Strong Employment Data Add to Rosy View of Economy The U.S. economy is hitting a sweet spot seldom seen in past expansions, posting in July a record 82nd straight month of job creation and an unemployment rate at a 16-year low, despite slow growth in output.
(…) The latest evidence was a Labor Department report Friday that showed U.S. employers added 209,000 jobs to payrolls in July and the unemployment rate fell to 4.3%. With the July increase in hiring, the record stretch of monthly hiring is equivalent to six years and 10 months, almost three years longer than the second-best streak, from 1986 to 1990. (…)
The monthly pace of hiring has averaged 184,000 this year. That is remarkably consistent with the monthly pace of 187,000 during President Barack Obama’s last year in office, despite the starkly different views of economic policy espoused by the two men. (…)
From a year earlier, average hourly earnings increased 2.5%, thanks to a 9 cents-an-hour increase from the prior month. That is slower than normal in the past quarter-century. Still, the wage picture isn’t all bad. When adjusting for low inflation, real wages grew 0.9% in June from a year earlier, a stronger rate than the 30-year average. (…)
One in four net new jobs last month came in restaurants, among the lowest-paying fields. Labor-force participation is rising among Americans with a high-school diploma or less. The figures are stable for those with college degrees, suggesting low-skill, low-wage workers are getting a slightly bigger piece of the economic pie. (…)
The share of adults between 25 and 54 years old working or looking for work rose in July to the highest level since late 2010, though it remains below the prerecession rate. (…)
Make sure to read Rise of the machines in the EARNINGS WATCH section below.
Why Jobs, Wages and Savings Mean Weaker Profits
The U.S. economy has reached a turning point: If companies don’t start paying employees more soon, consumer spending may slow. But the alternative—faster wage growth—would raise companies’ costs.
Either way, it is hard to very optimistic about where profits are heading. (…)
Even though last week’s personal income and spending data were weak, consumers’ spending ability is not critical. Aggregate payrolls (employment x wages) are up 4.5% and accelerated lately while inflation is 1.6% and decelerating. No real squeeze just yet.
Americans’ daily self-reports of spending averaged $109 in July, the sixth month in a row in which spending has averaged $100 or more. This is the highest spending average in Gallup’s trend since May 2008. (…)
Canada’s job market runs hot as jobless rate hits 9-year low
The unemployment rate fell to 6.3 per cent, the lowest since October 2008, as the labour market added another 10,900 jobs during the month, Statistics Canada reported from Ottawa. The total increase over the past year of 387,600 is the biggest 12-month gain since 2007. (…)
The bulk of the gains over the past year have been full –time, with 353,500 jobs. In July, the economy created 35,100 full-time jobs while dropping 24,300 part-time jobs. The full-time job gains means the total number of hours worked – a key determinant of income – are also accelerating.
Total actual hours worked were up 1.9 per cent in July from a year earlier, the fastest year-over-year gain since August 2015. Wages continue to rise at historically low levels, which continues to be the main wrinkle in the country’s labour market. The pace of annual wage rate increases was unchanged at 1.3 per cent in July. That’s still better than the record low 0.7 per cent in April.
The decline in the jobless rate was also due in part to a lower participation rate, which fell to 65.7 per cent, from 65.9 per cent, as people left the labour force.
U.S. Trade Deficit Narrows Yet Again
The U.S. trade deficit in goods and services was $43.6 billion in June after May’s $46.4 billion; that earlier figure was revised from $46.5 billion and compares to $43.8 billion in June 2016. Total exports advanced 1.2% (+5.8% y/y) after a 0.4% rise in May. Imports were 0.2% lower (+4.6% y/y) in June after edging down 0.1% in May.
Exports of goods rose 1.5% in June (+6.9% y/y), after increasing 0.1% in May. Gains came in most end-use categories, especially food, feed & beverages 5.9% (9.9% y/y), “other” 3.9% (3.3% y/y) and autos 2.9% (10.0% y/y). Only nonauto consumer goods fell, those by 1.9% (+2.1% y/y).
