OCTOBER 2018 CPI
Released this morning:
- Core CPI up 0.2% in October and 2.1% YoY but is +1.2% annualized in the last 3 months. Good, especially given oil’s recent drop which will bring fuel and gasoline prices sharply lower during the important holidays period.
- Core Services prices are not accelerating, indicating no major cost push from wages just yet.
- Food prices have been weak all year and declined some more in recent months.
- Consumer discretionary income will be strong during Q4 and early 2019.
More Signs of Trouble in China’s Auto Market In another sign of China’s deteriorating auto market, sales of Geely cars here declined in October, ending a hot streak of 46 straight months of year-over-year growth as U.S.-China trade tensions drag down the world’s biggest car market.
Geely is the main domestic brand of Zhejiang Geely Holding Group Co., which owns Volvo Cars. It has been on a roll for the past four years, with sales tripling between 2014 and 2017, to 1.24 million. Geely is now the second-best-selling car brand in China, after VolkswagenAG’s VW brand, with a 6% market share, according to auto intelligence company LMC Automotive.
But a 10% year-over-year sales decline last month showed that not even Geely can defy gravity in a sinking market. Passenger-car sales in China have fallen for the past four months year-over-year, and are on course to notch up an annual decline for the first time in nearly three decades.
Most auto makers, foreign and domestic, are struggling. Ford Motor Co.’s passenger-car sales in China were down 45% in the first nine months of the year, while sales of the Fiat Chrysler Automobiles NV-owned Jeep fell 35%, and General Motors Co.’s Buick sales were down 9%, according LMC Automotive.
Only the premium segment has seen consistent growth, with Cadillac sales up 30% in the first nine months of 2018, and the German trio ofAudi , BMW and Mercedes-Benz all growing by 10% to 13% over the same period.
Sales of Geely-brand cars were up 27% year-over-year in the January to September period before the slowdown finally bit last month. (…)
China Bet Its Economic Future on Consumers, and They Aren’t Spending Enough China’s economic slowdown spilled over to consumers and home buyers last month in a turn that economists said points to difficulties ahead, even as the government tries to bolster growth by boosting infrastructure investment.
(…) Retail sales rose 8.6% in October from a year earlier, slowing from a 9.2% on-year gain in September, and while automobiles have been slowing in recent months, a broader range of consumer products—such as stationary and jewelry—also slowed sharply. (…)
Housing sales rose 9% last month from a year earlier, compared with an 11% gain in September, a drop that some economists and analysts attributed to restrictions on purchases governments imposed over the past two years, when prices and sales were soaring. (…)
Value-added industrial output rose 5.9% in October from a year earlier, accelerating slightly from a 5.8% on-year increase in September. Mr. Zhang of UBS said some of that gain likely reflected a front-loading of orders. (…)
Investment in roads, buildings and other fixed assets, outside rural households, climbed 5.7% in the January-October period from a year earlier, Wednesday’s data showed. It was faster than the 5.4% increase recorded in the January-October period. Investment in railroads and other infrastructure projects, which dropped earlier in the year, rose 3.7% in the first 10 months, compared with 3.3% growth of the first nine months. (…)
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Reuter’s has a good piece on China’s economy
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China’s economic trends: tmsnrt.rs/2iO9Q6a
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China’s weak economic data herald more stimulus
Natural Disasters Take a Toll on Japan’s Economy Japan’s economy shrank slightly in the three months through September, owing largely to a typhoon and an earthquake, but economists said a return to growth is likely if trade friction doesn’t worsen.
The world’s third-largest economy contracted at an annualized pace of 1.2% in the third quarter of 2018, roughly in line with forecasts, after expanding at a 3% annual pace the previous quarter. (…)
Exports declined 1.8% from the previous quarter as heavy rains disrupted auto production. A powerful typhoon that hit Osaka and flooded its airport as well as an earthquake on the northern island of Hokkaido weighed on tourist spending.
Private consumption, which accounts for nearly 60% of gross domestic product, also declined slightly. Bad weather kept consumers at home, while increases in fresh-food and energy prices made them reluctant to spend elsewhere, economists said.
The Nikkei Japan Composite PMI rose sharply from 50.7 in September to 52.5 in October. “November PMI data will be important to assess whether the stronger monthly improvements in output and new business are knee-jerk reactions.”
