THE DAILY EDGE: 2 APRIL 2019: Back To Fairly Valued

U.S. Retail Sales Ease in Broad-Based Decline

Total retail sales fell 0.2% during February (+2.2% y/y) following a 0.7% January increase, revised from 0.2%. Retail sales excluding autos declined 0.5% (+2.0% y/y) after a 1.6% increase, revised from 0.9%.

A measure of the underlying pace of retail spending is nonauto sales growth excluding gasoline and building materials. These sales fell 0.2% in February (+2.9% y/y) following a 1.7% January rise, revised from 1.1%. (…)

Many important January stats are being revised upward, alleviating recession fears. February data may also have been impacted by the shutdown, bad weather and a slow start to the tax refund season because of the shutdown. Continued strong income data (employment x wages) and muted inflation suggest reasonably sustained consumer spending.

Control Retail Sales excludes Motor Vehicles & Parts, Gasoline, Building Materials and Food Services & Drinking Places and is what goes into GDP calculations. This Doug Short chart keeps expectations up:

UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT

Bill Dudley, former president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee, previously chief U.S. economist at Goldman Sachs:

I also take solace that the most important part of the U.S. economy — the household sector — is in very good shape. Incomes have been accelerating, boosted by job and wage gains. Household finances are relatively strong: Debt levels have grown slowly during this expansion, and debt payments take up the smallest share of income in many decades. 

But David Rosenberg does not relent:

My friends, after this latest set of dismal personal income and spending numbers, I am more convinced than ever that the U.S. economy is heading into a recession before long. (…) most of the data releases, or at least the ones that feed into GDP, are slowing pretty markedly and from already low figures – it is tough for me to see where the catalyst is coming from.

U.S. manufacturing PMI dips to lowest since June 2017 and price pressures moderate

The latest PMI signalled a moderate improvement in operating conditions across the U.S manufacturing sector in March, dropping to its lowest level since mid-2017 amid softer increases in output and new orders. Nonetheless, the rate of job creation remained solid despite broadly unchanged levels of outstanding business. Meanwhile, cost pressures eased further as the rate of input price inflation softened for the fifth successive month. Output charges also rose at a slower pace.

The seasonally adjusted IHS Markit final U.S. Manufacturing Purchasing Managers’ Indexâ„¢ (PMIâ„¢) posted 52.4 in March, down from 53.0 in February, and broadly in line with the ‘flash’ figure of 52.5. The moderate improvement in the health of the manufacturing sector was the weakest since June 2017 and notably softer than the trend seen for 2018. Moreover, the first quarter average of 2019 was the lowest since the third quarter of 2017.

A key factor behind the lower headline figure was a slower rise in output. The rate of expansion eased to a marginal pace that was the weakest since June 2016 and below the series trend. Panellists stated that the slower increase in production was due to softer underlying client demand. Similarly, new business growth eased in March. Total new orders expanded at a modest pace that was the slowest since June 2017. At the same time, new export orders rose at only a marginal rate that was the weakest for five months, with firms noting that global trade tensions and the ongoing impact of tariffs had dampened foreign client demand.

In line with less marked growth in new orders, panellists registered the softest rise in input purchasing since June 2016. Where an increase was reported, companies often linked this to the replenishment of stocks. Meanwhile, both pre- and post-production inventories rose in March.

On the price front, input price inflation softened further to the slowest since August 2017. Where a rise in costs was reported, goods producers linked this to higher raw material prices, stemming from the ongoing impact of tariffs and greater demand for inputs. The increase was partly passed on to clients through higher output charges. The rise in factory gate prices was nevertheless the slowest since December 2017.

Backlogs of work were broadly unchanged in March, albeit with the index dipping very marginally below the 50.0 no change mark for the first time since July 2017. Nonetheless, employment rose at a solid rate. A number of firms stated that there were further vacancies to fill, but that they were having difficulties finding skilled or suitable candidates. Business confidence among manufacturers remained below the series trend but picked up from February. The solid degree of optimism was attributed to new product development and efforts to increase productivity.

The March survey is consistent with production falling at a quarterly rate of 0.6% according to historical comparisons with official data.

Encouragingly, companies report that at least some of the slowdown is due to capacity constraints, notably in terms of skill shortages. One-in-three companies reporting a drop in headcounts cited an inability to fill vacancies. Those looking for positive signals will therefore note that hiring remained encouragingly solid during the month and expectations of future output perked up, albeit still running below levels seen this time last year.

However, things may well get worse before they get better, as the forward-looking indicators are a cause for concern. New order growth has fallen close to the lows seen in the 2016 slowdown, often linked to disappointing exports, tariffs and signs of increasing caution among customers. The ratio of new orders to existing inventory has meanwhile fallen to its lowest since June 2017, suggesting the production trend may weaken further in April.

