THE DAILY EDGE: 17 JUNE 2019

U.S. Retail Sales Firm Broadly; Revisions Show Improvement

Total retail sales increased 0.5% (3.2% y/y) during May following a 0.3% April increase, revised from a 0.2% slip reported initially.(…) Retail sales excluding motor vehicles and parts rose 0.5% (3.2% y/y), the same as during April, revised from 0.1%.

Last month, sales of motor vehicle & parts increased 0.7% (3.1% y/y) after a 0.5% fall during April. This compared to a 6.2% gain in unit sales of motor vehicles during May.

A measure of the underlying pace of retail spending is nonauto sales growth excluding gasoline and building materials. These sales rose 0.5% (3.4% y/y) after a 0.4% rise, revised from unchanged.

Sales strength was broad-based last month. (…) Restaurant & drinking establishment sales  increased 0.7% (3.7% y/y) after a 0.3% rise.

Post the important April revision, retail sales have been quite strong, rising at a 10.8% annualized nominal rate since March. Yet, they are only up 3.2% YoY in May.

Bespoke details the broad strength:

• Retail Sales: Even Stronger Below the Surface

The table below shows monthly streaks of gains or losses for each of the sectors tracked in the Retail Sales report.  Here we can see how broad and consistent the strength has been in Retail Sales after taking revisions into account.  Five sectors have seen m/m growth for five straight months, and no group has seen more than one straight month of decline.   Bars and Restaurants are one group that has seen sales growth for five consecutive months, and while it has yet to overtake Food and Beverage Stores in terms of its total share of sales, it’s getting close.

(Bespoke)

However, we are still feeling the effect of December’s huge –1.6% drop and the very erratic monthly trends since last November. In the last 7 months, only three showed positive growth in real sales.

Looking at retail sales on a quarterly basis, real growth was negative in Q4’18 and in Q1’19 and in April, before surging in May (which may be revised…). If we annualize April and May, real sales are up 2.6% but this follows –1.6% annualized in the previous 2 quarters. On a trailing 6-month basis, real sales have totally stalled since last October.

The FOMC has to deal with this erratic behavior and decide if this stalling is transitory, the month of May perhaps being a solid, though revisable, evidence of consumer strength, or if we are seeing a repeat of 2000 and 2007 when real sales stalled in the year before the recessions.

Some economists suggest that restaurant sales are a good gauge for discretionary spending as dining out is an easily postponable expenditure. Bespoke above shows how strong restaurant sales have been in the past 5 months but they are using nominal sales, disregarding the sharp acceleration in Food-at-Home inflation which has risen 3.6% annualized since December.

In reality, real restaurant sales growth has decelerated sharply to only 0.7% YoY in May from 6.8% in July 2018.

 

The May Restaurant Industry Snapshot from TDn2K confirms the slow growth: on a rolling 3 months basis, same-restaurant sales are up only 0.5% in nominal dollars while traffic is down 2.5%. “It is only through an acceleration of guest check growth that the industry continues to achieve positive sales.”

Americans now spend more on food away from home than at home…

…in large part because restaurant inflation has substantially outpaced grocery store inflation. Any economic slowdown will really hurt the restaurant industry.

In all, the FOMC members will struggle with the consumer but should not consider it a dependable source of strength.

U.S. Business Inventories Rise in April as Sales Decline

Total business inventories increased 0.5% (5.3% year-on-year) during April, after being unchanged in March (unrevised). Total business sales decreased 0.2% (+2.8% y/y) following a 1.3% gain (revised down from 1.6%). The inventory-to-sales (I/S) ratio ticked up to 1.39 from an upwardly-revised 1.38. Business inventory swings can have a meaningful impact on GDP. In the first quarter inventories added 0.6 percentage point to GDP growth.

Retail inventories increased 0.5% (4.6% y/y) in April after declining 0.3%. Auto inventories, which comprise roughly 35% of retail inventories, grew 0.8% (8.2% y/y). Non-auto retail inventories rose 0.4% (2.6% y/y).(…) Factory sector inventories gained 0.3% (3.8% y/y). As reported last week, wholesale inventories were up 0.8% (7.6% y/y). (…)

The inventory-to-sales ratio in the retail sector was unchanged at 1.45. The non-auto I/S ratio ticked up down to 1.19, slightly above the historic low of 1.17 reached in November 2018 (data goes back to 1967). The wholesale and factory sector I/S ratios edged up to 1.34 and 1.37 respectively.

Business Sales is not a widely mediatized stat. Yet, it strongly correlates with the growth in S&P 500 revenues.

S&P 500 Revenues grew 3.5% in Q1 per Ed Yardeni, above Business Sales’ 2.6% growth rate, substantially helped by the surge in March in what has also been a pretty erratic trend in MoM sales. In effect, Business Sales are up only 0.6% annualized in the last 6 months.

