LEADING ECON. INDIC.

RECESSION WATCH

U.S. Leading Economic Indicators Rise Moderately; Coincident Indicators Growth Evaporates

The Conference Board’s Composite Index of Leading Economic Indicators increased 0.2% (2.7% y/y) during April following a 0.3% March gain, revised from 0.4%. (…)

The rise in the Leading Indicators was lead by higher stock prices and improved consumer expectations for business/economic conditions. Fewer initial claims for unemployment insurance, more orders for consumer goods & materials, an increased number of building permits and a steeper yield spread between 10-year Treasuries and Fed Funds also contributed positively to the index rise. A lower ISM new orders index and fewer nondefense capital goods orders contributed negatively. The length of the average workweek had no effect on the leading index change.

Three-month growth in the leading index improved to 2.5% (AR) from little change between December and February.

The Index of Coincident Economic Indicators edged 0.1% higher (1.8% y/y) for the second straight month. The change in personal income less transfer payments, nonagricultural payroll employment and manufacturing & trade sales contributed positively to the index change. Industrial production growth had a negative effect for the third month in the last four.

Three-month growth in the coincident index of 0.4% (AR) was below 3.1% late in 2018.

The Index of Lagging Economic Indicators edged 0.1% lower last month (+2.7% y/y) following firm gains during Q4’18 and Q1’19. The average duration of unemployment, fewer commercial & industrial loans outstanding and growth in unit labor costs contributed negatively to the index change. The ratio of consumer credit outstanding-to-personal income, six-month growth in the services CPI and the business inventory-to-sales ratio had positive effects on the index change. The average prime rate charged by banks was unchanged for the third straight month.

Three-month growth in the lagging index fell sharply to 1.5% (AR) from 5.4% at yearend.

The ratio of coincident-to-lagging economic indicators is sometimes considered a leading indicator of economic activity. It continued its long-lived sideways movement during April.

Advisor Perspectives’ charts offer some perspective:

The 12-m chart looks pretty safe but things are getting dicier when looking at the 6-m chart:

This one has not plunged just yet as it typically does prior to recessions:

 Millennial Home Buyers Might Never Come Knocking

(…) The homeownership rate among households headed by someone under 35 was 35.4% as of the first quarter, according to the Census Bureau. In 1999 that level was about 40%.

A case can be made that the millennial wave has merely been delayed. The recession that ended in 2009 was unusually severe, and it hit millennials particularly hard, just as many of them were entering the workforce. (…) As a result of millennials’ delayed entry into the workforce, it is probably taking them longer to develop the financial wherewithal to buy a home.

Many also are saddled with higher levels of student debt than previous generations, making mortgage approvals more daunting. Moreover, the tough labor market they faced early in their careers may have delayed other life events that often coincide with the decision to own a home. Compared with previous generations, for example, millennials have been getting married and having children later.

Some of the scars left by the financial crisis may never fully fade, though, limiting the number of millennials who achieve homeownership at any point in their lives. (…) Like previous generations who came of age during hard economic times, they may be less willing to take on financial risks than people born in more prosperous periods. (…)

A greater preference for urban living also could make millennials less likely to become homeowners than previous generations. (…) Home prices are, of course, substantially higher in many cities than in outlying areas, and while the higher incomes offered by urban jobs help mitigate that, for many city-dwelling people they remain out of reach. Only 33% of New York City homes are owner-occupied, for example, compared with 64% nationally. (…)

Another argument is that there is a clear shortage of affordable entry-level homes in areas where millennials aspire to live because the economics simply don’t work for builders given the costs of materials, labor and municipal regulations.

• ‘Playing Catch-Up in the Game of Life.’ Millennials Approach Middle Age in Crisis  New data show they’re in worse financial shape than every preceding living generation, and may never recover. Their woes have delayed traditional adult milestones in ways expected to alter the nation’s demographic and economic contours.

(…) millennial households had an average net worth of about $92,000 in 2016, nearly 40% less than Gen X households in 2001, adjusted for inflation, and about 20% less than baby boomer households in 1989.

Wages didn’t look much better. At the same ages, Gen X men working full time and who were heads of households earned 18% more than their millennial counterparts, and baby boomer men earned 27% more, when adjusting for inflation, age and other socioeconomic variables.