Germany’s Economy Contracts for First Time in Years Economists say the economy isn’t in danger of slipping into a recession soon
Gross domestic product—the broadest measure of goods and services produced in an economy—fell 0.8% in annualized terms in the third quarter, data released Wednesday by the Federal Statistical Office showed.
That marks the first decline in Germany’s quarterly GDP since the first three months of 2015, when it fell by an annualized rate of 0.5%, and is well below the 3.5% rate registered in the U.S. during the third quarter. (…)
Economists said that bottlenecks in the approval of passenger cars in the wake of a new emissions-testing protocol hit automotive production. Exceptionally low Rhine water levels—the river is a major transportation route for oil and other goods—depressed activity further. (…)
Germany’s statistics body said that the decline in Germany’s GDP was largely caused by developments in foreign trade, as exports dropped and imports rose from the second quarter.
Export expectations in the manufacturing sector hit the lowest level in almost two years in October, according to a survey of about 2,300 manufacturers by the Ifo Institute, a supply-side economics think tank.
The German government and economic institutes have already trimmed their outlooks. The government’s council of economic experts now expects growth of just 1.6% this year, compared with 2.3% projected previously. For 2019, they predict growth of 1.5%. (…)
Markit’s PMI points to 1.5-2.0% growth in the near future:
The service sector followed manufacturing in recording a loss of momentum at the start of the fourth quarter, though the good news was that the slowdown in service sector business activity growth in October was less severe than signalled by the earlier flash PMI estimate.
In isolation, the latest numbers look generally positive: service providers reported rising inflows of new business thanks to a strong domestic market, helped by sustained strong employment growth, and on the whole they remained optimistic about the outlook. But given the deteriorating manufacturing performance, there is now greater onus on services to drive the economy, and the moderations in order book growth and business confidence show some worrying signs of vulnerability.
(…) But perhaps more fundamental to the longer-term inflationary picture is ongoing upward pressure on salaries and wages, which continue to be pushed higher by an improving job market.
OPEC, partners discuss oil supply cut of up to 1.4 million bpd: sources OPEC and its partners are discussing a proposal to cut oil output by up to 1.4 million barrels per day (bpd) for 2019, three sources familiar with the issue said, a larger reduction than previously thought to avert a price-sapping oversupply.
U.S. Budget Deficit Widened in October, Treasury Says The federal government started its new fiscal year much as it ended the last one—with spending up and revenues lagging behind the broader economy.
Panel Warns China Tech Prowess Threatens U.S. Report finds China’s dominance of networking-equipment manufacturing threatens 5G wireless infrastructure
In a new report, the U.S.-China Economic and Security Review Commission found Chinese dominance of networking-equipment manufacturing threatens the security of U.S. fifth-generation, or 5G, wireless infrastructure. The panel cited Chinese telecommunications giants Huawei Technologies Co. and ZTE Corp. in particular.
In addition, China’s position as the world’s largest manufacturer of internet-connected household devices creates “numerous points of vulnerability for intelligence collection, cyberattacks, industrial control, or censorship,” said the panel, which includes appointees by Senate and House leaders of both parties.
Beijing has denied interfering in U.S. affairs and says much of U.S. policy toward China is an inappropriate attempt to contain its rise.
While many policy makers historically considered the commission’s recommendations to be aggressive, they are increasingly being viewed as mainstream as U.S. officials’ attitudes toward Beijing harden. (…)
EARNINGS WATCH
With 454 companies in, the beat rate is 78% and the beat factor a record +6.6%:
The blended growth rate is now seen at 28.0% (24.6% ex-Energy), from 21.6% on Oct.1. Q4 estimates are at 17.8%, from 20.1% on Oct. 1 while full year 2019 earnings are expected to rise 8.8% (10.2%).
Today’s CPI continued the decline in inflation since the summer which should help equity valuations and interest rates.
Amid these exceptionally strong S&P 500 earnings, investors are scrutinizing the future in search of signs of earnings peaks. It won’t find it in Q4’18 but as we move into 2019, growth becomes much slower past the tax reform.Analysts are now seeing Q1’19 earnings up 7.4% and full year 2019 up 8.8%. Nothing wrong with such growth rates in the 11th year of a cycle (!) but the margin of safety has narrowed considerably.
