Month: December 2019

Trump Agrees to Limited China Trade Deal

Michael Pillsbury, an adviser to the president, said he spoke with Mr. Trump, who said the deal calls for China to buy $50 billion worth of agricultural goods in 2020, along with energy and other goods. In exchange the U.S. would reduce the tariff rate on many Chinese imports, which now ranges from 15% to 25%.

The Wall Street Journal reported earlier Thursday that the U.S. side has offered to slash existing tariff rates by half on roughly $360 billion in Chinese-made goods, in addition to canceling the tariffs on $156 billion in goods that Mr. Trump had threatened to impose on Sunday. That offer was made to Beijing in the past five days or so.

Should Beijing fail to make the purchases it has agreed to, original tariff rates would be reimposed. Trade experts call that a “snapback” provision, though the president didn’t use that term, Mr. Pillsbury said.

In what Mr. Pillsbury described as a “goodwill gesture,” the U.S. plans to announce some tariff rate cuts on Friday. “The president is upbeat and enthusiastic about his breakthrough,” according to Mr. Pillsbury, a China scholar at the Hudson Institute who advises the Trump administration. (…)

The phase one deal with China, if completed, would cover only a small portion of the U.S. complaints against China’s trade practices, leaving largely untouched such fundamental issues as subsidies and Chinese pressure on American firms to share technology. Many in the U.S. business community remain skeptical that discussions on phase two or phase three deals will bear fruit.

In recent months, the U.S. has been collecting about $5 billion a month from the tariffs on China, which are paid by U.S. importers. If all the tariff rates were cut in half, it would save American companies about $2.5 billion a month, or $30 billion a year, in tariff payments.

Gregory Daco, chief U.S. economist at Oxford Economics, estimates that cutting the tariffs by half would boost U.S. economic growth by about 0.2 percentage points next year, but cautioned that uncertainty would likely linger.

“Importantly, we can’t reverse the damage already done by the two-year long trade war, nor omit the dense fog of uncertainty that will continue to restrain business and consumer activity in 2020,” Mr. Daco said. (…)

• China Offers No Confirmation on U.S. Trade Deal

China indicated that a near-term trade agreement with the U.S. has yet to be completed despite President Trump’s signoff, highlighting the unpredictability of a negotiation process that has rattled global markets and businesses. (…)

None of China’s state-owned media outlets or economic agencies involved in the trade negotiations made any public statement on Friday about the deal endorsed by Mr. Trump. At a regular news briefing, Foreign Ministry spokeswoman Hua Chunying referred only to how news of the agreement helped fuel a surge in U.S. and European stocks. It also lifted Chinese shares. Pointedly, Ms. Hua didn’t confirm the existence of a deal. (…)

Beijing walked away from a nearly completed deal in early May because the leadership felt that the text of the agreement was too lopsided in Washington’s favor. That led the Trump administration to ramp up its trade war with China, putting a drag on the world economy. (…)

Markets Get a Dose of Clarity. It May Not Last The U.K. must now negotiate a free-trade deal with the EU, while in the U.S. there is the small matter of a presidential election.

John Authers talks currencies:

(…) The result is unambiguously positive for British assets, although currency effects may be troublesome for U.K. investors. The huge rise in the pound won’t flatter the foreign earnings of the multinationals that dominate the FTSE-100. (…)

The case in favor of sterling bulls is that a negotiated Brexit is now assured. The risk of another year of political uncertainty is over, along with the risk of a weak minority government led by a very ideological Labour party. Johnson has to negotiate a free trade agreement with the EU by the end of next year; but the argument is that his standing is now so enhanced, and the nature of the MPs he commands (many of them from industrial heartland seats who know that they have to deliver for their working-class electorate) is so changed that he won’t do anything that damages the British manufacturing sector. That means an extension is likely, to be followed by a deal that is reasonably favorable to the auto sector and other British exporters. Meanwhile, Johnson plainly favors fiscal stimulus. Investors, like British voters, agree that this is a good idea.

This bullish case is fair as far as it goes, but ignores plenty of risks. Services are more important to the British economy than manufacturing, and the EU is unlikely to want to do any favors to the City of London. The rise in sterling takes away one of the advantages that has tided the U.K. through the political chaos of the last few years — the competitiveness that comes with a weak currency. (…)

A weaker dollar is exactly what President Trump has vocally wanted. On a trade-weighted basis the dollar is clearly below its 200-day moving average, bolstering both American competitiveness and the financial position of the many emerging markets that have taken on dollar-denominated debt. It also lightens pressure on the Fed to cut rates further, which will bolster confidence. (…)

A weaker dollar should help U.S. stocks by flattering the overseas profits of the companies in the S&P 500. (…)

A weaker dollar, growing faith in the avoidance of trade conflict, and signs of improvement in the eurozone should all help the rest of the world to fight back. Valuation disparities should also help: American stocks look far too expensive, and much of the rest of the world looks cheap. True, this has looked like a good bet for a long time and it hasn’t happened, but this is another chance (…)

This BAML chart (via Isabelnet) supports Authers’ hopes:

Ed Yardeni shows how different perspectives (scales) can affect the view.

