Soft Underlying Price Pressures Reaffirm Fed’s Patient Posture U.S. consumer prices rose a lower-than-expected 0.3% in April, though new tariffs complicate the outlook
Excluding the volatile food and energy categories, so-called core prices rose by a milder 0.1%, the same pace as in March and February. (…) In the 12 months through April, overall prices rose 2%, the first time year-over-year inflation has hit the 2% mark since November. Core prices were up 2.1% on the year.
Shelter costs, which make up about 40% of the core consumer-price index, rose 0.4% for the second month in a row in April. That helped push core inflation slightly higher despite steep declines in categories like clothing and used vehicles. (…)
A report by the Federal Reserve Bank of San Francisco earlier this year estimated that an across-the-board 25% tariff on all Chinese imports would raise consumer prices an additional 0.3 percentage point, on top of the 0.1 percentage-point boost from tariffs implemented thus far. (…)
Here’s the Cleveland Fed’s Median CPI table to highlight various inflation trends: the Median CPI has consistently risen 0.2-0.3% MoM and is now up 2.8% YoY. Same monthly consistency for the 16% Trimmed-Mean CPI, up 2.3% YoY. The core CPI has slowed MoM from +0.22% (+2.6% annualized) between November 2018 and January 2019 to +0.13% in the last 3 months (+1.2%) but is still up 2.1% YoY. If it continues on its 0.1% MoM cruise, core CPI will soon sink well below 2.0% YoY.
Another dichotomy is in trends between core CPI and the core PCE deflator. Since June 2014, core CPI is up 10.0% while the core PCE deflator is only up 7.5%.
There are many reasons explaining the different inflation gauges, the main one being that the CPI measures out-of-pocket consumer expenditures on a fixed basket while the PCE includes indirect costs on goods and services taking into account substitution effects.
Since June 2014, average hourly earnings in the private sector rose 13.4%. Deflated by the the core PCE: +5.9% or +1.2% per year in real terms over 5 years. Deflated by the core CPI, the average annual gain shrinks to +0.7%.
Another dichotomy: core goods are deflating at an accelerating pace while core services are inflating at an accelerating pace as this Haver Analytics table shows:
Shelter costs spiked in recent months but labor-intensive services are directly impacted by rising labor costs. Goods industries are increasingly fighting against rising labor costs and declining selling prices, slowing top line growth while operating expenses keep rising. Imagine the effect on margins and profits if real demand were to decline as well, something the White House staff should educate the President on. Don’t take this economy for granted.
David Dollar, Senior Fellow, John L. Thornton China Center:
(…) President Trump said this week that “tariffs are an excellent alternative to a trade deal,” implying that escalating tariffs would be as good for the U.S. economy as a deal. Hopefully this is just a negotiating ploy, because it certainly is not true. Tariffs are paid by the American firms that import from China, not by the Chinese exporters. In theory, there are cases where the exporter – China in this case – responds by lowering prices, which would be a gain for Americans. Recent studies find that this is NOT happening in this case – Chinese export prices have not gone down. And the full cost of tariffs is being passed on to American consumers.
Keep in mind that this is the objective of protection: to raise prices of goods so that producing in America becomes more profitable. A good recent study of the 25 percent tariff on washing machine shows how this works. The full cost of the tariffs was passed on to households who had to pay more for washing machines. This made U.S. producers more profitable and they added 1,800 jobs. However, the extra cost to consumers was 1.5 billion dollars – I’ll do the math for you, that’s more than 800,000 dollars per job.
You may be surprised at the price tag, but economists are not. A study by Gary Hufbauer at the Peterson Institute looked at 26 previous cases of import tariffs and found that on average it costs 500,000 dollars per year to protect one job through protection. To come back to washing machine case: The extra $1.5 billion paid by consumers means that they cannot buy other things. They go to fewer restaurant meals, buy fewer automobiles, maybe cut back on healthcare – and so what happens is jobs are lost in other sectors of the economy. Careful research generally establishes that the jobs lost are many times greater than the jobs that are gained in protected sectors. (…)
Miscalculations and Miscues Mar U.S.-China Trade Talks The U.S. and Chinese governments both sent signals ahead of their trade talks last week that a pact was so near they would discuss the logistics of a signing ceremony. In a matter of days, the dynamic shifted dramatically.
