Inflation Is Eating Away Worker Wage Gains U.S. consumer prices rose for a third straight month in June, eating away at sluggish wage growth and sending inflation to its highest rate in more than six years.
(…) In June, for a second month in a row, annual inflation fully offset average hourly wage growth over the previous year. That left workers’ real hourly earnings flat over the 12-month period despite falling unemployment and a strong economy even as workers made up for higher prices by clocking slightly more hours a week in June.
Production and nonsupervisory employees, a category which includes blue-collar workers, saw their real average hourly wages fall 0.2% in June from a year earlier after a similar slip in May. (…)
Shelter and rent costs, which account for about a third of overall consumer spending, rose 0.1% in June from May and were up 3.4% from a year earlier. Prices for medical-care services rose 0.5% from May and 2.5% from June 2017. And food prices rose 0.2% last month from May, though the annual increase in this category was more muted at 1.4%. (…)
A separate inflation measure favored by the Federal Reserve, the personal-consumption expenditures price index, showed consumer prices rose 2.3% in May from a year earlier, and core prices rose 2%. (…)
Ian Shepherdson, chief economist at Pantheon Macroeconomics, said the Chinese goods subject to the newly proposed tariffs account for almost 6% of the core CPI, meaning that a 10% levy would lift the index by up to 0.6 percentage point. (…)
According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.8% annualized rate) in June. The 16% trimmed-mean Consumer Price Index also rose 0.2% (2.7% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.
Over the last 12 months, the median CPI rose 2.8%, the trimmed-mean CPI rose 2.2%, the CPI rose 2.9%, and the CPI less food and energy rose 2.3%
I think we can settle for 2.4% current inflation with an upward bias.
The UIG measures currently estimate trend CPI inflation to be approximately in the 2.3% to 3.3% range. Since January, there has been a notable pickup in the twelve-month change in the CPI from 2.1% to 2.9%, with this series now moving closer to the UIG “full data set” measure.
Bespoke plots the correlation between the UIG and median CPI:
For the Rule of 20 P/E, being a proxy for interest rates, I use the YoY change in core CPI which rose from 1.7% in November to 2.3% in June. I have been saying that equity markets are now in a race between growth of earnings and growth of inflation. Trailing earnings, pro forma the tax reform, have risen 17.8% since the end of November 2017. Meanwhile core inflation is up 35%, shrinking the fair P/E from 18.3 to its current 17.7 (20 – 2.3). The Rule of 20 P/E , which was 22.1 at the end of November, peaked at 23.5 in January and retreated to 20.8 at present.
Full year 2018 EPS are forecast at $161.18 per Thomson Reuters, up 6.7% from current trailing earnings. Using this estimate, the Rule of 20 P/E declines to 19.6. This slight undervaluation would disappear if inflation reaches 2.7%. Note that total inflation is now 2.9%, core PPI is +2.8%, Processed Goods PPI is +6.8% and Services PPI is +2.8%.The impending trade war would most likely take us over 3.0% very quickly. If so, fair P/E would drop below 17.0
Current forecasts show 2019 EPS up 9.9%.
All this to say that absent meaningful earnings surprises, the stage appears set for a more or less sideways market, unless the trade issues get resolved.
Cass Truckload Linehaul Index
June’s Cass Truckload Linehaul Index continued the increasing rate of acceleration that began in 2017 by posting an 9.5% YoY increase to 134.7, the largest YoY percentage increase in this index to date (the base year is 2005). (…) the Cass Truckload Linehaul Index has not only been positive now for 15 consecutive months, but the strength is continuing to accelerate. “We are increasing our realized contract pricing forecast for 2018 from a range of 6% to 8% to a range of 6% to 12%, and current data is clearly signaling that the risk to our estimate may be to the upside,” stated Donald Broughton, analyst and commentator for the Cass indexes.
The latest data point shows total intermodal pricing (all-in intermodal costs) rose 10.9% YoY in June to 136.7, the largest YoY increase since August 2011. June marked the twenty-first consecutive month of increases, and brings the three-month moving average up to 8.8% YoY. (…)
Fed Chair Jerome Powell Says Trade Policies Complicate Outlook Federal Reserve Chairman Jerome Powell said a strong economy will allow the central bank to keep raising interest rates gradually and said it was too soon to judge how recent trade policy actions could influence the central bank’s policies.
(…) In his most direct comments on the issue to date, Mr. Powell highlighted a worse-case scenario, of sorts, for the Fed. “You can imagine situations which would be very challenging, where inflation is going up and the economy is weakening,” he said. (…)
Trade Tensions Help BMW Enter China’s Fast Lane German company could become the first foreign car maker to majority own its operations in China.
