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 February 2018): Facial Recognition!

Fed Gives Bullish Signals on Economy

Several Fed officials late last month believed the economy was set to grow even faster than when they elevated their growth projections at their December meeting, according to minutes of the Jan. 30-31 session, which were released Wednesday. Some officials also appeared more certain inflation would return to their 2% target over the coming year after years of consistently lagging behind. (…)

The minutes didn’t signal any immediate change in the Fed’s likely path of increases. But the stronger growth outlook, which was made before Congress approved a separate spending bill that should further boost economic demand this year and next, supports the current rate path and could serve as an important prerequisite for moving a touch more aggressively later this year. (…)

“A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate,” the minutes said. (…)

At the January Fed meeting, staff economists projected this measure would rise “notably faster in 2018” before reaching the 2% target in 2019 and remaining there after that. (…)

At the January Fed meeting, staff economists projected this measure would rise “notably faster in 2018” before reaching the 2% target in 2019 and remaining there after that. (…)

Home Sales Post Their Sharpest Drop in Three Years Sales of previously owned U.S. homes in January experienced their sharpest annual drop in more than three years as low inventories and rising prices and interest rates took a toll.

The National Association of Realtors reported on Wednesday that existing home sales in January fell 3.2% from December, versus the gain economists expected to see. Sales were 4.8% below their year-earlier level, marking the biggest annual decline since August 2014.

The NAR suggested tight inventories were to blame, and some economists also noted that bad weather may have delayed some sale closings. These might have affected January sales, but the bigger pressures hitting the housing market will play out this year. (…)

The median price of an existing home sold last month, at $240,500, was 5.8% higher than a year earlier.

And while they probably didn’t affect January home sales, higher mortgage rates could also bite into sales in the months to come. The average rate on a 30-year fixed mortgage was 4.38% during the week ended last Thursday, according to Freddie Mac, a level it has only briefly been higher than over the past five years. (…)

Just kidding Weather must have been bad throughout the U.S. since all four regions showed weakness in January…and December, by the way. (Charts from Haver Analytics)

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FLASH PMIs

U.S. private sector companies experienced a marked improvement in business activity growth during February. This was highlighted by a rise in the seasonally adjusted IHS Markit Flash U.S. Composite PMI Output Index to 55.9, up from 53.8 in January and the highest reading for almost two-and-a-half years.

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February data pointed to similarly sharp increases in both manufacturing production and service sector activity. The latter recorded a much stronger rate of expansion than at the start of 2018, helped by the largest rise in new work received by service providers since March 2015.

Stronger new business growth underpinned a robust upturn in private sector payroll numbers during February. The latest increase in staffing levels was the most marked since August 2015.

Confidence regarding the outlook for business activity over the next 12 months picked up to its strongest since May 2015. A number of survey respondents cited greater sales volumes at their business units and hopes of a sustained improvement in U.S. economic conditions.

Meanwhile, cost pressures continued to intensify in February, with the latest rise in average input prices the sharpest recorded since July 2013. Higher cost burdens and improving client demand contributed to the fastest rate of prices charged inflation for almost three-and-a-half years.

February data revealed a robust and accelerated expansion of U.S. service sector output. At 55.9, up from 53.3 in January, the seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index signalled the steepest rate of growth for six months. Moreover, the latest reading was one of the highest achieved since early-2015.

A continued rebound in new order volumes helped to support business activity growth during February. The latest upturn in new work received by service sector companies was the steepest since March 2015. Anecdotal evidence suggested that resilient business and consumer confidence had helped to boost sales volumes in the latest survey period. Service providers sought to expand operating capacity by taking on additional staff in February.

The rate of job creation was the fastest since August 2017, but this did not prevent a further rise in backlogs of work across the service sector. Moreover, stronger demand helped to support an improvement in business expectations for the next 12 months. February data indicated that service sector business confidence reached its highest since May 2015.

