Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

THE DAILY EDGE (23 April 2018): PMIs, Earnings, Technicals

U.S. economy hits brakes in early 2018, but it’s gassed up and ready to go for the spring

(…) The economy likely decelerated to a growth rate of about 2% from a more robust pace of 2.9%, 3.2% and 3.1% in the prior three quarters, according to a MarketWatch survey.

The expected slowdown is not a shocker. For one thing, it’s happened repeatedly over the past decade and a half. Growth starts out slow and then speeds up during the rest of the year.

“It’s become an annual tradition for the U.S. economy to start the year on its heels and this year was no different,” said BMO Capital Markets senior economist Sal Guatieri, who pointed out first-quarter growth has averaged 1% since 2003 compared to 2% for the rest of the year. (…)

In the early stages of 2018, Americans cut bank to rebuild their bank accounts after the savings rate fell to a 12-year low. As a result, the increase in consumer spending in the first quarter could drop to as low as 1%. (…)

The first hint came last week in a pickup in retail sales in March that broke a string a three straight declines. (…)

The unemployment rate sits at a 17-year low. Job openings are a near a record high. Recent tax cuts and federal tax refunds are putting more money in people’s pockets. (…)

High five Oil Prices Are Approaching $70. Is the Economy Ready? Crude prices at $70 a barrel are seen as a bearable weight on the U.S. economy for now but could pose trouble if they keep climbing.

(…) When drivers take to the road this summer, they will likely be paying the highest prices for gasoline since 2014. That will likely negate any financial benefits from tax cuts this year for low-income households, according to Deutsche Bank, and could further eat into disposable income. (…)

“In the past, any time oil prices have gone up it was as a result of supply constraints and the U.S. was at the mercy of foreign oil,” said Joseph Tanious, senior investment strategist at Bessemer Trust. “But U.S. oil production has picked up in a meaningful way—there could be also some benefits to having modestly rising oil prices.” (…)

The U.S. consumer is still better off than before 2015 but another 17% rise to $3.20/g on average will close the remaining gap. That said, most of the 2018 tax relief is gone in the exhaust smoke…

image

(…) Growth prospects look pretty strong, which is why the Fed is raising short-term interest rates, the two sanguine policymakers explained [John Williams and Charles Evans]. Those rate hikes, they said, are in and of themselves acting to flatten the yield curve.

In addition, they argued, the curve will likely steepen as the U.S. government runs a bigger deficit and issues more debt, they said. (…)

Williams, who will leave his current job as San Francisco Fed president in June to take over at the New York Fed, also said he expects the Fed’s shrinking balance sheet will help steepen the curve by putting upward pressure on longer-term rates. (…)

Dallas Fed President Robert Kaplan earlier this week said that while the Fed has flexibility to raise rates now, the 10-year yield imposes limits on how far it can do so. The 10-year yield on Friday was at 2.96 percent, the highest in more than four years.

Minneapolis Fed President Neel Kashkari, who consistently voted against rate hikes last year, said in a CNBC interview on Friday that the flattening curve was “a yellow light flashing,” a warning that the Fed should soon stop raising rates or risk braking the economy too quickly and plunging the country into recession. (…)

FYI, from David Rosenberg:image_thumb7[1]

(…) Speaking at a gathering of finance ministers and central bankers here Friday, ECB President Mario Draghi warned that the eurozone’s growth cycle may have peaked, and suggested his bank would move only slowly to phase out its large monetary stimulus.

Across town, Jens Weidmann, president of Germany’s central bank, acknowledged signs of a slowdown in Europe’s largest economy in the first quarter. But Mr. Weidmann played down the change, suggesting he would continue to press the ECB to phase out easy money soon.

“There’s no reason to see a turning point in growth—Germany’s economy is still booming,” said Mr. Weidmann, who also sits on the ECB’s 25-member rate-setting committee. (…)

ECB officials have differed publicly over how quickly to phase out their stimulus. One group of officials, centered around Mr. Weidmann, is keen for the ECB to take advantage of strong economic growth to phase out QE and move toward higher interest rates. But another group of officials, which includes ECB President Mario Draghi and chief economist Peter Praet, is more cautious, worried that eurozone inflation, at 1.3% in March, remains too weak. (…)

APRIL FLASH PMIs

The US economy picked up pace again at the start of the second quarter. The April PMI surveys registered the second-strongest monthly expansion since last October. Manufacturing is leading the upturn, with factories reporting the strongest output gains for 15 months, and the vast service sector is enjoying a steady, robust expansion.