(…) On Sunday, White House economics adviser Larry Kudlow said in an interview on “Fox News Sunday” that China has invited Messrs. Lighthizer and Mnuchin to Beijing to continue trade negotiations, but that there were “no concrete, definite plans yet.”
Mr. Kudlow suggested one possible way out. He stressed twice during the Fox News interview that the American and Chinese presidents expect to meet again at the next G-20 in Japan at the end of June. (…)
With a deal now in limbo, with no formal plan to resume, the key to future developments may be in the hands of Mr. Trump and Mr. Xi. Each of the leaders has emphasized their personal rapport through the dispute. Mr. Xi sent Mr. Trump a letter as last week’s talks began, saying, according to Mr. Trump, “Let’s work together, let’s see if we can get something done.”
Mr. Trump after the talks ended Friday said on Twitter: “The relationship between President Xi and myself remains a very strong one, and conversations into the future will continue.” He added tariffs “may or may not be removed depending on what happens with respect to future negotiations!”
“At this point, it seems that the only way to break the impasse is through direct dialogue between the two leaders,” said one Beijing official. (…)
China Names Its Trade-Deal Price as Trump Sets Month Deadline
In a wide-ranging interview with Chinese media after talks in Washington ended Friday, Vice Premier Liu He said that in order to reach an agreement the U.S. must remove all extra tariffs, set targets for Chinese purchases of goods in line with real demand, and ensure that the text of the deal is “balanced” to ensure the “dignity” of both nations. (…) “For the interest of the people of China, the people of U.S. and the the people of the whole world, we will deal with this rationally,’ the vice premier said. “But China is not afraid, nor are the Chinese people,” adding that “China needs a cooperative agreement with equality and dignity.” (…)
Liu argued that the U.S. team is pushing for bigger Chinese purchases to level the trade imbalance than had originally been agreed. According to Liu, Presidents Xi Jinping and Donald Trump had achieved an initial consensus “on a number” when they met in Argentina. That “is a very serious issue and can’t be changed easily.” (…)
- On the first point, the WSJ today has this quote: ““There is a real desire on our end to keep the tariffs on,” one White House official said. “That is a sticking point.”
- And Trump needs “a number” he can proudly wave at his base.
- And Xi needs “a balanced text” for his own base.
This morning:
“At no time will China forfeit the country’s respect, and no one should expect China to swallow bitter fruit that harms its core interests,” China’s top newspaper, the ruling Communist Party’s official People’s Daily, said in a commentary.
State television said in a separate commentary that the effect on the Chinese economy from the U.S. tariffs was “totally controllable”.
“It’s no big deal. China is bound to turn crisis to opportunity and use this to test its abilities, to make the country even stronger.” (…) (Reuters)
With Trade Deal in Jeopardy, Trump Pledges Aid to Farmers With a U.S.-China trade deal in danger of collapse, the Trump administration said it will begin work on a new program to provide aid to farmers, signaling to Beijing that Washington is preparing for a prolonged conflict.
(…) Agriculture Secretary Sonny Perdue confirmed on Twitter that a new aid program is under way. Mr. Perdue tweeted that he spoke via phone Friday with Mr. Trump who “directed [the U.S. Department of Agriculture] to work on a plan quickly.” (…)
Many farmers said at the time that the payments were insufficient to offset the losses that were occurring from the decline in trade. Even with the program in place last year, net farm income fell over 16% in 2018 and has been hovering near levels last seen during the recession of a decade ago. (…)
Trump country vs tariffs (from recent peak):
- Soybean prices: –20% (but 3-30% from 2016 high and –55% from all-time high)
- Grain prices: –26%
- Cattle prices: –14%
Meanwhile, tariffs on steel are having this other effect:
Car sales are weak almost everywhere:
China Car Sales Tank 16.6% In April, Falling For A Record 11 Months In A Row
Sales for the world’s largest auto market continue to deteriorate, with the latest report confirming that passenger vehicle sales in China tanked yet again – this time dropping 16.6% year-over-year to 1.54 million units, following a 12% decline in March and an 18.5% slide in February. In addition, April SUV sales fell 14.7% to 642,220 units.