There is also the matter of earnings. Earnings do matter:

Analysts clearly tend to overpromise and underdeliver:

Ex-MSCI P/Es are indeed low in absolute terms, but not relative to their history:

A lower USD would help S&P 500 earnings.

And, there is still Brexit, the Eurozone mess, China, Japan…

U.S. Producer Prices Are Unexpectedly Tame; Core Prices Weaken

The Producer Price Index for final demand was unchanged during November (1.1% y/y) following a 0.4% October rise. (…) Producer prices excluding food & energy declined 0.2% last month (+1.3% y/y) after rising 0.3%. (…) The PPI excluding food, beverages and trade services, another measure of underlying price inflation, held steady last month (1.3% y/y) after a 0.1% October gain.

Food prices jumped 1.1% (3.2% y/y) and added to a 1.3% October increase. Higher prices for beef & veal led the increase as they surged 5.4% (4.8% y/y), and dairy product costs improved 1.6% (7.7% y/y). (…)

Finished consumer goods prices less food & energy rose 0.2% (1.6% y/y) after a 0.1% uptick. (…)

Services prices for final demand declined 0.3% (+1.4% y/y) and reversed October’s increase. (…)

S&P 500 P/Es at 3180:

• on known trailing EPS:

• on estimated forward EPS:

• on known trailing EPS and inflation:

Federal Reserve Keeps Interest Rates Steady, Sees Long Pause Officials indicate comfort with leaving policy on hold through next year, while keeping eye on economy

(…) “Our economic outlook remains a favorable one,” said Fed Chairman Jerome Powell. The rate-setting committee voted 10-0 to leave the central bank’s benchmark rate in a range between 1.5% and 1.75%, the first unanimous vote since May.

New projections released after the meeting showed most officials think rates are low enough to stimulate growth. If their favorable outlook holds, most expect they could leave rates unchanged through 2020. In that scenario, most see the Fed raising rates once or twice after that. (…)

“As you can see, inflation is barely moving, notwithstanding that employment is at 50-year lows—and expected to remain there,” Mr. Powell said. “And so the need for rate increases is less.” (…)

“I would want to see a…significant move up in inflation that’s also persistent before raising rates to address inflation,” he said. (…)

The FOMC’s official forecast is for core personal consumption expenditures (PCE) at +1.6% in 2019, 1.9% in 2020 and 2% by 2021.

Inflation Isn’t Likely to Take Off Anytime Soon

Consumer prices rose at a 2.1% annual pace in November, from 1.8% in October, mainly due to higher energy and shelter costs, the Labor Department said Wednesday.

Meanwhile, U.S. unit labor costs—a measure of labor costs and production output—were revised down sharply for the second and third quarters in a Tuesday productivity report.

The readings suggest that companies have less pricing power because of factors including globalization and consumers’ growing tendency toward comparison shopping, say economists, who expect these trends to continue even though U.S. unemployment is at historic lows and companies face higher prices for some products tied to tariffs. (…)

The Cleveland Fed’s Median CPI measure is steady at +2.4% annualized but the 16% trimmed-mean CPI is stuck in the 3.0-3.5% range:

The Atlanta Fed’s sticky/flexible CPI provides another perspective on inflation trends: Sticky Prices (total is same as core) are now up 2.8% YoY, up from 2.1% one year ago and 2.4% last June. Flexible Prices have decelerated from the 2.0-3.0% range of 2017-18 to –0.5-+0.5% in 2019 while Flexible Core prices have slowly accelerated from negative to between 0% and 1.0% in the last 12 months.

Given the FOMC’s focus on inflation expectations, the Atlanta Fed’s analysis is interesting:

(…) because sticky
prices are slow to change, it seems reasonable to assume
that when these prices are set, they incorporate expectations
about future inflation to a greater degree than prices that
change on a frequent basis. (…) the evidence
indicates that the flexible-price measure is, in fact, much
more responsive to changes in the economic environment—
slack—while the sticky-price variant appears to be more
forward looking. (…)

In terms of the overall, or “headline”
CPI, we judge that about 70 percent of it is composed of
sticky-price goods and 30 percent of flexible-price goods.
About half of the flexible-price CPI comprises food and
energy goods, the remainder being largely autos, apparel,
and lodging away from home. The sticky-price CPI includes
many service-based categories, including medical services,
education, and personal care services, as well as most of
the housing categories which, by construction, change only
infrequently. (…)

We find that forecasts of the headline CPI that are based
on the sticky-price data tend to be more accurate than the
forecasts based on headline inflation. Further, CPI predictions
using sticky-price data perform pretty well relative to
CPI forecasts using core CPI data. (…)

So we have 70% of the CPI, the sticky part, rising 2.8% YoY in November and trending up, muted down to the 2.0% range by Flexible Prices hovering around zero.

Conclusion: total inflation is not accelerating but one should be flexible on that…

For the Rule of 20 Valuation Barometer, the inflation component declined from 2.4% to 2.3% in November but, based on the above, it seems unlikely to provide much upside to P/E ratios in the near future. This is happening when trailing EPS are flat to down, creating a widening gap between Fair Value (yellow line) and the Index (blue) with valuation into the “Rising Risk” area. With little or no backwind, the ship must stay away from reefs and unamicable environments…

• The 13/34–Week EMA Trend Chart (CMG Wealth) remains positive: