THE DAILY EDGE (7 May 2018)

Jobless Rate Falls to 3.9%, Lowest Level in 17 Years Unemployment in the U.S. has fallen to one of the lowest levels of the post-World War II era, the result of a historically long jobs expansion that shows little evidence of slowing.

(…) Employers added a total 164,000 jobs and have created an average 200,000 jobs a month this year, up from last year’s average gain of 182,000. (…)

Friday’s report suggested there are more workers available for full-time jobs than the main unemployment rate suggests. A separate measure—which takes into account part-time workers who would prefer full-time jobs, and workers too discouraged to look for work—fell to 7.8% in April. That is the lowest level since 2001, but still above the 6.9% of December 2000. (…)

The labor force contracted in April but grew by 1.3 million from a year earlier. The percentage of prime-age workers, those between 25 and 54, who are working or looking for work ticked down in April but has risen from near 80% in 2015 to 82%.

The retirement of baby boomers. Many younger workers with lower wages are replacing them, suppressing the national average pay. (…)

Economists remains totally puzzled by the lack of wage pressures. Hourly earnings rose 0.1% MoM in April and March was revised lower from +0.3% to +0.2%, keeping the YoY growth rate at 2.6% for the 3rd consecutive month.

I read all kinds of explanations, none really conclusive. Perhaps the Payroll survey data on wages has not kept pace with demographic and industry shifts as well as compensations schemes favoring commissions, bonuses and other perks and benefits. There are a few realities the wages data just don’t seem to fully grasp:

• Most companies, large and small, are complaining of the scarcity of workers, skilled or not.
• Minimum wage rates have gone up across the U.S..
• Wages and salaries per Personal Income data are up 4.4% YoY in aggregate and +4.5% annualized in Q1, from +3.3% in 2017 and +2.9% in 2016. Since employment is up 1.6% YoY, same as in 2017 (+1.8% in 2016), wages and salaries per employed has accelerated from +1.1% in 2016 to +1.7% in 2017 and +2.8% in Q1’18.
• Total private industry compensation per the Employment Cost Index is +2.8% YoY in Q1’18 from +2.5% in 2017 and +2.1% in 2016.

This chart plots YoY employment growth (red, rs) with the aggregate payrolls for private employees (average hourly earnings X aggregate weekly hours). Note how aggregate payrolls growth has been accelerating since 2017 while employment growth has been slowing.

This next chart from Deutsche Bank (via The Daily Shot) shows how “wage costs” scored poorly in Q1 conference calls.

Wages and compensation are thus clearly accelerating, though not booming. So far, companies have been able to more than offset this with rising prices and increased sales.

• Truckers, Railroads Slashed Payrolls in April An employment pullback in the freight sector came even as companies say they are struggling to recruit workers to meet strong shipping demand

Payrolls at trucking firms dropped by 5,500 from March, according to preliminary figures the Labor Department released Friday. The rail sector, where recruiting is so tough that some carriers are offering signing bonuses of up to $25,000, cut 800 jobs last month, reflecting the challenges of filling jobs that involve long hours in tough working conditions.

Those declines contrasted with strong gains at parcel-delivery companies and warehouse operators, which added a combined 12,300 jobs in areas that have benefitted from the growth of online shopping. (…)

Despite the decline in April, the trucking sector has added nearly 17,000 jobs in the past year and companies say they are anxious to add drivers. (…)

• AAR: Rail Carloads Up 3.3% YoY, Best April Ever for Intermodal

  

 

U.S. Farmers Are Already Suffering From Lost Chinese Orders for Corn, Soybeans and Pork Tariff dispute threatens to upend exports to a key market and U.S.’s share of global agricultural markets

(…) Chinese importers have canceled purchases of corn and cut orders for pork while dramatically reducing new soybean purchases, according to U.S. Department of Agriculture data. Chinese importers’ new orders of sorghum, a grain used in animal feed, have dwindled while cancellations increased. (…)

In 2017, China was the second-biggest customer for U.S. agricultural products, spending nearly $20 billion.

In soybeans, China-based importers are holding off on new orders from the U.S., including advance purchases of this fall’s crops. The risk that a shipment will face a steep tariff by the time it is delivered has directed Chinese buyers to book more beans from South American suppliers, according to Bunge’s Mr. Schroder. (…)

“With the trade negotiations, a lot of unknowns with our future demand is clearly not a positive to the pork market at this stage,” said Jason Roose, vice president of U.S. Commodities Inc., a livestock and grain advisory firm based in Des Moines, Iowa. (…)

Ed Breen, chief executive of crop-seed supplier DowDuPont Inc., said Thursday that if China steps back from U.S. soybean purchases, growing markets like Mexico, Indonesia, Vietnam and Turkey would fill the void.