After a relatively disappointing start to the year, the second quarter should prove a lot more encouraging. The current data point to an annualised GDP growth rate of 2.5%, with scope for some substantial upside surprises in coming months.

First, growth in new orders accelerated to show the largest surge in demand for goods and services for just over three years. Second, companies’ expectations of growth over the coming year jumped to a three-year high. Third, hiring remains robust as firms struggle to cope with demand. The surveys point to non-farm payroll growth of approximately 200,000 in April.

The details of the survey therefore suggest that output growth is on course to accelerate as we move into the summer. Prices are meanwhile being pulled upwards by the strength of the upturn, however, sending hawkish signals for policy makers.

image

  • Eurozone economy stays in lower gear as PMI holds steady in April
  • Flash Eurozone PMI Composite Output Index at 55.2 (55.2 in March). Growth unchanged.
  • Flash Eurozone Services PMI Activity Index at 55.0 (54.9 in March). 2-month high.
  • Flash Eurozone Manufacturing PMI Output Index at 55.8 (55.9 in March). 17-month low.
  • Flash Eurozone Manufacturing PMI at 56.0 (56.6 in March). 14-month low.

The Eurozone economy remained stuck in a lower gear in April, with business activity expanding at a rate unchanged on March, which had in turn been the slowest since the start of 2017. Growth has downshifted markedly since the peak at the start of the year, but importantly still remains robust.

The April data are running at a level broadly consistent with Eurozone GDP growth of approximately 0.6% at the start of the second quarter.

The decline in the PMI from January’s high is neither surprising nor alarming: such strong growth as that seen at the start of the year rarely persists for long, not least because supply fails to keep up with demand. With recent months seeing record delivery delays for inputs to factories and growing skill shortages, output is clearly being constrained. In France, strikes were also reported to have disrupted growth, and may continue to do so in coming months

However, it’s also clear that underlying demand has weakened, in part due to exports being hit by the stronger euro. With companies’ future optimism having slipped to the lowest since last year, it looks likely that growth may well slow further in coming months.

image

Survey data depicted a positive backdrop in the Japanese manufacturing sector during April. The improvement in the headline PMI was underpinned by stronger rates of growth in output, new orders and employment. Furthermore, business confidence strengthened, while output prices were hiked to a stronger degree, signalling optimism in demand conditions.

Although new export orders declined for the first time since August 2016, as the stronger yen begins to impact price competitiveness, the rise in total new business inflows signals stronger domestic demand.

image

Inflation and Recession Watch Indicators

This is from Steve Blumenthal:

The NDR Inflation Timing Model consists of 22 indicators that primarily measure the various rates of change of such indicators as commodity prices, consumer prices, producer prices and industrial production. The model totals all the indicator readings and provides a score ranging from +22 (strong inflationary pressures) to -22 (strong disinflationary pressures). (…)

What you are looking at is a summary of 10 different recession watch indicators. Some of the signals have a higher success rate than others, but what I like is how they combined the indicators and created a weight of evidence summary.

Here is how to read the chart:

  • Mostly all green is good.
  • Compare :Current Level” to “Key Recession Level”
  • Bottom line: No current sign of recession in next six to nine months.

EARNINGS WATCH

Big week with 179 reports due.

Here’s a summary of Factset’s account for the season so far:

Overall, 17% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 80% have reported actual EPS above the mean EPS estimate, 7% have reported actual EPS equal to the mean EPS estimate, and 13% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (74%) average and above the 5-year (70%) average.

In aggregate, companies are reporting earnings that are 5.9% above expectations. This surprise percentage is above the 1-year (+5.1%) average and above the 5-year (+4.3%) average.