Services exports rose 1.0% (+3.9% y/y). For categories ranked by dollar amount, travel by foreign tourists in the U.S., $18.3 billion in June, increased 1.8% (+7.6% y/y) and revenue from business services, $11.9 billion, was unchanged (+0.5% y/y), while charges for the use of intellectual property, $10.2 billion, eased 0.2% (-2.4% y/y).
On the import side, purchases of goods edged lower 0.2% in June (+4.7% y/y). The decline came in petroleum, which dropped 10.2% (+9.1% y/y), after May’s 2.2% increase. The quantity of energy-related petroleum product imports actually fell 1.9% from a year ago, while the quantity of crude petroleum imports was up 1.9% from a year ago.
Nonpetroleum goods imports rose 0.7% (4.4% y/y), following May’s 0.6% reduction. Among those imports, autos rose 3.5% (5.5% y/y), reversing their May decrease of 2.4%. “Other” goods also rose 3.5% (10.4% y/y) after a 2.9% rise in May. In contrast, nonauto consumer goods fell 1.5% (-1.9% y/y), following May’s decline of 2.9%. Foods, feeds & beverages were up 0.6% (+8.3% y/y) and capital goods edged 0.2% higher (8.0% y/y).
Semi Order Jump a Sign U.S. to Keep on Trucking
Orders for semi trucks are rebounding after an almost two-year long slump, a positive sign for a U.S. economy that’s having growth crimped by sluggish passenger-car sales. Preliminary net orders for Class 8 trucks — which weigh in at more than 33,000 pounds — surged 81 percent in July, the biggest monthly jump in almost three years, according to ACT Research. Demand has been perking up after a 20-month streak of shrinking orders ended in November. (…) (Bloomberg Briefs)
EARNINGS WATCH
From Factset:
- Overall, 84% of the companies in the S&P 500 have reported earnings to date for the second quarter. Of these companies, 72% have reported actual EPS above the mean EPS estimate, 9% have reported actual EPS equal to the mean EPS estimate, and 19% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (70%) average and above the 5-year (68%) average.
- At the sector level, the Information Technology (85%) and Health Care (84%) sectors have the highest percentages of companies reporting earnings above estimates, while the Telecom Services (50%), Energy (53%), and Consumer Discretionary (56%) sectors have the lowest percentages of companies reporting earnings above estimates.
- In aggregate, companies are reporting earnings that are 6.3% above expectations. This surprise percentage is above the 1-year (+4.7%) average and above the 5-year (+4.2%) average.
- In terms of revenues, 70% of companies have reported actual sales above estimated sales and 30% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is well above the 1-year average (56%) and well above the 5-year average (53%).
- In aggregate, companies are reporting sales that are 0.7% above expectations. This surprise percentage is above the 1-year (+0.5%) average and above the 5-year (+0.5%) average.
- The blended earnings growth rate for the S&P 500 for the second quarter is 10.1% today, which is higher than the earnings growth rate of 9.0% last week. [And +6.4% on June 30]. If the Energy sector is excluded, the blended earnings growth rate for the remaining ten sectors would fall to 7.8% from 10.1%
- The blended sales growth rate for the S&P 500 for the second quarter is 5.1% today, which is slightly below the sales growth rate of 5.2% last week. [+4.9% on June 30].
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MARGINS WATCH
If the Energy sector is excluded, the blended revenue growth rate for the index would fall to 4.2% from 5.1%.
In effect, margins keep rising in Q2 with and without Energy. Q2 margins are up in every sector but Consumer Discretionary.
- At this point in time, 83 companies in the index have issued EPS guidance for Q3 2017. Of these 83 companies, 50 have issued negative EPS guidance and 33 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 60%, which is below the 5-year average of 75%.
Importantly, 10 of the 64 Industrials that have reported so far have guided up for Q3. That is 16% of Industrials. Ex-Industrials, 6.5% have guided up so far. Lower dollar but maybe also this:
“When we compete internationally, when Raytheon competes internationally, we do not compete against companies. We compete against countries. So, having an administration that supports industry in going after international business changes the game. And we have an administration now that is significantly supporting international work for domestic – actually U.S. industry. And that has opened several doors for us. Now we’ve been very successful before those doors were opened. So it’s bottom line just accelerating our ability to grow internationally. And so that’s why we’re very positive about the future of the company, especially relative to the international business. (…)” –Raytheon (July 27)
Some surprises are simply amazing: Utes!!