Input costs meanwhile increased sharply in February, with the latest rise the strongest for around four-and-a-half years. Average prices charged by service sector firms increased at the fastest pace since September 2014.

U.S. manufacturers reported a strong upturn in business conditions during February, which continued the positive trend seen at the start of 2018. At 55.9, up from 55.5 in January, the seasonally adjusted IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) pointed to the fastest improvement in overall business conditions since October 2014.

A sharp and accelerated rise in incoming new business helped to boost the headline PMI in February, while manufacturing production growth was little-changed since January. The latest rise in new order volumes was the steepest for around three-and-a-half years, which survey respondents attributed to greater sales to domestic clients alongside further export gains.

Improving manufacturing business conditions also reflected a robust rise in payroll numbers and sustained pre-production stock building in February. Meanwhile, there were signs of stretched supply chains, with delivery times from vendors lengthening for the fourteenth month running.

Greater demand for inputs and rising commodity prices contributed to a sharp rise in average cost burdens across the sector. The latest increase in manufacturing input prices was the fastest since December 2012. Efforts to alleviate pressure on operating margins led to the steepest rate of factory gate price inflation for just over four years in February.

Eurozone business activity continued to rise at a steep pace in February, albeit with the rate of expansion cooling from the near 12-year high recorded in January. Price pressures and employment growth also remained elevated, though likewise saw rates of increase ease slightly. (…)

The headline IHS Markit Eurozone PMI fell from 58.8 in January to 57.5 in February, according to the estimate, which is based on approximately 85% of usual final replies. The slower growth of business activity reflected an easing in the rate of increase of new orders which, while elevated, slipped to a five-month low. (…)

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At the eurozone level, the goods-producing sector continued to record a faster pace of expansion than the service sector, though growth of output and new orders slowed in both cases. However, both sectors continued to enjoy the best periods of expansion seen for seven years.

Despite slowing, the sustained growth of new business was sufficiently strong to encourage companies to boost staffing levels to one of the greatest extents seen over the past 17 years. Service sector jobs growth remained at the joint highest in a decade, while manufacturing payroll growth dipped further from recent 20-year record highs to a five-month low.

Backlogs of work continued to rise, indicating that firms on balance once again lacked sufficient capacity to meet demand. The increase was nonetheless the smallest for six months, reflecting the combination of recent hiring and slower inflows of new work.

Price pressures meanwhile remained elevated. The rate of input cost inflation and selling price inflation remained at levels exceeded only rarely since early-2011, dipping from January’s highs.

Higher prices were linked to improved pricing power amid stronger demand as well as incidences of upward salary pressures. The steeper rate of selling price inflation was seen in manufacturing, where average prices charged for goods at the factory gate showed the largest rise since April 2011, though service sector charges also showed the second-largest increase over the same period. (…)

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The PMI readings for the first two months of the quarter generally provide a reliable guide to official GDP growth, and indicate that the eurozone economy is expanding at a quarterly rate of 0.9% in the opening quarter of 2018.

February Japan flash PMI data is a fairly mixed bag overall. On the one hand, output and new business inflows increased to weaker extents, while recent yen appreciation has coincided with slower new export order growth. Furthermore, a number of panellists indicated that the stronger currency had prompted them to lower prices to overseas customers. Indeed, further yen strengthening will create unwanted drag on inflationary pressures.

That said, employment growth accelerating to an 11-year high signals confidence that expansionary output and demand trends will continue for the time being.

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Index of 500 Stocks Is Powered by Just Three Tech titans Amazon, Microsoft and Netflix have fueled nearly half of the S&P 500’s advance this year, a worrying sign for investors expecting a strengthening economy to lift shares from other industries that typically improve with growth.