In terms of revenues, 72% of companies have reported actual sales above estimated sales and 28% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the 1- year average (70%) and well above the 5-year average (57%).

In aggregate, companies are reporting sales that are 1.6% above expectations. This surprise percentage is above the 1-year (+1.1%) average and above the 5-year (+0.6%) average.

The blended, year-over-year earnings growth rate for the first quarter is 18.3% today, which is higher than the earnings growth rate of 17.4% last week.

The blended (year-over-year) revenue growth rate for Q1 2018 is 7.6%.

image

Facset calculates that the blended net profit margin for the S&P 500 for Q1 2018 is 11.1%, up from 10.1% in Q1’17.

image

If we assume that the aggregate impact of the tax reform is to increase S&P 500 companies profits by 7%, we can infer that ex-tax reform, Q1’18 margins are up by about 0.3% to 10.4%.    

Looking ahead, “at this point in time, 11 companies in the index have issued EPS guidance for Q2 2018. Of these 11 companies, 4 have issued negative EPS guidance and 7 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 36% (4 out of 11), which is well below the 5-year average of 74%.” (Factset)

Thomson Reuters monitors analysts revisions, often influenced by conference calls. So far, so good there as well.

image

image

TECHNICALS WATCH

Lowry’s Research warns that “price can at times be very misleading as an indicator of market conditions, as price/capitalization-weighted indexes can be unduly affected by a relatively small number of stocks, most often of the large and mega-cap variety.”

Lowry’s explains that, as of April 18th, even if the major price indexes are much lower than their January highs, both the NYSE all-issues and its Operating Companies Only (OCO) Adv-Dec Lines reached new bull market highs, suggesting not only broad-based strength.

Lowry’s also notes that its measures of breadth reached new highs in all market cap segments, “with the largest gains in the S&P and OCO Small Cap Adv-Dec Lines. These latter new highs may be the most important indications of the bull market’s health, as small caps, historically, have been among the first to show weakness and deteriorating breadth in an aging primary uptrend.”

However, Lowry’s warns that its Supply-Demand measures, while indicating limited downside risk due to apparent declining supply, also show the absence of a sustained uptrend in Demand.

Fingers crossed China ‘Welcomes’ Mnuchin’s Interest in Traveling to Beijing for Trade Talks U.S. Treasury secretary said a trip to China was “under consideration” to discuss ways to defuse trade tensions between the two countries.
Money Investors’ New Headache: It’s Getting Harder to Buy or Sell When They Want Worsening liquidity comes as banks have reduced inventory of riskier assets and investors more closely track bond indexes

(…) Investors say it began nearly a decade ago, when post-financial-crisis regulation prevented banks from trading for themselves, and forced them to hold larger amounts of capital—thereby shrinking their inventory of riskier assets. This, in turn, reduced banks’ ability to serve as intermediaries between buyers and sellers. (…)

In the U.S. stock market, half of the more than 8,500 listed companies trade less than 100,000 shares a day—a tiny sliver of what big stocks trade, according to an April 10 report from the Securities and Exchange Commission. (…)

Even in the world’s deepest bond market, U.S. government debt, liquidity has worsened as trading activity can’t keep up with booming supply. The Federal Reserve’s network of primary dealers, which are required to bid at government bond auctions, reported $455 billion of daily Treasury debt trades for the seven days ended April 11. That figure has declined since 2007—even though since that time, tradable Treasury debt has more than tripled. (…)

This year’s volatility has even hampered liquidity in the popular E-mini S&P 500 futures on the Chicago Mercantile Exchange, a derivative product widely used for betting on the stock market’s direction or hedging against market swings. In the most active E-mini contract, the average number of contracts available to be bought or sold at the best price slumped from more than 500 in October to just 96 in March, according to MayStreet LLC, a data-analytics company. (…)

The lack of liquidity in the corporate bond market is also very scary. In 2001, when the corporates market was $2.5 trillions, primary dealers were holding nearly $50 billions worth of corporate bonds, 2% of the outstanding. In 2007, dealers held around 9% of the outstanding. In 2017, dealers held $34 billions corps in a $5.3 trillion market, 0.6% of the outstanding.