Chinese Premier Li Keqiang this week said it could become the first foreign company to be allowed majority control of an auto-sector joint venture in China. (…)
Auto manufacturers are quick to learn that it is best to produce where you sell. Since China is, and will be for a long time, the biggest car market in the world, that is where new plants will likely go.
German auto makers Daimler, BMW, and Volkswagen operate four manufacturing plants in the U.S. that employ 36,500 American workers. Last year, the German auto makers produced 804,200 vehicles at those plants, but less than half were sold in the U.S. The rest, around 480,911 vehicles, were exported to Canada, Mexico, Europe, China and other markets. (WSJ)
RECESSION WATCH
Fidelity Investment:
Global Activity Past Its Peak
- The global expansion is becoming less synchronized, with the pace of overall activity likely past its peak.
- China’s economy remains in an expansionary phase, but the industrial sector has slowed materially and the risks of a growth recession continue to rise. Policymakers may have begun to ease monetary conditions, but overall activity is in a decelerating trend.
- Countries most impacted by slowing China industrial activity—including Germany, Japan, and South Korea—have experienced deceleration in recent months.
- Overall, the global expansion continues, but maturing cycles among many larger economies imply that the risks of a growth slowdown may be higher than generally appreciated.
Gavekal Research:
The Recession Of 2019
(…) My reasoning is simple, and is based on the behavior of an indicator I have long followed, which I call the World Monetary Base, or WMB. Every time in the past that this monetary aggregate has shown a year-on-year decline in real terms, a recession has followed, often accompanied by a flock of “black swans”. And since the end of March, the WMB has again been in negative territory in year-on-year terms (see the chart below). As a result, and as I shall explain, there is a significant risk of a recession next year.
(…) based on the experience of the past 45 years, it seems likely that the world is entering its seventh international dollar liquidity crisis since 1973.
- Already the usual suspects—Argentina, Brazil, Turkey, South Africa—are having a tough time. And the times are likely to get even tougher for those countries which have external debts in US dollars coupled with a current account deficit.
- Already, the US stock market is outperforming all other major stock markets (most of which are actually going down)—a sure sign that the world is starting to suffer from a shortage of US dollars.
- Already the spreads between the US bond market and a number of government bond markets outside the US have started to widen. This is a sign that countries outside the US have started to raise interest rates in an attempt to stabilize their exchange rates. Unfortunately, the attempt is destined to fail, if, as I believe, the problem is not an overabundance of local currencies but a shortage of US dollars.
Charles Gave goes on detailing the events:
The first effect to watch out for is a contraction in international trade as a consequence of the US dollar shortage. Based on recent PMI surveys, new export orders are contracting just about everywhere but the USA.- Commodity prices are rolling over.
- Equity markets in China and in many emerging markets are correcting seriously.
- World bank shares are underperforming, if not correcting outright.
- The USD keeps rising.
William Blair:
Are Widening Risk Spreads a Warning Signal?
The first six months of 2018 offered a rare set of events for the fixed-income markets: interest rates rose and risk spreads for corporate bonds rose.
While this combination of events is not unprecedented, credit spreads widened during the first half of 2018 by a magnitude not experienced during a period of simultaneously increasing interest rates in more than 25 years.
Traditionally, an environment marked by increasing risk spreads on corporate bonds is a warning sign of broader market deterioration. (…)
[But] we do not believe this phenomenon was driven by deteriorating fundamentals or liquidity conditions. We believe these prevailing conditions have been driven by technical forces impacting the market.
Rather, we believe that corporate bond market participants are demanding higher risk premiums for lending their money longer term—but this same dynamic does not appear in the Treasury market due to the FOMC’s ongoing purchases of agency MBS and Treasury securities across the yield curve.
We believe that the corporate bond market has become increasingly attractive in this environment, as yields and risk spreads have increased to better compensate investors for the risks assumed, while the Treasury market could be prone to a repricing similar to what the corporate bond market experienced if and when the FOMC reduces the size and scope of their security purchase program.
But that is not about to begin any time soon…Quite the opposite, in fact.
For balance,
Byron Wien: No Recession in Sight
We believe that the current business cycle has at least several more years left to run. The major signs that would herald the beginning of the next recession are not yet in place. Unemployment is low and likely to decline further; wages are rising, but not sharply; the Federal Reserve is tightening, but real interest rates are zero; inflation is moving higher slowly; the yield curve is not inverted; profits are increasing; and the leading indicators are still rising. Until some of these indicators change, the expansion is likely to continue. (…)
Blackstone:
(…) Analysts may be fundamentally underestimating the risk of a trade dispute in global markets. (…)
The beginning of the beginning In 1930, the Smoot-Hawley tariffs started with a modest list of approximately 800 products, but by the time it was rolled back in 1934, tariffs covered 20,000 imported items. Beginning as an effort to protect sugar from Cuban imports and other agriculture in the 1920s, restrictions grew exponentially to cover just about everything that moved. Global trade ground to a halt, decreasing by nearly two thirds between 1929 and 1934.1 US imports decreased 66% from $4.4 billion (1929) to $1.5 billion (1933), and exports decreased 61% from $5.4 billion to $2.1 billion.