Among women, incomes were 12% higher for Gen Xers and 24% higher for baby boomers than for millennials, using the same measures. (…)

About one third of millennials owned homes in 2016, compared with half of Gen Xers at similar ages in 2001, and just under half of baby boomers in 1989 (…) The St. Louis Fed found the median wealth of a family headed by someone born in the 1980s was a third below the level that they would expect, compared with earlier generations at the same age and adjusted for inflation.

The regional Fed bank concluded that people born in the 1980s are at risk of becoming America’s lost generation, Mr. Emmons said, men and women who feel an almost insurmountable burden to catch up financially. (…)

A Gallup poll last summer found that millennials were the only generation that favored socialism over capitalism by a slight margin. (…) Tough times for millennials struggling to reach a more comfortable middle-class life have triggered support for populist candidates and promises of universal health care and free college education. (…)

Meanwhile

Trump Moves to Ease Other Trade Tensions Amid China Impasse With U.S.-China trade talks at an impasse, President Trump moved to tackle trade disputes with U.S. allies and North American neighbors. The administration agreed to end metals tariffs on Canada and Mexico, and postponed a decision on auto tariffs.

(…) Mr. Trump said the U.S. had reached a deal to exempt Canada and Mexico from tariffs on steel and aluminum that were imposed last year. The action is expected to help clear one of the stumbling blocks for ratification of the U.S.-Mexico-Canada Agreement that was negotiated by the Trump administration last year. (…)

“Just reached an agreement with Canada and Mexico, and we will be selling our product into those countries without the imposition of tariffs or major tariffs,” Mr. Trump said. (…)

For now, the U.S. tariffs remain in place against other trading partners, including China and the European Union. A number of other countries, such as Argentina, Brazil and South Korea, agreed to steel quotas in exchange for avoiding the tariffs. (…)

Just curious: what did Trump achieved with these tariffs? What did the U.S. gain here after warring during 11 months with its closest allies? The truth is that America has not won a single war since WWII and does not seem about to win its trade wars as well.

(…) After a months-long deadlock at the bargaining table, the deal came together in a matter of days as Mr. Trump faced increasing economic pressure in his war with China and escalating anger from his own Republican congressional caucus, which insisted it would not ratify the renegotiated NAFTA as long as the tariffs on Canada and Mexico remained.

The breakthrough came when the U.S. dropped its key demand that Canada and Mexico accept quotas capping their metals exports. (…) (Globe and Mail)

Wait, wait!

(…) The new Nafta deal is still a long way from having the votes to pass, and Democrats want to rewrite the labor and drug-patent provisions, but at least the pact won’t fail because of Trump Administration steel-tariff suicide.

The step backward is that Friday’s tariff-lifting deal allows the U.S. to re-impose the tariffs if either aluminum or steel imports “surge meaningfully beyond historic volumes of trade over a period of time, with consideration of market share, ” according to the joint U.S.-Canada statement.

This is a U.S. warning to Canada in particular to restrain its exports, since the word “meaningfully” is likely to be defined by the U.S. steel and aluminum industries. They’ll complain to the White House at the first sign of price and supply competition and call it a “surge.” (…) (WSJ)

U.S., China bicker over ‘extravagant expectations’ on trade deal

China accused the United States on Monday of harboring “extravagant expectations” for a trade deal, underlining the gulf between the two sides as U.S. action against China’s technology giant Huawei began hitting the global tech sector. (…)

In an interview with Fox News Channel recorded last week and aired on Sunday night, Trump said the United States and China “had a very strong deal, we had a good deal, and they changed it. And I said ‘that’s OK, we’re going to tariff their products’.”

In Beijing, Chinese Foreign Ministry spokesman Lu Kang said he didn’t know what Trump was talking about.

“We don’t know what this agreement is the United States is talking about. Perhaps the United States has an agreement they all along had extravagant expectations for, but it’s certainly not a so-called agreement that China agreed to,” he told a daily news briefing.

The reason the last round of China-U.S. talks did not reach an agreement is because the United States tried “to achieve unreasonable interests through extreme pressure”, Lu said.”From the start this wouldn’t work.” (…)

But [Trump] said that he had told Chinese President Xi Jinping before the most recent rounds of talks that any deal could not be “50-50” between the two countries and had to be more in favor of the United States because of past trade practices by China.