Some believe that China won’t be able to stay away from U.S. crops for long, given the country’s immense needs. The longer-term danger for U.S. farmers and agricultural companies, though, is developing a reputation for being an unreliable supplier, prompting other countries to ramp up their own crop production, according to Dan Basse, president of research firm AgResource Co. in Chicago. In time, that could cut into the U.S. share of global agricultural markets, he said. (…)

INFLATION WATCH

April Rents Rev Up for the Rental Season with Highest Annual Increase in 16 Months

(…) The national average rent in April saw the highest year-over-year increase since the end of 2016, a 3.2% uptick compared to the same time last year, reaching $1,377/month. Month-over-month, national rents grew by 0.3%, or $4, compared to March, revving up as we approach the start line of 2018’s peak rental season. (…)

OIL

Saudis Move to Push Oil Prices Higher, in Break From Past Policy Crown Prince Mohammed is behind the move to push oil prices higher, aiming to raise revenue as his government seeks to overhaul the economy.

Saudi Arabia is maneuvering to push oil prices up to at least $80 a barrel this year, shifting away for now from its long-time role as a stabilizing force in global energy markets.

Crown Prince Mohammed bin Salman, the country’s day-to-day ruler, is behind the move, aimed at raising revenue as his government seeks to carry out a wide-ranging economic overhaul, senior Saudi officials said. (…)

“There is no intention whatsoever from Saudi Arabia to do anything to stop the rally” in oil prices, said a senior Saudi government official, who cited the minium $80 estimate. “It is exactly what the kingdom wants.”

For every dollar that oil prices rise, Saudi Arabia gets about $3.1 billion a year in extra revenue, according to Rapidan Energy Group, a Washington consultancy. That cash infusion comes as the Saudi economy goes through a rough patch that shows just how dependent it remains on oil. (…)

Saudi officials are prepared to drive oil prices higher in June when they push for a continuation of OPEC’s output limits with Russia. They have also proposed scrapping the nuclear deal with Iran and reimposing sanctions on its oil, which could drive prices up further. And Saudi officials have privately floated their desire for higher prices in the media, which helps push prices up. (…)

Despite a 50% surge in prices since last year, drilling budgets at the largest global oil-and-gas companies are up only about 7%, according to consultancy Wood Mackenzie. (…)

This chart illustrates the discrepancy between oil consumption and additions to conventional oil reserves since the turn of the century and particularly since 2010.

Production of shale oil has made up for the shortfall so far but if and when the shale revolution starts to fade, the lack of spending on conventional oil exploration will hurt.

• Iran Sanctions Could Raise Oil Prices by $10 a Barrel Should Trump reimpose limits, the global market could lose around one million barrels of oil a day.

U.S. Pushes Nafta Partners to Accept a Wage Floor in Auto Sector

The administration is seeking to complete its overhaul of the North American Free Trade Agreement with new rules that would penalize the Mexican auto industry unless it boosts wages—to roughly $16 an hour. (…)

Robert Lighthizer, the U.S. trade representative and lead negotiator for the Trump administration, is reworking Nafta to require that 40% of the content of any car that trades duty-free within the North American bloc to come from workers who earn above a particular wage level, according to industry officials familiar with the trade negotiations. (…)

Mexican auto assembly workers made less than $8 an hour on average in 2017, with workers at parts plants making less than $4 an hour, according to the Center for Automotive Research. (…)

If the proposals are enacted, the burden for calculating whether a car meets the labor rule would fall largely on auto makers that do the final assembly. The rules could lead to significant costs for auto-parts suppliers as they shift production to help their customers, the big auto makers, meet the rules, in addition to administrative expenses to ensure compliance. (…)

So, the U.S. government will now become involved in foreign wage negotiations, allowing the U.S. automotive industry to boost its own wages knowing that D.C. will protect its competitiveness. Doing so, the government is also upending the whole complex but efficient automotive ecosystem which has provided American consumers with increasingly affordable cars during the past 25 years. Another example of a government  totally oblivious to the impact its micro-management policies will have on all consumers and the overall economy ( e.g.: lumber, aluminum, steel).

• A Nafta Deal in May? Negotiators Will Try, But It Won’t Be Easy

Now this to upset somebody:

China Plans $47 Billion Fund to Boost Semiconductor Industry

SENTIMENT WATCH

Stocks and Bonds Are Going Nowhere, Stranding Investors U.S. stocks and bonds appear deadlocked, reflecting the conflicting impulses of a strong economy against rising interest rates and creeping inflation fears.

