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 (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.

 Truckload-Index-2008-February-2018.png Intermodal-Index-2008-February2018.png

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

THE DAILY EDGE (21 March 2018)

Soaring U.S. Libor Rate Trickles Into Funding Markets Worldwide

(…) The Libor increase is due in part to the deluge of Treasury-bill issuance since the U.S. debt ceiling was raised in February, which has helped drive bill rates to the highest since 2008. The U.S. tax overhaul is also coming into play, by spurring expectations that companies will park cash in commercial paper as part of repatriating money. And of course there’s the fact that the Federal Reserve is tightening policy.

Whatever the explanation, the phenomenon is becoming a global one. (…)

U.S. interest rates rose after the U.S. elections but they really accelerated since last September: LIBOR spiked 62%, the 2Y 79% and the 5Y 62%. This is surely biting in both the real and finance worlds.

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And now this breakout: (The Daily Shot)

BTW, did you know that capacity utilization in the Eurozone has reached its previous peak levels?

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And that German export prices are on an upswing?

TRADE WARS

(…) The administration plans to release on Thursday a package of proposed punitive measures aimed at China that include tariffs on imports worth at least $30 billion.

But the tariffs won’t be imposed immediately. Rather, U.S. industry will be given an opportunity to comment on which products should be subject to the duties. As part of the package, the White House will announce possible investment restrictions by Chinese firms in the U.S. and will direct the Treasury Department to outline rules governing investment from China. (…)

It plans to argue that Chinese state-owned firms buy U.S. technology not for commercial purposes, but to apply for military use and otherwise gain an edge in the race for global technological dominance. (…)

The U.S. also contends Beijing improperly subsidizes Chinese companies looking to overtake U.S. rivals in such advanced technologies as semiconductors, artificial intelligence and robotics.

(…) That could mean that the U.S. would insist that Chinese firms form joint ventures before doing business in the U.S., unless China dropped those restrictions.

(…) finance ministers and central bankers from the Group of 20 countries, meeting in Buenos Aires on Tuesday, failed to reach any new agreement on shared principles when it comes to trade policies, as the split between the U.S. and other major economies deepened over the U.S.’s tariff policies. (…)

The telecommunications equipment maker was a subject of debate in Canada’s Parliament this week, and the chief executive of South Korea’s largest telecom, considering vendors for next-generation wireless technology, reportedly called Huawei a “concern.”

Australia, where U.S. officials have been pushing a case that the Chinese company is a national security risk, recently pressured the Solomon Islands to drop Huawei as the contractor on an undersea cable connecting the South Pacific nation with Australia. It offered instead to fund a separate cable itself.

Australia is now consulting other nations about their security concerns around Huawei’s involvement in next-generation 5G wireless equipment, officials said. (…)

This Chart Shows Worrying Dot-com Bust Deja Vu for James Paulsen

(…) One key metric for fund-manager veteran James Paulsen, who’s now an investment strategist at Leuthold Group, looks at tech stocks versus utilities — the staid, non-cyclical, dividend-rich sector that’s been underperforming and unloved. The relationship between the two shows a potentially scary parallel to the dot-com bubble of the late 1990s, said Paulsen, who’s been in the markets since 1983.

“Similar to the late 1990s, investors today are following each other into the same popular investments and are also, en masse, abandoning discredited conservative alternatives,” said Paulsen. “Caution is increasingly being thrown to the wind and more aggressive behaviors are enhancing the chances of a mishap.” (…)

U.S. Companies Poised for M&A Shopping Spree

U.S. companies are poised to launch a spending spree linked to the recent tax overhaul, hoping to add to growth through mergers and acquisitions, according to a new survey by Ernst & Young LLP.

The professional services company surveyed some 500 executives last month of companies with over $500 million in annual revenues and found that 73% plan to “accelerate” deal making strategies, according to the report. (…)

Some 48% of companies are “willing to pay more for acquisitions in light of tax reform,” according to the survey. (…)

Three quarters of responding executives said their companies are likely to expand manufacturing efforts in the U.S., while 66% expect to pass some of the tax savings to customers. Some 89% of respondents say their companies plan to “enhance compensation,” due to the tax reform. (…)

As I wrote on January 29:

a U.S. company acquiring another company can now write off the entire value of the acquired company’s qualifying assets, effectively reducing the acquisition cost of those assets by 21%. Looked at the other way, most U.S. companies just became more valuable as a result of this wording change in the tax code.

  • New law. A 100% first-year deduction for the adjusted basis is allowed for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (after Sept. 27, 2017, and before Jan. 1, 2024, for certain property with longer production periods). Thus, the phase-down of the 50% allowance for property placed in service after Dec. 31, 2017, and for specified plants planted or grafted after that date, is repealed. The additional first-year depreciation deduction is allowed for new and used property. (THOMSON REUTERS TAX & ACCOUNTING NEWS)
  • The act also removed the rule that made bonus depreciation available only for new property. (Journal of Accountancy)
  • The asset is no longer required to be new to be eligible for 100% expensing. Used property will now qualify, as long as it is the taxpayer’s first use of the property. (Forbes)

The new tax law effectively makes most companies with tangible assets more valuable since acquirers are now allowed to deduct the entire cost for those assets, even if they have already been depreciated by the acquired company. In effect, the tax code allows the same assets to be depreciated for tax purposes over and over. Confused smile

The Paradox of European Stocks’ Failure to Catch Up With U.S.

I have repeatedly fought the “sell the U.S. – buy Europe” theme in the past. This BB article is a good pros-cons piece but it lacks the main point: Europe remains highly disfunctional which is preventing it from solving its issues. Draghi has done his best to boost the economy and markets but politicians have not done much to address key banking, labor, finance, taxation and trade issues. Plus Brexit. If you want to buy equities, why bother Europe when there’s the U.S., Canada and Japan?

vgk

Here’s a case in point from Pictet:

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Now this: