250,000 range, which accounts for more than 40% of the market, declined by 0.6%, according to NAR. (…)

First-time buyers were 29% of the market in February, down from 31% a year ago. (…)

Looks like a weak trend to me. Last 2 months, sales were up only in the South and West. Down elsewhere. Inventory is down 8.1% YoY in February!

Source: Piper Jaffray via The Daily Shot

Trump to Announce $50 Billion in China Tariffs
  • U.S., China Sharpen Trade Swords As the Trump administration pursues talks to grant some allies exemptions from U.S. tariffs on steel and aluminum, China is preparing to target U.S. farm exports.
Triple B risks lurking in the US credit market A decade after the financial crisis, the quality of the investment grade market is deteriorating