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 (19 January 2018)

New Home Building Dropped Sharply at End of 2017

Housing starts fell 8.2% in December from a month earlier to a seasonally adjusted annual rate of 1.19 million, the Commerce Department said Thursday. Residential permits, which can signal how much construction is queued up, also fell, dropping 0.1% to an annual pace of 1.30 million last month.

Last month’s housing starts decline came after two strong months of growth that stemmed from rebuilding efforts occurring in the wake of hurricanes that ravaged the southern and eastern U.S. Such large back-to-back growth usually isn’t sustainable and appears to have corrected back to a normal level in December. (…)

December also saw inclement winter weather in the South and East that likely significantly impacted home construction. The South saw housing starts drop 14.2% and the Northeast dropped 4.3% to the lowest level since May 2017. (…)

The median sales price for existing homes hit $248,000 in November, up 5.8% from a year earlier, which is a more rapid rise than both inflation and wage growth.

But construction of new single-family homes appears to be ramping up at a solid pace. Permits and starts both increased by about 9% in 2017 from the previous year. (…)

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(Haver Analytics)

U.S. Jobless Claims Fell to Near 45-Year Low

Initial jobless claims, a proxy for layoffs across the U.S., fell last week to a seasonally adjusted 220,000 in the week ended Jan. 13, the Labor Department said Thursday. This marked the lowest level for claims since February 1973.

Last week’s drop comes after four consecutive weeks of increases. (…) The four-week moving average, a steadier measure, fell by 6,250 to 244,500 last week. (…)

Second mortgage and bank card defaults spike as spending rises

Source: National Mortage News, h/t Kent; (via The Daily Shot)

Starting to bite!

Pointing upAlready biting hard on smaller banks! Latest stat as of Q3’17 and smaller banks are already at recession highs. Total credit card loans jumped at a 16% annualized rate in Q4’17…

CHINA GROWTH SLOWING IN 2018

China’s GDP grew 6.9% in 2017. The communist party holds its national congress every 5 years and Xi Jinping made sure that the economy was humming nicely by the time the delegates met in October 2017.

These charts suggest that the slowdown is already underway when measured objectively (via The Daily Shot):

The consumer spending is also slowing:

Meanwhile, 5Y yields jumped 70%…

U.S. Crude Production Set to Surpass Saudi Arabia

(…) The IEA raised its outlook for U.S. crude supply this year by 260,000 barrels a day, to a record 10.4 million barrels a day, largely a result of the recent rally in crude prices. (…)

OPEC’s 14 members averaged a compliance rate of 95% with the cuts throughout last year, according to the IEA, falling to 39.2 million barrels a day from a high of 39.6 million barrels a day.

But U.S. production offset around 60% of those cuts, the agency said. With growth of 600,000 barrels a day last year, the U.S. shale industry “beat all expectations,” benefiting from higher oil prices and “cost cuts, stepped up drilling activity and efficiency measures enforced during the downturn,” the IEA added. (…)

“The oil market is clearly tightening,” the IEA said, noting a continued decline in global oil inventories.

Commercial petroleum stocks in the Organization for Economic Cooperation and Development—a group of industrialized, oil-consuming nations, including the U.S.—fell for the fourth straight month in November, by 17.9 million barrels, to stand at 90 million barrels above the cartel’s target of the last five-year average.

The IEA left its oil demand growth estimate for 2018 unchanged, at 1.3 million barrels a day, compared with growth of 1.6 million barrels a day last year.

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SENTIMENT WATCH
U.S. Treasury 10-Year Yield Rises to Highest Level Since 2014
Just kidding Higher Yields in 2018 Don’t Mean Market Turmoil Thank better growth dynamics in the U.S. and Europe.

(…) while the specific level of yields is important, the nature of the move and its drivers will play an equal, if not greater, role in determining the broader economic and market effects. (…)

Where yields end up in 2018 will, of course, have an impact on markets and the economy. They play an important role in influencing market prices, especially the large number of assets that reflect discounted future cash flows. They also affect borrowing, credit and mortgage activities. And, through the foreign-exchange markets, they can have an indirect effect on growth.

At least as important is the way these higher yields are reached. Big jumps tend to be more disruptive then gradual increases, including by heightening the risk of disorderly deleveraging by over-extended and over-indebted households and businesses.

The drivers of higher yields also matter. As an illustration, the possible adverse effects on markets and economy are a lot less severe if a rise is due to stronger inclusive growth as opposed to a central bank policy mistake or a market accident.

So where does this leave us?

Higher and more volatile yields, particularly when compared to those of 2017, should be part of the baseline for this year. This is unlikely to be a runaway process as the influence of central banks, while probably reduced, will still be significant. And pension funds will continue to try to immunize their liabilities, enabled in part by the substantial profits they can now monetize on their equity holdings. The potential for broader disruptions will also be contained by the probability that the main driver will be better growth dynamics — not just in the U.S. but also in Europe and elsewhere.

Yes, yields are probably heading higher this year absent some major non-economic shock. But this event by itself probably is unlikely to translate into broad economic and financial disruptions.