Despite the market contracting, names like Volkswagen, Honda and Toyota all gained ground. Ford Motor Co. and General Motors Co.’s Wuling and Baojun brands both fell in April, according to LMC Automotive. Ford reported a 54% sales plunge in China last year and said last week that it’s introducing more than 30 vehicles targeted specifically for Chinese consumers over the next three years to help it hone its focus on the market. (…)
Do you think Chinese consumers are currently attracted by American brands? (BTW, China is the fastest growing market in the world).
Too leveraged to tighten, the Canadian version (IN GODS WE TRUST):
(…) In a speech in Winnipeg this week, Mr. Poloz waded pretty deeply into the housing weeds, including in areas that are beyond the purview of the country’s central bank. His call for innovations in Canada’s mortgage market – pushing ideas such as longer durations and shared-equity mortgages – prompted a fair bit of head-scratching in the banking sector, which had no idea Mr. Poloz was so eager to express such opinions about a business that the central bank does not regulate. Some wondered if there was a subtle shift in monetary policy hidden in the message somewhere.
(…) Two weeks ago (…) Mr. Poloz noted that housing was the most dominant issue in the rate deliberations of the policy-setting Governing Council. The bank also released a research paper breaking down the contributing factors to the decline in housing resales over the past three years. In a news conference at the time, Mr. Poloz even invited reporters to ask him to talk more about the bank’s latest views on housing – but no one in the room took him up on it. He picked up on the theme again at his next speaking opportunity, in Winnipeg this week.
If there’s one message to take away from all this, it’s that the Bank of Canada wants the country and the world to know that it’s keenly aware of the potential risks posed by the housing market to the country’s economic outlook and its financial stability.
(…) it’s unavoidable that rate changes will affect housing activity, and, by extension, the debt associated with housing. That has spillovers for consumer spending, home construction and the businesses of the lenders to whom consumers are indebted – all issues to which the central bank, in its role as guardian of a healthy economy and a stable financial system, must remain sensitive.
To understand Mr. Poloz’s publicly heightened attention to the sector is to understand his sensitivity to risks to economic and financial stability from the complex adjustment housing markets are undergoing – and, critically, from the record levels of mortgage debt. Risk management is at the root of everything Mr. Poloz does on the job, and he has been saying, for years, that housing-market imbalances and elevated household debt are the bank’s biggest risks. (…)
(…) Employment rose by 106,500 in April, Statistics Canada said, the biggest one-month increase in data going back to 1976. Canada has added 426,400 jobs over the past year and 700,000 jobs in two years. (…)
The volatility in Canada’s employment numbers is very special, like if employers are doing stop and go since mid-2018. Did Canada really create the equivalent of 1.1 million U.S. jobs in April?
Builders started work on an annualized 235,460 units last month, the highest level in 10 months and up 23 percent from 191,981 units in March, the Canada Mortgage and Housing Corp. reported Wednesday. The gain was driven by new multi-unit construction in Toronto and Vancouver. (…)
Multiple-unit urban starts were up 30 percent to an annualized 175,732 units, while single-detached starts in urban centers were up 6 percent, CMHC said in its release. Vancouver recorded a 63 percent increase last month, while new home starts in Toronto were up 18 percent.
Builders also had been holding back construction earlier this year because of excessively cold weather. New home starts slumped to 166,290 units in February — the lowest monthly level in three years — as chilly weather slowed construction.