(…) But as one factory in Wisconsin is showing, the forces driving automation can evolve — for reasons having to do with the condition of the American workforce. The robots were coming in not to replace humans, and not just as a way to modernize, but also because reliable humans had become so hard to find. It was part of a labor shortage spreading across America, one that economists said is stemming from so many things at once. (…)
In earlier decades, companies would have responded to such a shortage by either giving up on expansion hopes or boosting wages until they filled their positions. But now, they had another option. Robots had become more affordable. No longer did machines require six-figure investments; they could be purchased for $30,000, or even leased at an hourly rate. As a result, a new generation of robots was winding up on the floors of small- and medium-size companies that had previously depended only on the workers who lived just beyond their doors. (…)
In Wisconsin, where it has 550 employees, all non-union, wages started at $10.50 per hour for first shift and $13 per hour for overnight. Counting health insurance and retirement benefits, even the lowest-paid worker was more expensive than the robots, which Tenere was leasing from a Nashville-based start-up, Hirebotics, for $15 per hour. Hirebotics co-founder Matt Bush said that, before coming to Tenere, he’d been all across America installing robots at factories with similar hiring problems. “Everybody is struggling to find people,” he said, and it was true even in a slice of western Wisconsin so attuned to the rhythms of shift work that one local bar held happy hour three times a day. (…)
Chubb warns of ‘unsustainable’ environment for insurers
(…) “The current environment is unsustainable over any reasonable period of time,” said Mr Greenberg. “Many companies are not earning their cost of capital — and many are losing money, or will lose money in the future.” (…)
The investment income garnered last year by the US property and casualty industry of $48bn was about $10bn lower than 2007, according to AM Best, the rating agency. Meanwhile, depressed returns from traditional securities have prompted investors to pile in to the insurance sector — intensifying competition and putting downward pressure on pricing. (…)
Chubb’s reinsurance business has shrunk to account for only about 3 per cent of the group’s premium income, although Mr Greenberg said there was also pricing pressure in the wider property and casualty insurance industry. “We will trade revenue growth — not happily, but willingly — all day long, to preserve an underwriting profit,” he said.
Cost control to preserve margins, over and above top line growth. Corporate America is focused on margins.
MIND THE GAAP
Buffett believes operating income is a better gauge of how Berkshire and its more than 90 businesses are doing than net income, which fluctuates more because it incorporates investment and derivative gains, which fell 64 percent from a year earlier. (Reuters)
Even Warren Buffett sees problems with some of GAAP’s provisions. Nothing is perfect. Nothing is pure. YTD, GAAP EPS are 7.5% below Operating EPS. The ratio was 11.0% in 2016 and 13.9% in 2015 when energy-related write-downs hit. The ratio was 9.5% in 2014 and 6.6% in 2013. Based on Capital IQ’s estimates, the ratio for 2017 will be 8.4%. Since 1988, the average is –14.3%, –12.1% when excluding Q4’08 to Q3’09 (-68% due to financial crisis).
BTW, GAAP EPS rose 26.4% Yoy in Q1’17 and are set to rise 18.5% in Q2 and another 19.5% in the second half.
SENTIMENT WATCH
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Weird Science: Wall Street Repeals Law of Gravity Stocks continue to rise, even though no one really knows why.