As China Trade War Boils, Trump Courts a Favorite Punching Bag

With his trade war with China heating up, Donald Trump is suddenly talking up a quick deal with Japan to help out ailing American farmers. Yet leaders in Tokyo are in no rush to assist a U.S. president who has repeatedly threatened them with higher tariffs.

Trump is expected to mention his desire for an early harvest trade deal in Tokyo next week, when he will be the first foreign leader to meet Japan’s new emperor. Ahead of that, he’s expected to sign an order giving Japan and the EU 180 days to “limit or restrict” sales of automobiles and their parts into the U.S. in return for delaying new auto tariffs, Bloomberg reported Thursday. (…)

The development marks a shift from when Trump took office in 2017 and pulled out of the Trans-Pacific Partnership, which was a 12-country trade agreement backed by Japan. (…)

Japan is holding upper-house elections in July and before that it’s politically sensitive — and maybe impossible — for Abe to concede anything, much less on agriculture. (…)

Besides the trade fight, the Trump administration is said to be preparing to seek more money from Japan for hosting U.S. troops. (…)

• Toyota Miffed After Trump Sends Message Saying Carmaker ‘Not Welcomed’ in U.S.

(…) In an unusually strong-worded statement, Japan’s largest automaker said Trump’s proclamation Friday that the U.S. needs to defend itself against foreign cars and components “sends a message to Toyota that our investments are not welcomed.” The company said it has spent more than $60 billion building operations in the country, including 10 manufacturing plants. (…)

The pushback by Toyota marks a break from years of attempting to work its way into Trump’s good graces. (…)

U.S. may scale back Huawei trade restrictions to help existing customers

(…) The Commerce Department, which had effectively halted Huawei’s ability to buy American-made parts and components, is considering issuing a temporary general license to “prevent the interruption of existing network operations and equipment,” a spokeswoman said.

Potential beneficiaries of the license could, for example, include internet access and mobile phone service providers in thinly populated places such as Wyoming and eastern Oregon that purchased network equipment from Huawei in recent years.

In effect, the Commerce Department would allow Huawei to purchase U.S. goods so it can help existing customers maintain the reliability of networks and equipment, but the Chinese firm still would not be allowed to buy American parts and components to manufacture new products. (…)

• Top U.S. Tech Companies Begin to Cut Off Vital Huawei Supplies

Chipmakers including Intel Corp., Qualcomm Inc., Xilinx Inc. and Broadcom Inc. have told their employees they will not supply Huawei till further notice, according to people familiar with their actions. (…) Germany’s Infineon Technologies AG fell in early trading Monday after the Nikkei reported it halted shipments to the Chinese company in the wake of the U.S. ban. Shares of STMicroelectronics NV and Austrian-based AMS AG were also hit. (…)

Blocking the sale to Huawei of critical components could also disrupt the businesses of American chip giants like Micron Technology Inc. and retard the rollout of critical 5G wireless networks worldwide — including in China. That in turn could hurt U.S. companies that are increasingly reliant on the world’s second largest economy for growth. (…)

Huawei is said to have stockpiled enough chips and other vital components to keep its business running for at least three months. It’s been preparing for such an eventuality since at least the middle of 2018, hoarding components while designing its own chips, people familiar with the matter said. (…)

FYI, Apple derives between 10% and 13% of its quarterly revenues from China.

• Google Bans Huawei Phones From Some Android Services Google is halting some services for smartphones made by Huawei, a sign that the U.S. decision to deny the Chinese tech giant access to U.S. technology will bite into its booming consumer-device business.

• Forced Tech Transfers Are on the Rise in China, European Firms Say The practice has become more widespread despite official assurances from Beijing it would be stopped

(…) Such technology transfers have continued to take place despite official assurances that this practice would be stopped, according to an annual survey by the European Union Chamber of Commerce in China, with 20% of the survey’s 585 participants saying they have felt compelled to transfer technology to maintain market access, up from 10% in 2017.

Foreign ministry spokesman Lu Kang said the foreign-investment law stipulates that no administrative measures can be taken to force technology transfer.