For those who would not want to peruse all 16 charts, my conclusion is that:

  1. Beginning and/or ending dates can make a big difference.
  2. Chosen periods can influence the analysis.
  3. Sometimes it is best to consider what happened immediately following the rate peaks. Unsurprisingly, the effects often carry beyond the end date.
  4. As Mark Twain said, facts are stubborn, but statistics are more pliable.
  5. I stick with my conclusion: beware rapidly rising long-term rates.

In the 12 periods of rapidly rising long-term rates between 1965 and 1996 (I grouped a few short periods on the chart), not one was accompanied with any meaningful gains in equities while most saw equities perform a really deep dive (average –14.5%).

(…) Since 1996, there were some instances when rising rates coincided with higher equity prices, like in 1998-2000, maybe 2005-06,  and 2010. The first two instances saw equity valuations truly explode as investors bought into “great stories”, only to totally deflate when the dreams turned into terrible nightmares. (…)

Bullish outlook boosts inflows into equity funds

In the latest week, investors poured $23.8bn into equity funds, taking the year-to-date total to more than $40bn, according to estimates from fundtracker EPFR Global. (…)

THE DAILY EDGE (18 January 2018)

U.S. Industrial Production Rose 0.9% in December U.S. industrial production rose sharply in December, boosted by gains in utilities output as cold weather swept across the nation and increased demand for heating.

(…) November industrial production was revised to a 0.1% decline from an originally reported gain of 0.2%.

From a year earlier, industrial production rose 3.6% in December, the largest annual gain since 2010. In the fourth quarter as a whole, industrial production jumped 8.2% at an annual rate “after being held down in the third quarter by Hurricanes Harvey and Irma,” the Fed said. (…)

Manufacturing output, the biggest component of industrial production, edged up 0.1% in December. The December increase shows a pullback in growth from October and November, when output grew 1.5% and 0.3% respectively.

Capacity use, a measure of slack in the industrial economy, increased 0.7 percentage point to 77.9% in December. (…)

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(Haver Analytics)

Fed Reports Tight Labor Markets but Modest Wage Gains Economic activity across the U.S. expanded into 2018, with tight labor markets and modest wage and price growth, according to the Federal Reserve beige book report.

Most of the Fed’s 12 regional districts reported modest to moderate economic gains, while the Dallas Fed district saw robust growth, the Fed said in a roundup of anecdotal information about regional economic conditions known as the beige book. The latest report was based on information collected through Jan. 8.

Employment continued to grow at a modest pace, with most districts reporting labor shortages, which were said to constrain growth in some cases, the report said.

Wages grew at a modest pace, though a few districts said firms were raising wages across more industries and positions, the report said.

(…) businesses in some districts said they now have the ability to increase their selling prices. (…)

GOP tax-cut proponents promise 3-4% growth. This economic milestone shows that’s nearly impossible.

(…) The CBO combines estimates of the country’s labor potential—how many people are working or looking for work, and how many hours a week people are working—with estimates of the nation’s capacity to produce goods and provide services.

The government economists use that data to determine how much the economy would produce if most hot dog stands had busy vendors, most cubicle setups had software jockeys with clients to please and most drill presses had drill-press operators and a full list of orders. Most people who want a job have one, and most factories that need workers have them. (…)

Federal Reserve forecasters put the economy’s long-term growth rate at 1.8 percent at their September meeting. Productivity expert John Fernald, an economics professor at the global business school INSEAD and senior research adviser at the San Francisco Fed, pegged that same rate at 1.6 percent. (…)

Also in Canada:

Source: Scotiabank Economics (via The Daily Shot)

America Has a Foreign Tourist Problem

(…) Over the past few years, though, that gravy train has begun to dry up, a trend that accelerated as President Donald Trump began to make good on campaign promises to restrict immigration. As a result, businesses that make up the multibillion-dollar industry relying on that revenue have grown increasingly nervous. (…)

Last week, the Commerce Department reported a 3.3 percent drop in traveler spending for last year, through November, the equivalent of $4.6 billion in losses and 40,000 jobs. The U.S. share of international long-haul travel fell to 11.9 percent last year, from 13.6 percent in 2015, according to the U.S. Travel Association, a slippage the group said equates to 7.4 million visitors and $32.2 billion in spending. (The average “long-haul” visitor to the states spends 18 nights and $4,400, according to U.S. Travel.) (…)

ECB’s Nowotny says strengthening euro “not helpful”

The ECB is gradually turning more hawkish…

China Growth at 6.9%: In 2017, the State Struck Back

China’s economy expanded a hefty 6.9% last year, the first growth acceleration in seven years, though the roaring property market and infrastructure spending that helped drive the pickup showed signs of flagging.

The pace of growth for 2017 beat market expectations and ticked up from the 6.7% reached in 2016, bucking a slowing trend that began in 2011.