(…) Second-quarter profits grew an impressive 12%, and revenues are up 5%, but investors already expect nothing less. Companies beating profit and sales targets have merely performed in line with the market afterward, while those that dared miss trailed by three percentage points the next day and five points over the ensuing five days, note Bank of America Merrill Lynch’s equity strategists. “This is the first time in 17 years that we’ve seen no reward for beats,” they wrote. Even rosier outlooks have failed to excite: Companies nudging up their 2017 forecasts merely chugged along in line with the market, while those cutting projections underperformed. (…)
In reporting second-quarter results, Charles Schwab (SCHW) CEO Walter Bettinger said clients had opened more than 350,000 brokerage accounts from April to June. That brought new accounts in 2017 to 719,000—34% above the total a year earlier, and the strongest first-half showing in 17 years. (…)
Meanwhile, money continues to swirl through the financial system, and Corporate America’s $2.2 trillion first-quarter cash stash looks set to grow. Apple, for one, ended June with a staggering $261.5 billion in cash. That’s more than the market value of 490 companies in the large-cap S&P 500. The internet went wild trying to describe just how big this was, and my favorite quip was this: If you spend $1 million each day, it’ll still take you 716 years to go through this pile. (…)
But Mike O’Rourke, Jones Trading’s chief market strategist, adds a sixth: “Failing to recognize the structural shift in the U.S. economy at the turn of the century, the Fed has been mistakenly chasing 20th century 3.5% GDP growth in a 2% GDP growth U.S. economy,” he writes. “The excess has wound up in asset prices.”
With benchmark rates just above 1% and the Fed’s balance sheet at a staggering $4.5 trillion, financial conditions remain among the easiest in history. “The policy mistake investors should fear is not the one that the Fed will create by continuing to tighten,” O’Rourke warns. “The policy mistake has already been made, and investors should fear how it will be unwound.”
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Amazon helps explain paradoxes facing investors Outlook of expensive stocks and bonds contrasts with an ever angrier populace
(…) More scientifically, analysis by Bloomberg of corporate executives’ comments in earnings calls found that in May, June and July, Amazon was mentioned a “staggering” 635 times. President Trump came up only 162 times while wages — the great concern of the population at large, and of the Federal Reserve — came up only 111 times. The preoccupation with Mr Bezos has intensified over the past month. (…)
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The Market Really Is Different This Time Small-time investors are moving away from stock-market euphoria, not toward it
(…) Over the past month, small investors have pulled $17 billion out of U.S. stock mutual funds and exchange-traded funds and added $29 billion to bond funds. That’s the latest leg of a long-term trend: Since the internet-stock bubble burst in 2000, investors have withdrawn half a trillion dollars from U.S. stock mutual funds.
Instead of chasing this rising market upward, individual investors have been backing away from it. That retreat is increasingly automatic and has become an integral part of how the stock market works.
As millions of Americans reach the age of retirement and have to replace their salaries, they look less to stocks for growth and more to bonds for income.
Financial advisers, many of whom “rebalance” or periodically adjust portfolios to keep them in line with pre-set proportions in stocks and bonds, control more than $5.5 trillion in assets, the Wall Street Journal recently found. And target-date funds, those retirement-saving portfolios that automatically scale back their stockholdings as investors age, held $998 billion in assets as of June 30, according to Morningstar. (…)
Such continuous, gradual selling may well have helped the market rise so smoothly and keep it (so far) from overheating. (…)
(…) Corporate earnings are on track to grow in double digits for the second quarter in a row. With that impressive performance, it is easy to forget that a year ago we were ending a stretch of four straight quarters of shrinking profits. The shift to profit growth will make further strong growth harder to achieve—it is much harder to grow fast when the last year’s quarter was good. Combined with the tight jobs market, which will inevitably raise costs and reduce profit margins, earnings growth will likely slow for the rest of the year.
The strong global economy has been a significant boost to the market. The basic reason is that companies in the S&P 500 get nearly 30% of their revenues from overseas. A weaker dollar, due in part to the slower growth, has further boosted profits. If higher rates in the U.S. boosts the dollar, profits will be under more pressure.
The International Monetary Fund sees global growth staying solid through the end of next year. What can go wrong? The China debt bubble could finally implode or Europe’s period of political calm could end, but one of the biggest risks is a slowdown in the U.S., which is long overdue for a recession. Declining Treasury yields are a signal that a slowdown could be coming. That, obviously, would hit the stock market and pull down global growth.
Central Bank stimulus is declining but slowly. The risks are that rising interest rates in the U.S. and the end of bond buying in Europe slow their respective economies. But neither bank will tighten in a slowing economy, and low inflation gives them cover to keep policy loose.