• Argentine Market Sours as Rates Soar to 40% Argentina’s currency is reeling and its interest rates have surged to 40%, pummeling investors who piled into a market that had been one of the world’s best performers.

• Both EM local-currency and dollar bonds have taken a hit as debt funds outflows worsened in recent weeks (second chart below).

  

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Source: IIF

A big test of demand for long-dated US government bonds

This week, a new 10Y note of $25B, up from $24B in February will be sold, while the 30Y bond has also been upsized to $17B from $16B.

EARNINGS WATCH

Factset’s summary:

Overall, 81% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 78% have reported actual EPS above the mean EPS estimate, 5% have reported actual EPS equal to the mean EPS estimate, and 16% 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 7.9% 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, 77% of companies have reported actual sales above estimated sales and 23% 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 1.3% 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 24.2% today, which is higher than the earnings growth rate of 18.5% last week.

The blended, year-over-year sales growth rate for the first quarter is 8.5% today, which is higher than the growth rate of 8.2% last week.

At this point in time, 78 companies in the index have issued EPS guidance for Q2 2018. Of these 78 companies, 43 have issued negative EPS guidance and 35 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 55%, which is well below the 5-year average of 74%.

Trailing EPS are now $139.97 per Thomson Reuters. Normalizing for a full 12 months of tax reform (assuming 7% average accretion), trailing earnings are $146.75 and set to exceed $150 after Q2 if current estimates are met. On that basis, the Rule of 20 P/E is 20.2 (19.8 after Q2).

The yellow line below is the Rule of 20 Fair Value [(20 minus inflation) X Trailing EPS]. Currently at 2625, it would rise to 2685 after Q2 and its continued upward slope might prevent a big slippage below 20 like happened in early 2016 (to 18.3). Earnings should keep winning the race against inflation for another 6-9 months, keeping the slope positive.

Being right in the middle of their 15-25 valuation range, equities are now neutral per the Rule of 20 (equal upside to downside).

Using the straight, conventional P/E without considering inflation shows that the current 18.1 trailing P/E remains well above its 13.7 long-term median, even after dropping from 21.7 in January. The P/E would be 17.7 using trailing EPS after Q2 and 16.1 using 2018 EPS of $161, still considerably above its median.

The only two extended periods since WWII when inflation stood consistently below 3.0% were from mid-1958 to mid-1966 and since 2013. In both periods, the trailing P/E generally fluctuated between 16 and 19, averaging 18.2 between 1956 and 1966 (inflation averaged 1.4%) and 17.8 since 2013 (inflation averaged 1.9%). Note that the sum of average P/Es and inflation was 19.6 and 19.7 respectively, once again validating the Rule of 20 as the best gauge for earnings multiple given fluctuating inflation rates over time.

In effect, considering inflation, the current P/E in the 18 range is very much in line with previous valuations during similar inflation periods.

In all, equities are thus currently fairly valued, meaning that the valuation risk is fairly balanced offering similar upside potential and downside risk within the range of normal earnings multiples.

The 7% market setback since January 26, coupled with the 15% advance in trailing earnings, have effectively quickly restored valuations from overvalued to fairly valued. If earnings keep rising faster than inflation, sentiment and liquidity will make equity markets oscillate around their ascending fair value.

TECHNICALS WATCH

Lowry’s Research says that trends since The Feb. 8 and Apr. 2 closes reveal “ a gradual erosion in Supply, a rise in short-term Demand and steady longer-term Demand, all of which are most often associated with a process of investors methodically accumulating stocks. (…) What has been lacking, thus far, though, is a sustained trend of enthusiastic buying (…)”

The S&P 500 Index keeps journeying toward the end of its wedge within its 100d and 200d moving averages, both still rising. Volume seems to be bottoming out.

CFOs Confident About U.S. Fundamentals But Fear Protectionism

Over 60% of chief financial officers surveyed by Zurich Insurance Group AG, Ernst & Young LLP and the Atlantic Council said they are confident or extremely confident about investing in the U.S., while 71% expect the business environment in the country to improve over the next three years. (…)

However, nearly 70% of CFOs said they believe U.S. protectionism will rise in the coming three years, with nearly 50% indicating this would have a negative impact on investments. Nearly two-thirds expect the U.S. government to increase its scrutiny of cross-border mergers and acquisitions while two-thirds forecast more restrictive immigration policies. (…)

Over 40% of CFOs consider such policies as a hindrance for investment, the study said. (…)