I have documented the increasing downward revisions on small caps earnings since the summer months. Recent conference calls have made people even more nervous:
Source: BofA Merrill Lynch Global Research (via The Daily Shot)
- And here is the ratio of mentions of “better” or “stronger” vs. “worse” or “weaker” on earnings calls.
Source: BofA Merrill Lynch Global Research
Obviously, using “better” or “stronger” after this year will be pretty heroic, be it on the economy, corporate revenues or profits and profit margins.
Yes, earnings growth has peaked this quarter. But there is no evidence of an earnings peak yet.
Blackstone’s Byron Wien:
The high level of debt throughout the economic system has continuously worried investors, but low interest rates and strong growth have diminished the importance of this factor. (…) Corporate debt is off its peak, but still high. Because of tax cuts and additional spending, the U.S. budget deficit is increasing from $700 billion to $1 trillion. All this is happening while the Federal Reserve is raising short-term interest rates and shrinking its balance sheet. If rates continue to rise, the cost of servicing debt will increase at the same time that liquidity in the system is decreasing.
As the Federal Reserve buys fewer Treasurys in pursuit of “normalization,” Japan and China will also be participating less vigorously in Treasury auctions because of tariff issues. This is not good for the outlook for equities. Of all the factors influencing the market, this could turn out to be the most important. For the market to move higher, it will be dependent on earnings to overcome the impact of shrinking liquidity. (…)
No market can move higher without leadership, and a small group of technology stocks have certainly been the outstanding performers in the market before the sell-off began. The so-called FAANG stocks, Facebook, Apple, Amazon, Netflix and Google (Alphabet) had returned 38% annually since 2014. These stocks have been hit hard in the recent decline. At this point, technology stocks appear more reasonably priced than in 2000. Then, tech was selling at a 200% premium to the general market; today the premium is 30%, according to Barron’s. (…)
The February and October market corrections reflect the volatility risk stemming from the proliferation of passive and computer-driven programs. One such strategy, Risk Parity, popularized by firms like Bridgewater and AQR, has amassed over $400 billion in AUM. This approach makes allocations based on risk, rather than traditional stock and bond weightings. When volatility in one asset class increases, the portfolio is shifted to less volatile assets in order to maintain optimal risk levels, typically without much human intervention.
Similarly, recent research suggests that 60%–90% of daily equity trading is now performed by algorithmic trading, up from 25% in 2004. Meanwhile, passive exchange-traded funds have directed trillions of dollars into equity markets since 2009, and the percent of the U.S. equity market share captured by passive strategies has increased from 26% at the start of 2009 to 47% as of 3Q’18. All of these trends are likely to increase volatility moving forward. One result is to discourage investors who base decisions on fundamentals like earnings, but feel that the market is being controlled by professionally run, computer-based forces which they do not understand and, in some cases, fear.
Taking all of these factors into account, I believe we are going through a necessary correction prior to the next upleg, which should occur after the mid-term election, regardless as to whether the Democrats take control of the House of Representatives or not. Earnings will continue to drive the market and the prospects for earnings growth in the U.S. for 2019 remain strong in spite of what is happening elsewhere in the world.
Relevant chart from Ed Yardeni:
Trump Mocks France for World War Losses
After a fractious visit to Paris over the weekend, Trump returned to the theme of a European army to defend the continent’s interests and took renewed offence.
Trump’s tweet:
Emmanuel Macron suggests building its own army to protect Europe against the U.S., China and Russia. But it was Germany in World Wars One & Two – How did that work out for France? They were starting to learn German in Paris before the U.S. came along. Pay for NATO or not!
Trump’s tweet is twisting the facts but who’s surprised?
Trump likely never read Dale Carnegie’s book “How to Win Friends”. He also likely did not read much about U.S. history. Without the French army which, under Lafayette, Rochambeau and de Grasse, defeated the British in 1781 in the Battle of the Chesapeake and the Siege of Yorktown leading to the surrender by Cornwallis on October 19, 1781, Trump would likely drink tea, eat fish and chips and plum pudding and be currently negotiating Brexit rather than fighting China.
France almost got bankrupt financing the American revolution. A minimum of respect would be appropriate.