In the final quarter of 2017, the economy grew by 6.8% from a year earlier, the same pace as the previous quarter, which also topped analysts’ expectations. (…)

The communist party holds its national congress every 5 years and Xi Jinping made sure that the economy was humming nicely by the time the delegates met in October 2017. So

(…) despite recognizing the need to bring down the nation’s debt that is estimated to have reached 265% of China’s economy as of December, the government has largely kept the credit tap open. Bank lending hit a record last year. Local officials across the country boosted spending on slum renovations, rail lines and other infrastructure projects. (…)

A number of indicators for the last quarter of 2017, from industrial output, fixed-asset investment to retail sales, showed weakening momentum for expansion in 2018, as Beijing’s efforts to restrain risky lending begin to bite. (…)

Authorities are also slowing down approval of new infrastructure projects in a bid to control rampant borrowing, officials say. In recent months, for instance, the central government has outright canceled some subway and other projects. (…)

(…) Most of the reliable indicators tied to industry show growth peaking in mid or late 2017, and now trending gradually down. Since income growth tends to follow corporate profits in China, it’s a good bet consumption will initially hold up in 2018, helping offset the slowdown in investment. (…)

From ZeroHedge:https://www.zerohedge.com/sites/default/files/inline-images/20180117_chiona.png

‘Melt-Up’ Powers Dow Past 26000 as Fear Turns to Greed The market’s most recent gains have been powered in part by a sudden hunger for stocks among certain money managers and individual investors who have long been wary of the nearly nine-year bull market.

(…) Some admit it is hard to justify staying out of the market when stocks rise on a regular basis. (…)

A recent Bank of America Merrill Lynch survey concluded fund managers are increasingly bullish. Average cash balances among portfolio managers also fell to 4.4% this month, a five year low, the survey found. The majority of investors who participated in a January poll said they expect the stock market to peak in 2019 or beyond. A month ago, the majority expected a top in the second quarter of 2018. (…)

About 60% of individual investors said this month they think the stock market will go higher over the next six months, the highest percentage since 2010, according to a recent American Association of Individual Investors survey. (…)

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The small investor has done a 180!

image(Bespoke)

And the so-called bigger guys join the bandwagon: the Bank of America-Merrill Lynch January fund manager survey reveals that hedge fund net equity exposure has risen to 49%, its highest reading since 2006.

RBC has nice Price/Operating Cash Flow charts back to 1989. Nowhere to hide, is there?

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Apple to Pay Big Tax Bill on Foreign Cash, Touts U.S. Spending Apple will pay a one-time tax of $38 billion on its overseas cash holdings and ramp up spending in the U.S., as the world’s most valuable public company seeks to emphasize its contribution to the American economy.
2018 midterm congressional elections

From the excellent Angelo Katsoras at National Bank Financial:

(…) The party in power has lost House seats in 9 of the last 10 congressional elections held at the midpoint of a president’s first term. As for the Senate, the odds are better. The sitting president’s party has only given up seats in 6 of those 10 elections. Historically, supporters of the party not in power have tended to be more motivated to show up at the polls.

If we consider all the midterm elections in the post-war era, the president’s party has lost House seats 16 out of 18 times. The president’s party gained midterm seats only twice: in 1998 under Bill Clinton (66% approval) and in 2002 under George W. Bush (63% approval). The fact that Trump has the lowest approval rating of any modern president at this point in his tenure has heightened fears that Republicans will suffer heavy losses. Trump’s approval in a Gallup poll was 35% at the end of 2017. (…)

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Republicans currently hold a comfortable majority in the House of Representatives (241 to 194). In order for the Democrats to seize control of the House, they would have to gain 24 seats. Their greatest hope for gains lies in the 23 Republican-controlled districts won by Hillary Clinton in the last presidential election.

However, the Republicans do enjoy some important structural advantages. Their control of the House has been strengthened by two factors: 1) Democrats’ tendency to win with overwhelming margins in heavily Democratic urban areas, thus wasting votes; and 2) gerrymandering, which is the process of redrawing the boundaries of legislative districts to favour one’s party. This is done essentially by moving likely non-supporters to other electoral districts lost in advance. In order to overcome these barriers, Democrats would have to win the congressional popular vote by at least 8% to 10% to have a chance of regaining control of the House of Representatives. As the following chart illustrates, they are currently just above this threshold in the polls.

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As for the Senate, the Republicans’ margin of control is much slimmer (51 to 49, if we include the two independents that often vote with the Democrats). However, the Democrats will be defending 25 seats, compared with just eight for the Republicans.

The situation has been made even more challenging for the Democrats by the fact that 10 of their seats up for re-election are in states Trump won. In contrast, only one Republican seat is at stake in a state that Clinton won (Nevada).

In all, 435 seats in the House of Representatives and 34 of the 100 seats in the Senate will be contested in November 2018.

The loss of one or both chambers of Congress would constitute a major setback for President Trump and the Republicans for the following reasons:
 The GOP would not be able to pass any more major bills with just Republican support.
 Regardless of whether Muller has completed his investigation, it would increase the risk of Democrats beginning impeachment proceedings against Trump.
 Republican loss of Senate control would give Democrats veto power over Trump to nominate judges and heads of regulatory agencies. Trump needs a majority of votes in the Senate to confirm nominees. (…)