• U.S. Factory Activity Accelerated in March

The ISM said its manufacturing index rose to 55.3 in March from 54.2 in February. The new orders index increased to 57.4 and made up most of its February decline. The new export index declined to 51.7, its lowest level since October 2017. The order backlog index also declined modestly and remained well below its May 2018 high. The employment index recovered to 57.5 from the two-year low of 52.3. A sharply increased 25% of respondents reported more hiring while 12% reported fewer jobs.

Keep in mind that Markit’s PMI has proven to be a better gauge of the U.S.manufacturing activity. It gets less media coverage in America however.

• Global manufacturing growth remains weak in March

U.S. Construction Spending Increases

The value of construction put-in-place increased 1.0% (1.1% y/y) during February following a 2.5% January increase, revised from 1.3%.

The value of public construction jumped 3.6% (11.5% y/y), after an outsized 5.7% rise in January. It was powered by a 9.5% surge (22.8% y/y) in highway & street construction, which accounts for roughly one-third of public sector spending. (…)

The value of private construction activity rose 0.2% (-1.9% y/y). Residential building rose 0.7% (-3.4% y/y) but single-family construction dropped 1.1% (-7.1% y/y). Multi-family construction eased 0.4% (+7.5% y/y) after five months of strong increase. The value of improvements strengthened 3.6% (-1.5% y/y). (…)

Xi Jinping speech from six years ago resurfaces to ‘send message on trade war, leadership’

A speech delivered by Xi Jinping six years ago on how China needs to “cooperate and compete with the more advanced capitalist” countries was republished by the Communist Party’s journal on Monday, in what could be a hint of the Chinese president’s stance on the trade war with the US.

While the ruling party’s flagship journal on political theory – Qiushi, or Seeking Truth – often carries speeches given by Xi, they are generally more recent addresses.

Observers said the decision to run the transcript of the speech was likely to be a direction from the top aimed at sending a message. (…)

But the speech carried by Qiushi on Monday included a paragraph that was not in previously published versions, and it has caught the attention of observers.

In it, Xi called for his comrades to “have a sound understanding of the self-correcting ability of capitalist societies, to not underestimate the reality of the long-term advantage of Western developed countries on economic, scientific and military fronts, and to conscientiously prepare for all aspects of long-term cooperation and struggle between the two social systems”.

He also said in the speech that “for a long period to come, socialism in the primary stage must also cooperate and compete with capitalist countries armed with greater developed productivity”.

And he said China must “carefully study and learn from the civilisation achievements of capitalism, and be prepared to face the fact that people will compare the merits of Western developed countries to the shortcomings of China’s socialist development and blame us”. (…)

EU-U.S. Trade Talks Face Delay, Risking Trump Backlash

European Union governments are struggling to reach consensus on a mandate to begin trade talks with the U.S., risking a delay that would further provoke Donald Trump’s ire after the bloc’s refusal to include agriculture in the negotiations.

At a meeting of EU ambassadors in Brussels on Wednesday, France is expected to resist giving the European Commission the green light to start negotiations to eliminate industrial tariffs between the regions, according to two officials familiar with the matter, who asked not to be named because the talks are private. Failure to get France on board would mean the EU’s executive arm won’t be given a mandate to negotiate.

The main sticking points include the role of climate and environment in the mandate given the U.S. decision to withdraw from the Paris climate accord and a clarification of what this negotiation would mean for the shelved Transatlantic Trade and Investment Partnership, according to the officials.

A draft mandate prepared ahead of the meeting of ambassadors and seen by Bloomberg reiterates that the EU seeks trade accords only with countries that have signed up to the Paris agreement against climate change, even though the U.S. has pulled out. (…)

BTW, the USMCA has not been signed yet and House passage remains pretty iffy.

TECHNICALS WATCH

The “Golden Cross” just happened on the S&P 500 Index:

Almost on the NDX, although the equal-weight NDX did it March 15:

Small caps are not there, still in a declining 200dma trend:

But the broadest market gauge is just about there:

THE RULE OF 20 STRATEGY

The Rule of 20 only uses actual data and makes no forecast. It simply provides an objective view of where equity valuations stand relative to their history of fluctuating within a stable 16 to 24 Rule of 20 P/E range. As such, it provides a dependable way of assessing valuation risk vs reward.

As the chart below illustrates, at its current 19.66 level, the Rule of 20 P/E is back near its neutral, “fair value” level where upside potential to 24 is equal to downside risk to 16.

Interestingly, the S&P 500 Index peaked at 2866 in January 2018 with a Rule of 20 P/E of 23.5, a 17.5% overvaluation, troughed at 2338 on December 26 with a Rule of 20 P/E of 16.9, a 15.5% undervaluation, and is now back to 2860 with a Rule of 20 P/E of 19.7. During the period, inflation rose from 1.8% to 2.1% but trailing EPS rose 27%.

The Rule of 20 Strategy, all cash through most of 2018,  triggered a 100% equity position last December 24 at 2374. The model will raise some cash if and when the Rule of 20 P/E reaches 20.0 which would happen at 2916 if trailing EPS and inflation remain unchanged.

This is a mere 2.0% above current levels.