Geopolitics is impossible to predict. The problem now isn’t that there are more risks than usual but that investors are acting as if there are almost no risks. An upheaval involving any combination of Russia, Iran, Syria, North Korea or China might be just the thing to remind investors that the world, and the stock market, can be a dangerous place.
U.S. stocks have been the best performing asset class in the world for three years running, returning an average of nearly 16% annually. This year is on track to top 20%. To get here, lot of things have gone right and almost nothing wrong. That hardly ever lasts.
The shrinking profits of a year ago were essentially due to the collapse in oil prices. The “tight jobs market, which will inevitably raise costs and reduce profit margins” remains elusive…The strength in the dollar between 2014 and 2016 did not hurt margins…”one of the biggest risks is a slowdown in the U.S., which is long overdue for a recession”: the U.S. economy has been pretty slow for a while; recessions are generally induced by a hawkish Fed, not on the horizon for now.
(…) Yes, strange things can happen, and P/E ratios could have reached a sort of permanently elevated nirvana, but the ‘E’ might not oblige. Based on the recent pace of economic growth, inflation and stock buybacks, the market’s trailing P/E ratio would have to keep expanding for stock prices to rise 10% a year, reaching a level not seen outside of bubble peaks. Or one could hope for a boom in growth and profit margins, but then yields would rise and returns on the bond portfolio would suffer. (…)
From Jeremy Grantham’s most recent piece: GMO’s updated model suggests equities are not overvalued:
We might reasonably conclude from this finding that any large and more or less permanent decline in the market (i.e., to a new, lower trend, much more like the 1945 to 1995 period than today) would require an equally large deterioration in profit margins or increase in inflation or some combination. Without either, any large market decline would be very unusual historically and likely, I believe, to be temporary. I can conclude this point by offering my personal opinion for 2017 on the two most important factors: favorable for margins and unfavorable for inflation. If only life were easy! But, even if these guesses prove to be correct, this mixed signal does not suggest a major decline or perhaps any decline.
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Hot-Stock Rally Tests the Patience of Value Investors Value investing is mired in one of its worst stretches on record, prompting concerns that the investment style favored by generations of fund managers is losing its effectiveness.
(…) In the U.S., the Russell 1000 Growth Index outperformed its value stock counterpart by 10 percentage points in the first half, the widest spread over that period since 2009. Over the past decade, the performance of U.S. growth stocks has been almost three times better than that of value stocks, contributing to what index fund giant State Street Global Advisors calls “the longest period of underperformance for value since the late 1940s.” (…)
Investors have pulled $116 billion from U.S. large-cap value funds over the past 10 years, according to Morningstar, with more than one-fourth of that outflow occurring over the past 12 months.
(…) From the Great Depression to the U.S. tech bubble to the global financial crisis, the notion that a new paradigm would replace value investing has repeatedly occurred. Those predictions have almost always ended poorly. (…) Historically, calling the end of value investing has been a fraught exercise. (…)
(…) Market breadth, a measure of how many stocks are rising versus the number that are dropping, has turned “exceedingly negative,” according to Brad Lamensdorf, a portfolio manager at Ranger Alternative Management. (…)
“As the indexes continue to produce a series of higher highs, subsurface conditions are painting an entirely different picture,” Lamensdorf wrote in the latest edition of the newsletter. He noted that the year-to-date advance in equities — the S&P 500SPX, +0.19% is up 10.6% in 2017 — has been driven by outsize gains in some of the market’s biggest names. (…)
“The good performance of these large companies is masking the fact that many stocks, including REITs and those in the retail sector, have already entered bear-market territory,” Lamensdorf wrote, referring to real estate investment trusts.
According to an analysis of FactSet data, 79 components of the S&P 500 are trading at least 20% below their 52-week high; a bear market is typically defined as a 20% drop from a peak. However, more than half the components are in what could be deemed bull market territory — at least 20% above their 52-week low. (…)
Lowry’s Research monitors market breadth breaking it down between small, mid and large caps. History shows that breadth first narrows among small caps before gradually impacting larger caps. The percentage of small caps down 20% or more is virtually unchanged over the past five months, “whereas this percentage begins to rise as much as a year before a market top, even while the major price indexes keep climbing. Thus, the increasing weakness that characterizes a bull market approaching its final phases has not yet begun.”