Amazon.com Inc. AMZN 0.99% has accounted for 27% of the broader index’s 1.6% gain through Tuesday, according to S&P Dow Jones Indices’ data. That is followed by Microsoft Corp. MSFT -1.33% , which has contributed 13%, and Netflix Inc. at 8.3%. U.S. stocks fell Wednesday, but Amazon and Netflix extended their 2018 gains, adding to their dominance over the S&P 500. (…)

Roughly a third of global fund managers say they are overweight technology stocks in their portfolios, according to a Bank of America Merrill Lynch survey conducted at the start of the month. That was the highest share of overweights of all 11 S&P 500 sectors. (…)

Startups Still In a Rut

Winking smile Are alpha males worse investors? New research suggests high-testosterone traders earn lower returns

(…) A paper recently published by researchers at the University of Central Florida and Singapore Management University looks at the relationship between testosterone (a hormone associated with competitiveness and risk-taking) and investment performance. Using over twenty years of data on hedge-fund returns and thousands of images collected from Google, the authors find that fund managers with wider faces, a proxy for testosterone levels, tend to trade more frequently, invest in riskier securities and hold onto losing bets longer. As a result, between 1994 and 2015, high-testosterone fund managers (with an average facial width-to-height ratio of 2.10) underperformed low-testosterone ones (with an average ratio of 1.57) by 5.8% per year.

Is there anything investors can do to avoid testosterone-fuelled traders? One approach might be to seek out fund managers with long, thin faces. Or perhaps women and older men who are known to have less testosterone in their bodies. Another would be to bypass human managers altogether. If emotions inhibit traders’ ability to think rationally during market booms and busts, investors might be better off entrusting their money either to static index funds, or to trading algorithms without any emotions at all.

Full disclosure: I come out at 1.60…Sarcastic smile

THE DAILY EDGE (21 February 2018): The Ghost of Inflation

U.S. Home Construction Rose 9.7% in January Builders showed signs they are planning to ramp up construction later this year

The number of new housing units under construction rose 9.7% from a month earlier to an annual rate of 1.326 million, the Commerce Department said Friday. That marked the third increase in four months.

Builders also showed signs they are planning to ramp up construction later this year. The number of permits they lined up to build units rose 7.4% last month to an annual pace of 1.396 million. (…)

Apartment starts surged 24% in January, while construction of single-family homes rose just 3.7%. Permits for buildings with five units or more likewise were up more than 25%, while permits for single-family homes fell 1.7%.

Over the longer-term, new-home construction is picking up. Total starts rose 7.3% in the 12 months through January, while single-family starts rose 7.6% during that period. (…)

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U.S. Import Prices Rise in January Prices for foreign-made goods imported to the U.S. rose in January, driven by a broad range of product price increases and capping a week of solid inflation readings.

Import prices increased 1% in January from a month earlier, the Labor Department said Friday, beating expectations of economists surveyed by The Wall Street Journal. The January rise matched November’s increase and hasn’t been exceeded since May 2016, when the index grew 1.2%. (…)

Nonpetroleum import prices rose 0.5% in January and 2.8% annualized in the last 3 months. (Chart from Haver Analytics)

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  • Cass Truckload Linehaul Index

January’s Cass Truckload Linehaul Index (measuring changes in linehaul rates) continued the acceleration established in November and December (up 6.3% and 6.2% respectively) by posting a 6.5% YoY increase, to 133.5 (just shy of December’s 134.5 all-time high).(…) “In just the last seven months, our pricing forecast has increased from -1% to 2%, to 6% to 8%, and now giving us reason to believe the risk to our estimate continues to be to the upside,” stated Donald Broughton, analyst and commentator for the Cass Indexes. “The current strength being reported in spot rates tells us contract pricing rates should keep rates in positive territory well into 2018.”