And the world learned a painful lesson For the next 85 years tariff rates decreased, trade deals were reached and the world became smaller.
We are of the view that a full trade war will be avoided If the tariffs are a negotiating tool, then we should at least be prepared for higher inflation and slower growth. But if the tariffs are related to the wave of populism – with countries increasingly turning inward – then something much worse may be staring us in the face, with profound long-term implications.
Let’s enjoy the summer months. We shall know by the end of August if “The art of the Deal” worked or tanked us all.
Looking beyond the obvious harm of a trade war, the impact of President Trump’s confrontational approach may be to broaden and further liberalize global trade. Firstly, as with the metals tariffs, the President quickly shifts from stick to carrot and begins a negotiation process that delays and dilutes the negative impact. Secondly, in reaction to a more antagonistic U.S., other nations are incentivized to strike trade deals with each other to increase their bargaining power. President Xi of China recently called on fellow WTO members “to lock arms with China in fighting against the U.S. blatant protectionist acts.” In the meantime, he is signing bilateral trade pacts with Africa, Latin America, Europe and the ASEAN countries. We are hopeful that this trade “skirmish” produces not a full-fledged trade war, but a more durable trade “peace.” (Legg Mason Global Asset Management)
For a different angle:
The New Tariff of Abominations?
William Poole was a member of President’s Reagan’s Council of Economic Advisers 1982-85. He retired as President and CEO of the Federal Reserve Bank of St. Louis in March 2008.
China’s Effort to Control Debt Loses Steam Trade fight with U.S. and slowing growth make keeping a lid on lending less of a priority
Senior Chinese leaders led by President Xi Jinping have been sending unmistakable signals that the campaign to rein in financial risk isn’t the overriding priority it has been. Financial regulators are delaying the release of rules to curtail risky lending by banks and other institutions out of concern that the regulations would choke off a source of funding and rattle financial markets already shaken by worries over trade and the economy, people familiar with the decision said.
In a turnabout, the State Council, China’s cabinet, stopped hectoring city halls and townships to restrain spending and instead last week launched an inspection to urge them to speed up already approved investment projects to re-energize growth. The central government often uses inspections as a way to evaluate local officials and get top-level directives across.
An April meeting of the Politburo, the inner sanctum of power, offered an initial sign of the shift in government priorities toward growth. Mr. Xi, who presided over the meeting, called for expanding domestic demand as authorities continued to contain financial risks. Such pro-growth emphasis had been absent in Politburo meetings since 2015. (…)
The central bank in April began freeing up more funds for banks to make loans. The Chinese leadership is expected to further loosen China’s fiscal and monetary stance at a meeting later this month of the Politburo, government advisers and economists said. (…)
Russia Says OPEC+ Could Boost Oil Supply More Than Pledged
(…) “I can’t rule out that if there is a need for more than 1 million barrels we will be able to quickly discuss it all together and make all necessary decisions,” Novak told reporters in Moscow on Friday. The producers have “all needed tools,” if necessary, he said. (…)
Russia, which pledged to raise its oil production by 200,000 barrels a day, has been quick to meet the target. The country has added back nearly 80 percent of earlier 300,000 barrels cut so far in July, Novak said. The country would be fully in line with last month’s decision by the end of July, he said.
EARNINGS WATCH
Valmont Says Proposed U.S. Tariffs, Brazil Truckers’ Strike Impacting Customers Manufacturer lowers targets after evaluating proposed U.S. tariffs on Chinese goods
Manufacturer Valmont Industries Inc. VMI -8.92% has lowered its profit outlook after evaluating the possible impact of U.S. tariffs on Chinese goods, a recent trucker strike in Brazil and challenges in China’s construction market.
Omaha, Neb.-based Valmont, which manufactures such products as metal light poles and irrigation equipment and supplies metal coatings, said Thursday that the latest round of proposed tariffs, combined with weakness in farm income, have caused farmers in North America to delay irrigation purchases.
Shares in Valmont fell 8.9% to $138.30 on Thursday, marking a third consecutive daily decline. (…)
Valmont lowered its estimate for annual revenue growth to 4% from 7%; analysts polled by FactSet expected 4.6% growth. The company generated $2.75 billion of revenue in its last fiscal year.
The company also lowered its full-year per-share earnings forecast to a range of $6.51 to $6.61, down from $7.70 to $7.80. Expectations for adjusted per-share earnings were lowered to a range of $7.55 to $7.65, from $8 to $8.10. Analysts polled by FactSet expected $8.01 a share.
Hmmm…