Investor Sentiment

Posted yesterday: TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL

Consumers Cool U.S. Economic Growth, but Business Thrives Economic growth slowed in the first quarter, as consumers reined in spending even after tax cuts fattened the wallets of many households.

Gross domestic product—the value of all goods and services produced in the U.S., adjusted for inflation—expanded at an annual rate of 2.3% for the months January through March to $17.4 trillion, the Commerce Department said Friday. That marked a slowdown from the 3% growth rate registered during the final nine months of 2017. (…)

The annual growth rate has been below 2% on average since 2000. (…)

Nonresidential fixed investment, reflecting business investment in buildings, equipment, software and more, grew at a 6.1% rate. That was faster than the expansion’s 4.6% average. Business investment is a key driver of worker productivity and longer-run wage growth. (…)

Household outlays increased at a 1.1% rate in the first quarter, pulling back from the fourth quarter, when they rose at a 4.0% rate on strong holiday spending and consumers replacing property such as cars damaged by late-summer hurricanes. The saving rate rose from the fourth quarter to the first, meaning households pocketed added disposable income from tax cuts rather than spending it.

The price index for personal-consumption expenditures increased at a 2.7% pace in the first quarter, matching the fourth quarter’s pace. Core prices, which exclude volatile food and energy categories, rose at a 2.5% rate. (…)

Core PCE, the Fed’s preferred inflation gauge, went from +1.3% annualized in Q3’17 to +1.9% in Q4’17 to +2.5% in Q1’18. It is still +1.7% YoY in Q1’18 but that infers that March was +2.0% following January and February at +1.5% and +1.6% respectively. This is a scary acceleration!

In this table from Advisor Perspectives, the last column should read 2018 Q1. Note how weak Durable Goods were in Q1’18 after the strong, hurricanes-induced, Q4’17 but even averaging the last 2 quarters we only get +0.35% quarterly or +1.5% annualized, down from +2.4% annualized in Q2-Q3’17. Also note the very weak Nondurables.

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  Heard on the Street: Americans Are Getting Paid More but Aren’t Spending It

The Labor Department on Friday reported that the employee cost index—its comprehensive measure of pay and benefits—was up 2.7% from year earlier. That was its biggest gain since 2008.

That increase doesn’t reflect the extra money many people are taking home as a result of the tax cut.

(…) it is possible that households have reached a transition point where they will be devoting more of what they make toward saving and paying down debt.

Indeed, while the personal saving rate—the share of after-tax income that doesn’t get spent—rose to 3.1% from 2.6% in the first quarter, the savings rate was above 5% just two years ago. (…)

MORE ON U.S. INFLATION

After this morning’s consensus-topping GDP data, which showed real growth of 2.3% annualized in Q1, the U.S. output gap is now almost closed according to Congressional Budget Office estimates of potential. In theory, that means price pressures will intensify. True, the Fed’s preferred measure of inflation, the core PCE deflator, currently shows an annual inflation rate of less than 2%. But expect the latter to rise as the output gap eventually moves into positive territory. Also warranting optimism that the Fed will finally hit its 2% inflation target is the tightening labour market which is pushing up costs. As today’s Hot Charts show, the private sector’s employment cost index, which takes into account wages, salaries and benefits, rose again in Q1 and is now growing at the fastest pace since 2008. (NBF)

EVEN MORE ON U.S. INFLATION

Sorry to insist but Friday also saw the release of the all inclusive (wages and benefits) Employment Cost Index for Q1’18: +0.84% QoQ = +3.4% annualized. YoY it is +2.7% (private companies: +2.9%), from +2.4% (+2.6%) one year ago and +1.9% (+2.0%) two years ago.

Pretty clear trend, even scarier given current low unemployment rate and ever rising labor shortage. Note how private wages have started to increasingly outpace total wages.

Companies are loosening up on wages seeing their improved pricing power.

The Fed could well find itself way behind the curve pretty soon.

• Inflation Upturn Could Force Fed to Clarify Rate Intentions As prices and wages climb, tough talks loom on whether enough is being done to contain inflation

(…) Projections released at their meeting last month show all 15 participants expected annual core inflation of at least 2% by 2020, and more than half of them see it rising to at least 2.1% next year and staying there through 2020.

This was the first time officials have projected inflation exceeding the Fed’s 2% target, signaling they don’t expect to pick up the pace of rate increases in the case of a modest and temporary overshoot. (…)

Still, officials haven’t said how much or for how long they would let inflation go above 2% before moving to raise rates more aggressively to bring it down. “We haven’t agreed on that,” said Fed Chairman Jerome Powell at a news conference last month. (…)

• Fed Far From Ready to Declare Mission Accomplished on Inflation

Initial unemployment claims

cratered to 209k last week. The four-week moving average is now 229k (-14% YoY), almost a 50-year low (1969!). Relative to the labor force, we are in uncharted territory with 12 million workers (annualized) claiming new unemployment insurance payments, a low 1.4% of the labor force. It won’t be long the U.S. will run out of unemployeds.

Maybe Congress will wonder why maintain this costly program for such a small slice of the population. After all, the Administration, in its infinite wisdom and always caring for the bottom 90%, recently proposed to change the food stamp program to save some $13B per year distributed to some 42 million Americans.

“Under the proposal, households receiving $90 or more per month in SNAP benefits will receive a portion of their benefits in the form of a USDA Foods package, which would include items such as shelf-stable milk, ready to eat cereals, pasta, peanut butter, beans and canned fruit, vegetables, and meat, poultry or fish,” the budget reads.