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  • Cass Intermodal Price Index

The latest data point shows total intermodal pricing rose 5.0% YoY to 141.4 in January (an all-time high) with a YoY three-month moving average increase of 4.3%. (…)

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(…) The release of the recommendations had a swift market impact Friday. Stocks of steel and aluminum makers, including Nucor Corp. , US Steel Corp. and AK Steel Holding Corp. , soared. Aluminum prices rose 2% in London trading. Stocks of manufacturers that use the metals, such as Caterpillar Inc. and Harley-Davidson Inc., fell. (…)

It is one of the many ways that Mr. Trump, in pursuit of more aggressive trade enforcement, is turning to long-dormant powers that his recent predecessors have been hesitant to use, especially since the 1995 founding of the World Trade Organization discouraged such broad, unilateral trade actions. (…)

Section 232 “is a little like old-fashioned chemotherapy,” Texas GOP Rep. Kevin Brady told Mr. Trump. “It isn’t used as much because it can often do as much damage as good,” added Mr. Brady, who chairs the Ways and Means Committee, which oversees trade policy.

Defense companies have also raised worries. “We are concerned that tariffs may have an unintended impact on the global supply chains that our industry depends on,” said a spokesman Friday for the Aerospace Industries Association. “It’s particularly true of aluminum and steel.” (…)

“We really don’t think there’s very much likelihood” of sharp cost increases for U.S. consumers of steel and aluminum, Mr. Ross said Friday. “We really don’t think that’s a big factor.”

In the Tuesday White House meeting, Mr. Trump suggested he placed a higher priority on trying to protect workers than consumers, even at a time of a historically low 4.1% jobless rate. “You may have a higher price…but you’re going to have jobs,” he said. “To me, jobs are very important.” (…)

(…) “If the final decision impacts China’s interests, China will certainly take necessary measures to protect its own rights,” Wang said. [Wang Hejun, chief of the trade remedy and investigation bureau at China’s Ministry of Commerce] (…)

Ghost The Ghost of Inflation Reappears

(…) Looking more deeply at the January jump in CPI shows definite trends, according to Steven Blitz, chief U.S. economist at TS Lombard. Deflation in the prices of consumer goods we like to buy is ending; the rate of increase in the cost of things we have to buy either is rising, as for food and energy, or remains high, as for services or rent.

Goods inflation has been held down since the mid-1990s by increased low-cost imports, technology, or slowing spending by “aging baby boomers” (or should that be “aged”?). The dollar’s weakness is boosting import prices (up 1% in January and 3.6% from its level a year earlier), which should pass through to consumer prices this year and into the next. (…)

Pointing up Stephanie Pomboy of MacroMavens via the same Barron’s article::

Nondiscretionary outlays—for food, energy, housing, and medical expenses—have accounted for 55% of the increases in household spending over the past two years. During that same period, savings have been “pillaged,” she writes in a recent missive to clients. “The ineluctable conclusion is that the decline in saving is occurring out of necessity, not choice.”

In another note, Pomboy points out that the cost of paying back debt jumped by $62 billion through the third quarter—which predates the most recent rise in interest rates. Given the increase in rates since then and the Fed hikes likely this year, she conservatively estimates an additional $75 billion jump in debt service in 2018. “That alone would wipe out nearly all of the $80-to-$100 billion boost to growth forecast from the tax cuts,” she observes.

As for drag from the fiscal side, President Donald Trump’s suggestion last week of a 25-cent-per-gallon tax would wipe out 60% of the benefit of the tax cuts to individuals, according to Strategas’ Washington team lead by Daniel Clifton. No wonder this trial balloon was made of lead. (…)

Speaking of oil:

Saudi Arabia Is Taking a Harder Line on Oil Prices

(…) Producers should keep cutting for the whole year, even if it causes a small supply shortage, Al-Falih said. “If we have to overbalance the market a little bit, then so be it,” he told reporters in Riyadh last week. (…)

“They are definitely not a price dove anymore,” said Mike Wittner, head of oil market research at Societe Generale SA. “They have to think about their social costs, about Vision 2030, about the Saudi Aramco partial IPO or private placement. Al-Falih’s statement last week could not have been much clearer.” (…)

“If you’re Mohammed Bin Salman, and trying to radically reinvent your country” then “you need a certain price to make it work,” said Helima Croft, head of commodity strategy at RBC Capital Markets LLC. (…)

The Rise of the Jumbo Student Loan Most students with loan balances exceeding $50,000 in 2010 had failed to pay down any debt four years later

A study released Friday by the Brookings Institution finds that most borrowers who left school owing at least $50,000 in student loans in 2010 had failed to pay down any of their debt four years later. Instead, their balances had on average risen by 5% as interest accrued on their debt.