On a YoY basis, Business Sales are up 2.8% in April and only 2.4% ex-Petroleum. Why does it matter? Because this means that S&P 500 revenues will likely decelerate even more, challenging operating margins when labor costs are accelerating and supply chains are meaningfully disrupted.

S&P 500 companies’ earnings surprised by +6.0% in Q1 but it would be prudent not to bet on a repeat in coming quarters.

U.S. Industrial Production Rebounds

Industrial production increased 0.4% (2.0% y/y) during May and recouped a 0.4% April decline, revised from -0.5%. Output has declined 0.9% since December. (…) Manufacturing activity recovered 0.2% (0.7% y/y) during May following a 0.5% decline. Output is down 1.5% versus December. Utilities output rebounded 2.1% (0.3% y/y) last month after a 3.1% drop. Mining activity improved 0.1% (10.0% y/y) following a 2.2% increase. (…)

Capacity utilization rebounded to 78.1% in May and made up most of its April decline to 77.9%. (…) The factory sector utilization rate rose to 75.7%. Mining sector capacity utilization eased to 91.3%, and remained below December’s cycle high of 93.2%. Growth in capacity in the manufacturing sector continues to strengthen, up 1.1% y/y.

Don’t buy this “rebound” says Markit:

Official data on manufacturing output showed production rising in May, but the muted increase leaves the sector with a big hill to climb in June to avoid falling into contraction for a second successive quarter, corroborating earlier weak PMI survey data from IHS Markit.

Manufacturing output rose 0.2% in May according to official data from the Federal Reserve. The rise was the first recorded so far this year, so represented a welcome sign of revival. However, survey data hint strongly that the underlying business environment remained subdued in May, meaning growth could remain weak or production even contract in June.

The sector is consequently close to falling into a technical recession. Even with the 0.2% expansion of production in May, output so far in the second quarter is running 0.6% below that of the first quarter. Barring revisions to back data, it would need a 1.6% surge in production to avoid manufacturing output falling in the second quarter. With output having dropped 0.6% in the first quarter, two consecutive quarters of decline would meet the definition of a recession. The last time the manufacturing economy recorded two or more consecutive quarters of decline was 2015-16, and prior to that 2009.

The likelihood of production growth gaining momentum in June looks slim. The IHS Markit PMI survey’s manufacturing output gauge, which exhibits an 89% correlation with the three-month-on-three-month change in the official data, remained deep in territory consistent with falling output in May.

The PMI surveys tend to give a good indication of underlying production trends, cutting through some of the noise of volatile monthly changes in official data. As such, the US PMI hints that the rise in production in May masks a broader malaise in the factory sector. Indeed, the rise in output in May was linked to a jump in vehicle production. Excluding car makers, output was flat.

Worryingly, the PMI survey’s new orders index fell in May to its lowest since August 2009. The decline meant output growth exceeded that of new orders to the greatest extent since September 2016, a development which suggests companies will seek to adjust production down further in coming months in line with the downturn in order book inflows.

The PMI survey’s forward-looking new orders-to-inventory ratio meanwhile also fell in May, down to its lowest for almost two years, adding to the prospect of production remaining subdued in June. Furthermore, companies themselves also grew more concerned about the outlook, often linked to escalating trade war worries. Manufacturers’ expectations of their own production trends over the coming year fell markedly in May to the joint-lowest since the series began in July 2012.

• New York Fed Factory Gauge Drops by Record to Two-Year Low It adds to signs tariffs are weighing on manufacturers and the broader economy.

(…) New orders fell to a three-year low, while unfilled orders dropped to the lowest level since 2015. The employment index posted its first negative reading in two years, suggesting a pullback in the number of workers, while the average workweek shortened. (…)

TECHNICALS WATCH

Lowry’s Research keeps the green flag up, pointing out that historically, breadth leads price, and “new highs in the Adv-Dec Lines are typically followed by new highs in the price indexes. Thus, the new high in the NY all-issues Adv-Dec Line suggests that new highs in the S&P 500 should follow in the weeks ahead.”

That said, Lowry’s warns that small caps are the exception and “a continued lag in small cap breadth should be closely monitored, as this lag could be an early indication of an aging bull market.”

Lowry’s analysis of Supply and Demand suggest that “investors are finding little reason to sell into the rally. The lack of selling appears especially important since the rally from the June 3rd low has taken the S&P 500 back to the levels of the Sept. 2018 and late Apr. 2019 market highs – levels where enough selling existed to send prices lower. In addition, this lack of selling is occurring despite the presence of overbought readings on short-term indicators.”