Lowry’s does a similar analysis using advance-decline lines for each market segment and says that “all the segmented Adv-Dec Lines, both S&P and OCO, confirmed the recent bull market highs in their corresponding price indexes. Thus, the process of deteriorating breadth that eventually results in divergences between the broad-based Adv-Dec Lines – principally Lowry’s OCO Adv-Dec Line – and the major price indexes, remains in the future.”
Lamensdorf also cited a measure that compares market volume on advancing days to volume on days when the major indexes decline. This is a volatile metric, one that has both spikes and pronounced dips. However, since mid-2016, the spikes have topped out at progressively smaller highs. “This situation has occurred while the indexes have simultaneously hit higher highs; a classic negative divergence illustrating that large institutional sponsorship has not been following the indexes,” he wrote.
Lowry’s says that “there is little evidence of the expanding Supply that typically persists for months prior to a major market top. And, as discussed above, measures of market breadth and selectivity remain positive. Thus, a pullback in the days or weeks ahead should represent only a pause in an ongoing primary uptrend and, as such, eventually a buying opportunity.”
Separately, a read on market supply and demand from Ned Davis Research has shown weakening demand for stocks, despite major indexes continuing to grind higher, while the supply metric has started to rise. Rising supply and lower demand could indicate waning enthusiasm for equities at current levels.
Lowry’s also notes recent serious short term selectivity and acknowledges that broader market Demand has been weakening over the last two weeks and that an internal pullback is developing despite the mega cap DJIA at new highs and the large cap S&P 500 very near them.
There have been other signs of worsening technicals. Currently, 60.4% of S&P 500 components are above their 50-day moving average, considered a positive sign for short-term momentum. In mid-July, nearly 75% were, according to StockCharts. For the Nasdaq Composite Index COMP, +0.18% only 47.3% of components are above their 50-day, compared with 67% in late July, a dramatic swing lower.
Recently, nearly 6% of New York Stock Exchange- and Nasdaq-listed securities hit a 52-week low on a day when the S&P 500 ended at a record, according to data from Sentimentrader that was cited by Lamensdorf, who called this “an alarming percentage.”
He added that it was the second-highest level going back as far as 1965, and that “Similar spikes occurred in 1973 and 1999, both directly preceding significant corrections.”
From Bespoke:
The first chart below shows the average percentage that stocks in the S&P 500 (large cap), S&P 400 (mid cap), and S&P 600 (small cap) are trading from their respective 52-week highs. In the S&P 500, the average stock is trading down 10.2% from its 52-week highs, while in the small cap S&P 600, the average stock is down 19.8%. Overall, stocks in the S&P 1500 are down an average of 15.2% from their one-year highs. It is common for small cap stocks to be trading further from their 52-week highs than large caps, but we would be the first to admit that an average decline of 19.8% is pretty high. That’s close to bear market territory for the average small cap stock! In fact, of the 600 stocks in the S&P 600 Small Cap Index, 37% (223) are down more than 20% from their 52-week highs. The average decline of 10.2% in the S&P 500, however, is actually pretty normal for an environment like the present. (…)
The final chart below breaks out the average decline from 52-week highs by sector and market cap. Here you can see how the weakness in the Energy sector is really confined to its mid and small cap stocks. While the average large cap Energy sector stock is down 24% from its 52-week high, mid cap stocks in the sector are down an average of 40.1%, and small cap stocks are down 46%! (…) In terms of segments holding up the best, all three market cap ranges of the Utility sector are currently within 5% of their respective 52-week highs. Outside of Utilities, the only other segment that is within 5% of a 52-week high is Financials.
New Chief of Staff Reins in White House Aides-and Trump’s Tweets
Senate Confirms Slew of Trump Administration Nominees The Senate cleared the way for dozens of Trump administration nominees across the government to take office, allowing the administration to round out its top staff and regulatory commissions.
Fewer S&P 500 Companies Discussing “Trump” on Earnings Calls for Q2