EARNINGS WATCH
From Refinitiv/IBES:
- Through May 10, 448 companies in the S&P 500 Index have reported earnings for Q1 2019. Of these companies, 75.4% reported earnings above analyst expectations and 18.1% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 21% miss estimates. Over the past four quarters, 76% of companies beat the estimates and 17% missed estimates.
- In aggregate, companies are reporting earnings that are 6.1% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.2% and the average surprise factor over the prior four quarters of 5.4%.
- In aggregate, companies are reporting revenues that are 0.9% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 1.1%.
- First quarter earnings are expected to increase 1.3% from 18Q1 (was +0.9% May 3rd). Excluding the energy sector, the earnings growth estimate is 2.7% (+2.3% May 3rd). 19Q1 revenue is expected to increase 5.6% from 18Q1. Excluding the energy sector, the growth estimate is 6.2%.
- Trailing EPS are now $163.75.
Given the big surprise factor in Q1 earnings, analysts have been busy upping their estimates, but only for Q1. The estimated earnings growth rate for 19Q2 is 1.2% (+1.6% May 3rd). If the energy sector is excluded, the growth rate improves to 1.3% (+1.6% May 3rd). Smaller caps are not seeing as much upward revisions.
Corporate pre-announcements for Q2 have improved last week and are now comparable with Q1’19. Note that the 25-year N/P ratio averaged 2.7.
The earnings angst is likely to stay for a while given low inflation, particularly on goods, rising labor costs and the tariffs war. The Q1 decline in overall margins is set to continue throughout the year. Trump’s threat of 25% tariffs on all Chinese imports would certainly negatively impact margins and/or revenues, likely both and, if enacted, would seriously shake investors confidence on profits.
Factset calculates that profits of S&P 500 companies with more than 50% of their revenues from international markets sank 12.8% in Q1 (slow economies, strong USD). But while the more domestic companies recorded a 6.2% gain in profits, their margins declined nonetheless. Based on Factset numbers, Real Estate and Utilities were the only sectors to improve margins in Q1 while 7 sectors experienced declines.
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Factories Tire of Wage Wars, Offer Workers Better Amenities Companies are shaking up shift schedules and investing in better amenities to compete for blue-collar workers.
Five years ago, entry-level candidates could expect to earn nine bucks an hour at a Haworth Inc. office-furniture factory. (…) Things changed, though, as average unemployment in the counties where Haworth makes products like movable walls, desk chairs and storage cabinets tumbled from 6.3% in 2014 to 3.6% last year. Today’s newcomer makes $12.50 an hour. (…) Haworth’s revenue grows at about a 5% annual clip, trailing the approximately 8% in entry-level increases it has been dishing out.
The wage wars aren’t going away. As we chatted, a construction company offered jobs paying $13.50 an hour, a $500 signing bonus, benefits and a car to drive materials around the Grand Rapids area. A farm in nearby Zeeland offered $14 an hour to load turkeys into cages during the overnight shift. (…)
Haworth has been experimenting with friendlier shifts, Ms. Harten said, as a way to attract workers as unemployment sank. (…) Haworth’s scheme includes 20 different shift patterns and a variety of pay variations, adding complexity when most firms seek simplicity. (…)
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Small Businesses Are Squeezed by Tight Labor Market Job growth at the smallest businesses has fallen to the lowest levels in nearly eight years as tiny companies struggle to attract and retain workers in the tightest U.S. job market in half a century.
These are examples of the growing challenges facing most North American companies trying to keep labor costs under control while scrambling with their supply chains.
Certainly not an environment conducive for higher earnings multiples.
Speaking of sentiment:
Uber’s IPO Slips in Weak Debut Uber skidded into the public markets, falling 7.6% below the ride-hailing giant’s already conservative offering price in a bleak debut for the nation’s most valuable startup.
TECHNICALS WATCH
Lowry’s Research remains positive arguing that the dominant market trends are up. Personally, I do not like the converging trends in Lowry’s Buying Power and Selling Pressure indices. While Buying Power still dominates Selling Pressure, the narrowing gap looks ominously similar to the where we were in early October 2018