As of 2014 there were about 5 million borrowers with such large loan balances, out of 40 million Americans total with student debt. Large-balance borrowers represented 17% of student borrowers leaving college or grad school in 2014, up from 2% of all borrowers in 1990 after adjusting for inflation. Large-balance borrowers now owe 58% of the nation’s $1.4 trillion in outstanding student debt. (…)

Household Debt Sees Quiet Boom Across the Globe A decade after the crisis, a number of economies face a familiar problem—but regulators are better prepared

(…) At the top of the heap is Switzerland, where household debt has climbed to 127.5% of gross domestic product, according to data from Oxford Economics and the Bank for International Settlements. The International Monetary Fund has identified a 65% household debt-to-GDP ratio as a warning sign.

In all, 10 economies have debts above that threshold and rising fast, with the others including New Zealand, South Korea, Sweden, Thailand, Hong Kong and Finland.

In Switzerland, Australia, New Zealand and Canada, the household debt-to-GDP ratio has risen between five and ten percentage points over the past three years, paces comparable to the U.S. in the run-up to the housing bubble. In Norway and South Korea they’re rising even faster.

The IMF says a five percentage-point increase in household debt over a three-year period is associated with a hit to GDP growth of 1.25 percentage points three years down the road. (…)

Collectively, those 10 economies have $7.4 trillion in total economic output and a household debt stock about the same size. Taken as a whole, that’s more than the output of Germany or Japan. Moreover, many of them have a large stock of adjustable-rate mortgages that could suddenly become more costly to service should global interest rates rise. (…)

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Figure 29 suggests that in comparison to other high-income countries, fast-rising house prices relative to incomes in the countries studied have in large part been caused by both low levels of housing stock and a lack of house building. In 1990, the UK, Australia, and the US all had comparatively low levels of housing stock relative to population size, and while this increased slightly between 1990 and 2000, these levels have since declined.

As a result, the levels of housing stock per 1000 inhabitants aged over 20, in the whole period from 1990 and 2015, increased only marginally in the UK from 555 homes to 560, and decreased in Australia from 544 to 539. In the US, the figure in 1990 was roughly the same as the figure in 2015. Moreover, although starting from a higher level, Sweden has also seen a decline between 1990 and 2015. Comparatively, in Germany and Japan, which have had the largest long term declines in HPIR (as shown in Figure 29), housing stock per 1,000 inhabitants aged over 20 has risen rapidly from 546 to 616 and 459 to 576 respectively.

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In an analysis of eight high-income countries, the Resolution Foundation think tank found that millennials in their early 30s have household incomes 4 percent lower on average than members of so-called Generation X at the same age. (…)

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The peaks in dependency ratios around the late-1960s and 1970s represents the point at which members of the baby boomer cohort were just reaching working age. Higher dependency ratios in the years prior to this were caused by large numbers of dependent ‘children’ i.e. under 20s. In contrast, the increase in dependency ratios starting around the 2000s is caused by an increase in the proportion of over 65s.

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Americans Are Confident About Retirement A gauge measuring the chances of retiring comfortably rose to the highest level since 2001 this month, despite the market correction

(…) Despite the recent market correction, years of gains in equities have boosted the value of households’ retirement accounts. (…)

Hmmm…

Note Summertime, and the livin’ is easy
Fish are jumpin’ and the cotton is high
Oh, your daddy’s rich and your ma is good-lookin’
So hush, little baby, don’t you cry Note

(Steve Blumenthal, CMG)

An impressive 84% of investors in a UBS survey say last week’s market dip was “temporary” and “not indicative of recession” and 86% say “economic fundamentals are still strong,” according to a UBS “Investor Watch Pulse” survey released Friday. Still, 80% of those surveyed believe the market will be more volatile going forward. (…)

Big stock market declines typically are triggered by a growth scare or geopolitical event, but this downturn was sparked only by evidence of higher average hourly earnings, a signal of rising inflation, and worries the Fed would accelerate interest rate hikes. Confused smile (…)

Although 68% of those surveyed in the midst of last week’s volatile global market swings believe now is a good time to buy stocks, only 10% to 15% have put cash to work or boosted their stock investments during the pullback. (…)

The business owners surveyed remain hopeful, but are slightly more cautious than earlier this year. For instance, 51% are optimistic about the stock market outlook over the next six months, down from 81% in January. While 36% planned to boost hiring in January, by February, only 24% are. (…)

EARNINGS WATCH

Factset:

To date, 80% of the companies in the S&P 500 have reported actual results for Q4 2017. In terms of earnings, more companies are reporting actual EPS above estimates (75%) compared to the 5-year average. In aggregate, companies are reporting earnings that are 5.3% above the estimates, which is also above the 5-year average. In terms of sales, more companies (78%) are reporting actual sales above estimates compared to the 5-year average. If 78% is the final number for the quarter, it will mark the highest percentage of S&P 500 companies reporting positive sales surprises since FactSet began tracking this metric in Q3 2008. In aggregate, companies are reporting sales that are 1.5% above estimates, which is also above the 5-year average.

The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings growth rate for the fourth quarter is 15.2% today, which is above the earnings growth rate of 14.7% last week.

If the Energy sector were excluded, the blended earnings growth rate for the remaining ten sectors would decrease to 13.2% from 15.2%.

The blended sales growth rate for the fourth quarter is 7.9% today, which is equal to the sales growth rate of 7.9% last week. [Thomson Reuters says that excluding the Energy sector, the revenue growth estimate declines to 7.0%.]

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Thomson Reuters I/B/E/S reports that 42 of the 96 (44%) pre-announcements for Q1’18 were positive, up sharply from 29% and 32% at the same time in Q1’17 and Q4’17 respectively and from 26% since 1995.

Q1’18 estimates are +18.0% from +12,2% on Jan.1.

Trailing EPS are now $132.96. Pro forma for the tax reform, assuming a 7.0% average positive impact, trailing EPS rise to $142.27.

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Ed Yardeni:

Industry analysts have raised their consensus S&P 500 earnings estimate for 2018 by $9.00 per share over the past seven weeks to $155.26 during the week of February 2. That’s mostly on guidance provided by managements during January’s Q4-2017 earnings season about the very positive impact of the corporate tax cut enacted late last year. The actual Q1 earnings season is still ahead, starting in April. By then, corporations are likely also to report that the weak dollar (down 7.7% y/y) has boosted their earnings.

TECHNICALS WATCH

Lowry’s Research reminds us that the “market plunge from late Jan. was accompanied by two 90% Down Days (Feb. 2nd, Feb. 5th) and one near-90% Down Day on Feb. 8th – compelling signs of the intense selling needed to exhaust Supply. These 90% Down Days were followed by two 80% Up Days (Feb. 12th, Feb 14th) and the registration of a conventional short-term buy signal by our Short Term Index, also on Feb. 14th. While less-than-ideal, this combination of 80% Up Days and a short-term buy signal has, in the past, provided sufficient evidence that a sustainable market bottom is in place.”

UNEXPECTED OUTCOMES

Evergreen/Gavekal’s CIO David Hay does his annual exercise of forecasting the “unforecast”.