“If those companies truly have such concerns, I hope they can provide concrete evidence. If their concerns are legitimate and fact-based, it can be totally addressed, because we clearly have this policy. But without any proof, you cannot just invent that from thin air,” he said. (…)

The chamber noted that technology transfer requirements were particularly apparent in joint ventures with state-owned enterprises as partners, and that the problem affects companies making everything from chemicals to medical devices. Government metrics reward local companies for attracting new international technology, while rules sometimes require a foreign company to produce its product in China to sell it, making such transfers “a requirement of doing business in China,” respondents told the chamber. (…)

European firms have argued that the competitive landscape in China has shifted dramatically in the last two years, with 62% of respondents reporting that Chinese firms were just as innovative as European firms, or even more so. (…)

The NDX has performed well since the December trough, exceeding its previous high by a wider margin than the SPY. Its equal-weight index did even better but is now showing poor breadth:

 

Trump Isolated on Iran as World Sees Confusion in U.S. Strategy

• China Vows Support for Iran Amid Sanctions Dispute With U.S.

Just curious: anybody sees a clear and coherent strategy in all these confrontations?

A new battlefront to protect farmers?

• Big Food jumps on the ‘plant-based’ bandwagon Boom in meat and dairy substitutes sets up ‘battle for the centre of the plate’

EARNINGS WATCH

The facts (Refinitiv/IBES data)

• Through May 17, 460 companies in the S&P 500 Index have reported earnings for Q1 2019. Of these companies, 75.2% reported earnings above analyst expectations and 18.5% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 21% miss estimates. Over the past four quarters, 76% of companies beat the estimates and 17% missed estimates.
• In aggregate, companies are reporting earnings that are 6.1% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.2% and the average surprise factor over the prior four quarters of 5.4%. Remarkably, all sectors have positively surprised with the median surprise at +5.5%.
• The estimated earnings growth rate for the S&P 500 for 19Q1 is 1.4%. If the energy sector is excluded, the growth rate improves to 2.8%.
• Of these companies, 56.6% reported revenues above analyst expectations and 43.4% reported revenues below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 67% of companies beat the estimates and 33% missed estimates.
• In aggregate, companies are reporting revenues that are 0.9% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 1.1%.
• The estimated revenue growth rate for the S&P 500 for 19Q1 is 5.6%. If the energy sector is excluded, the growth rate improves to 6.2%.
• Trailing EPS are now $163.81.
• Corporate pre-announcements are about in line with Q1’19 at the same time.

Analysts keep revising S&P 500 earnings upwards…but not future earnings as the estimated earnings growth rate for the S&P 500 for 19Q2 remains stuck at +1.1%. If the energy sector is excluded, the growth rate improves to +1.2%.

Estimates for non-S&P 500 companies are ratcheted lower, however:

Which helps explain this:

Yes, earnings matter, if not all of the time, then eventually.

The Renaissance IPO ETF has v-shaped in the last 12 months, offering few technical clues as to its forward direction.

Lyft seems to have lost track of its destination having collapsed 25% since lift-off. Uber initially went what it thought was a safer route, pricing well below its intended valuation. It nonetheless sunk 20% after opening and now sits 7% below its departure gate. Last week, Avantor (AVTR), a manufacturer and distributor of laboratory supplies, IPO’ed with an $8.4B valuation, pricing at $14 per share, the low end of the revised range of $14 to $15, and 28% below the midpoint of its original range of $18 to $20. It’s now $14.50.

Amid the US-China trade fight, Luckin Coffee (LK), a Chinese coffee retailer, came to market with a $4.2 billion valuation at $17, sold 3 million more shares than originally planned while pricing at the high end of the range of $15 to $17. It closed at $20 last Friday. Luckin plans to surpass Starbucks as the largest coffee chain in China by the end of 2019. Note that the company has been in operation for less than two years! It had less than $1 million in revenue in 2017 but $125 million in 2018. SBUX has opened 3700 stores during its 20-year existence in China. LK now has 2,370 stores and plans to add 2,500 this year alone. At its current valuation of $5.6B, LK sells at 45 times last year’s revenues, but only 22 times if revenues double along with the store count. Oh!, forgot to mention that LK lost $241 million in 2018. But who cares!

FYI, China accounts for 13% of Starbucks’ worldwide stores.

TECHNICALS WATCH

Lowry’s Research remains positive on equities, seeing “ample evidence that a short term low may be in place. However, since the conditions are less than ideal, investors should look for additional signs of Demand, like increased Up Volume for further confirmation.”