Trump Delayed Pence’s Tiananmen Square Speech in Hopes of Landing Xi Meeting

Vice President Mike Pence was set to deliver a speech criticizing China’s human rights record on June 4, the anniversary of the Tiananmen Square massacre — until Donald Trump stepped in.

The president delayed the speech to avoid upsetting Beijing ahead of a potential meeting with Chinese President Xi Jinping at the Group of 20 meeting in Japan at the end of this month, according to several people familiar with the matter. Trump also put off U.S. sanctions on Chinese surveillance companies that Pence planned to preview in his remarks.

The speech was tentatively rescheduled for June 24, just days before the Osaka meetings. But with Beijing signaling that Xi might not agree to a meeting, there is now debate within the administration about when Pence should deliver the speech and how hard he should be on the Chinese. (…)

“If he shows up, good,” Trump told Fox News. “If he doesn’t — in the meantime, we’re taking in billions of dollars a month. Eventually, they’re going to make a deal, because they’re going to have to. Look, they’re paying hundreds of billions of dollars.” (…)

United States suspends WTO intellectual property litigation against China

The United States has halted a World Trade Organization dispute over China’s treatment of intellectual property rights until Dec. 31, the WTO dispute panel hearing the case said in a statement published on Friday.

The panel of three adjudicators said the United States asked for the suspension on June 3 and China agreed the next day. (…)

Huawei Has 56,492 Patents and It’s Not Afraid to Use Them

(…) Last year alone, Huawei received 1,680 U.S. patents, making it the 16th biggest recipient, figures by Fairview Research’s IFI Patent Claims Services show. Huawei’s total portfolio of active patents and published applications is 102,911, according to Anaqua, an intellectual property-management software firm. (…)

U.S. companies adapting to ongoing China tariffs

Many companies have held off raising prices to offset tariffs, in hopes that they would go away.

As it becomes clear that the risk of tariffs will linger, more companies are taking steps to mitigate them and accepting trade conflict with China as a new fact of life, according to businesses and trade groups interviewed by Reuters. (…)

Jacob Parker, vice-president of China operations at the U.S.-China Business Council in Beijing, said even in the event of a trade deal, it was possible the persistent threat of tariffs would continue to push U.S. companies’ supply chains out of the country. Similarly, Chinese firms are likely reconsidering their reliance on U.S. companies, he said. (…)

On Thursday, shoemaker Crocs Inc. highlighted the threat of the Trump administration’s trade policy changes, especially the tariffs.

“It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes,” the company said. (…)

Kubota held off raising prices until now in hopes that the costs associated with tariffs – including higher prices for imported parts from China – would be short-lived. Kubota has 10 U.S. factories, with seven in Kansas. Its business has been hammered by retaliatory tariffs on U.S. farmers, Mr. Stucke said.

“We held out as long as we could,” he said. The company is implementing across-the-board price increases of 1 per cent to 5 per cent, depending on the item, as of Friday.

Broadcom’s $2 billion warning rattles global chip sector

Broadcom Inc sent a shockwave through the global chipmaking industry on Friday with its forecast that U.S.-China trade tensions and the ban on doing business with Huawei Technologies would knock $2 billion off the company’s sales this year. (…)

“We’ll see a very sharp impact simply because (there are) no purchases allowed and there’s no obvious substitution in place,” Chief Executive Officer Hock Tan said on a post-earnings call with analysts on the Huawei ban.

Huawei accounted for about $900 million, or 4%, of the company’s overall sales last year. Broadcom, however, also said the forecast cut “extends beyond one particular customer.”

“We’re talking about uncertainty in our marketplace, uncertainty because of the – of demand in the form of order reduction as the supply chain out there constricts – compress, so to speak,” Tan said. (…)

Finisar Corp, which makes sensors for facial recognition, transceivers and other components for telecommunication networks, said in a regulatory filing that ban on Huawei could have continuing negative impact on its future revenue. Huawei represented 10% of its total revenue in fiscal 2019.

The CEO of chipmaker Micron Technology also said the ban on Huawei brings uncertainty and disturbance to the semiconductor industry. (…)

Huawei Warns Trump’s Ban Might Wipe Out $30 Billion of Sales Growth

Sales at China’s largest technology company will likely remain stagnant at about $100 billion in 2019 and 2020, the billionaire said during a panel discussion, quantifying for the first time the hit from a plethora of Trump administration restrictions. Huawei however will aim to maintain its research and development budget and refrain from layoffs or major asset sales. (…)

The founder has conceded that Trump administration curbs will cut into a two-year lead it’s painstakingly built over rivals like Ericsson AB and Nokia Oyj. (…)

But Huawei has also said it will ramp up its own chip supply and find alternatives to keep its edge in smartphones and 5G. (…)

Huawei warns ban will hit 1,200 US suppliers Chinese telecoms group says cyber security vendors among those at risk