I keep watching Lowry’s Buying Power vs Selling Pressure indicators. “Buying Power remains in a short term downtrend as Selling Pressure remains in a short-term uptrend.” The convergence of these two indices to a near crossing is certainly “less than ideal” for any new commitment. Since equity markets have shown a clear sensitivity to trends in the tariffs war, it seems prudent to have some dry powder here.

Also back to last October’s levels:

• The Emerging Bear:

Sentimentrader’s Smart Money/Dumb Money chart shows a convergence similar to Lowry’s Demand/Supply trends:

TOO LEVERAGED TO TIGHTEN

Adding to IN GODS WE TRUST, David Hay, CIO at Evergreen/Gavekal (the whole piece is well worth reading):

(…) The March 22nd Grant’s Interest Rate Observer (GIRO, not to be confused with gyro), beloved by many of the planet’s most illustrious investors, noted that among the best reflectors of the junk debt market’s “quality”, so to speak, is the overall percentage of high yield that is rated CCC to C. This the lowest rung outside of those already in default. Prior to the onset of the Great Recession, roughly 29% of the junk market was in this lowly category. As of January of this year, it amounted to nearly 44% of the total. That’s obviously an eye-popping number. (…)

But as the GIRO article quoted Marty Fridson, widely considered to be THE authority on high yield debt, this is a big deal, and a bad one at that: “But let’s not even consider the further increase in the CCC to C component that’s likely to occur by the time the next recession commences…The predicted one-year default rate from this calculation is 15.63%. That compares with a 12.1% peak calendar-year default rate in 2009.” In other words, there is a very real potential for the junk bond market’s breaking-bad rate to exceed that seen during the worst economic collapse since the 1930s. No wonder the Fed is belatedly suddenly waking up to this looming calamity. (…)

Evan Lorenz from GIRO wrote on that topic in their March 22nd edition. To wit: “A blow-up in high yield (junk) defaults would cause special problems for such ETFs** as the Invesco Senior Loan ETF (BKLN) and the iShares iBoxx High Yield ETF (HYG)…(the underlying) loans and bonds are notoriously illiquid—they trade by appointment—whereas the sponsors of BKLN and HYG promise their investors daily liquidity.” (…)

My key point in this regard is that both stock and corporate bond investors are much too relaxed about the risks of recession to companies’ profits and balance sheets. Thus, should the threat of a contraction continue to rise—very much a non-consensus view at this time—the reaction could be as violent as it was six months ago. (…)

Moody’s has also observed that ETF investors “may be in for a shock during the next sustained market rout”. They opine that this is especially the case with ETFs that hold lightly-traded securities such as corporate bonds and loans. This could lead to a potentially jarring collision between perceptions and reality. ETF investors think they can get out of even junk bond and sub-investment grade bank loan ETFs on a moment’s notice. To a point that’s true. If they hit the sell button at their on-line broker, they’ll be out instantly. But if they do so during another period of mass liquidation, they’ll get a horrible execution price. In my opinion, this is almost certain to happen in the not too distant future, particularly given that corporate bond volumes have contracted so dramatically in recent years. For example, since 2014 junk bond trading volumes have vaporized by 80%. Thus, the bond market is dangerously illiquid these days, a fact many others have noted, including my close friend, Louis Gave. (…)

Importantly, the municipal bond market also has all the makings of another credit cataclysm. One of the biggest victims of our interest-rates-gone-missing times are state and local governments, the issuers of tax-free debt. The financially frailest states and municipalities also tend to be the ones, logically, with the largest unfunded retirement liabilities. Rock-bottom interest rates greatly exacerbate these short-falls.

It’s nearly certain that during the next recession these entities will become even more stressed and a number may actually default. Yet, if you look at the largest municipal bond ETF, it is chock full of bonds from regions of the country that have future financial crisis written all over them. (By the way, I would include California in that category even though it looks healthy for now. Over the years, it has made its tax base increasingly vulnerable to the next bear market in stocks and real estate.) (…)

In conclusion, if you are planning on riding out the next stock bear market–and the likely simultaneous recession–in corporate and/or municipal bond funds, you may have a nasty surprise headed your way. Even if you are averse to active equity management, you may want to think long and hard about having your bonds managed by someone who actually thinks. In good times, brain-free investing is tough to beat. But when the hurricane makes landfall, you better have a portfolio built with careful thought—and not loaded up with what everyone else owns.