According to the Department of Agriculture, the program would send food boxes to 16.4 million households, representing 81% of SNAP households. The boxes would account for half of the benefits for the household and the rest would be put on their Electronic Benefit Transfer card.

The USPS, which, during the 1990s, lost volume from the monthly food stamp checks going electronic, could make up for it with food boxes sent monthly throughout the USA. No doubt the USPS can deal with all the logistical challenges in a snap! What kind of food in the box? Which producers? Size? Dietary issues? Etc. Plus these mundane issues:

Would boxes be delivered door-to-door? Would people have to be home to receive Harvest boxes — a likely challenge for shift workers? Or would people have to visit a distribution center? What happens to elderly or disabled individuals? What about transportation costs, or accessibility, particularly in rural areas?

Harvest boxes would also be less reliable, because delivery can easily be interrupted while transferring benefits to a debit card rarely is. This is particularly relevant during events such as natural disasters, which Vollinger says SNAP has tackled effectively because of its ability to electronically distribute emergency benefits through EBT. (Vox)

But these are boring matters for another day.

Allow me this last one from this WSJ article Energy, a Bright Spot in Nafta Talks, Bogged Down by Dispute Over Rule Change

(…) U.S. businesses, however, including some energy companies, are balking at Washington’s pursuit of an unrelated rule change that would weaken or end Nafta’s protection of U.S. investments in Mexico or Canada from government intervention.

At issue is the Investor-State Dispute Settlement, which allows a U.S. business to take legal action if a foreign government harms the company’s investment in that country. For example, if the Mexican government nationalized, say, a U.S-owned oilrig in Mexico, the measure would give the American company the right to appeal to adjudicating panels set up under Nafta.

The protections are valued by a variety of U.S. industries, from manufacturing to financial services. But they are especially vital to the U.S. energy sector. Energy sector investments typically require substantial investment “before the first barrel comes out,” said Mexican Finance Minister José Antonio González Anaya, a former chief of Mexico’s state oil giant Petróleos Mexicanos, in an interview.

U.S. Trade Representative Robert Lighthizer is proposing the three member countries eliminate the Nafta protections, saying they create an incentive for U.S. companies to invest internationally and move jobs overseas. “Why is it a good policy of the United States government to encourage investment in Mexico?,” asked Mr. Lighthizer at a Congressional forum late last year. (…)

Yes! Why is it a good policy for any government to put their citizens at legal and financial risks in order to coerce them into investing only where Big Brother deems acceptable?

This is the same Lighthizer, totally focused on autos and steel, who renegotiated the “horrible” trade agreement with South Korea, claiming victory for

(…) extending the 25% U.S. tariff on Korean truck exports for another 20 years through 2041. This is the upside down world of Trump trade logic in which punishing American consumers with higher prices is a virtue. The tariff had been scheduled to phase out by 2021. Korean companies will probably evade the tariff by building more trucks in the U.S. and exporting the parts instead. (…)

Mr. Lighthizer is also trumpeting Seoul’s acceptance of a 30% cut in its steel exports to the U.S. This is a defeat for American steel users who are already paying higher prices despite the country-specific exemptions from Mr. Trump’s world-wide 25% tariff on imported steel. Reducing supply can have the same effect as a tariff in raising domestic prices. (…) (WSJ)

The problem is that this belies the claim that the steel protection was just a means to induce negotiation that would lower overall barriers. As the negotiations conclude, the barriers remain. (Forbes)

Meanwhile, Canada and Mexico have both negotiated trade agreements with the European Union, Australia, Chile, Japan, Malaysia, New Zealand, Peru, Singapore and Vietnam, giving companies in these countries lower tariffs and better access to America’s closest trading partners.

Why is it a good policy of the United States government to incite the rest of the world to invest and trade easily among themselves while trying to prevent Americans to invest and trade easily with the rest of the world?

Foreign Investors Lose Some Hunger for U.S. Debt Foreign investors’ appetite this year for U.S. debt hasn’t grown at the same pace as the government’s borrowing needs, which some analysts worry could push bond yields higher and eventually threaten to slow economic growth.

Investors in a broad category known as “indirect bidders,” which includes both mutual funds and foreign investors, have been winning the smallest percentage of the bonds they’ve bid for since 2011, according to bidding data for recent Treasury bond auctions. The average percentage of the auctions won by this group fell for the first time since 2012, a decline some analysts attribute to both lower demand from investors outside the U.S. and their recent tendency to post less-aggressive bids. (…)

While the percentage of Treasurys held by foreign investors has declined, such buyers remain crucial to the bond market, holding roughly $6.3 trillion of government debt. Even simply rolling over maturing bonds at the auctions requires foreign investors’ participation. They have bought at least 17% of government auctions each year since 2014, maintaining their support for the primary market during a period where the share purchased by bond dealers has consistently declined. (…)

Foreign holdings of Treasurys rose last year for the first time since 2014, keeping pace with the increase in government debt outstanding. In February, they climbed to $6.29 trillion of the $14.7 trillion of then-outstanding U.S. government debt, the Treasury said April 16, up from $6.26 trillion the prior month.

China’s holdings rose by $8.5 billion to $1.18 trillion while, Japan’s fell by $6.5 billion to $1.06 trillion. (…)

A separate set of Treasury figures known as allotment data shows foreign demand fell below its five-year average in March, after rising to a 21-month high in February. And the backdrop for this year and the foreseeable future is more challenging. (…)

• Dollar Roars Back as U.S. Growth Story Wins Over World Markets The dollar is rallying after floundering for most of the past year, another sign that global growth momentum may be shifting back to the U.S. and away from other major economies.

China exporters see business slow as recovery fades FTCR China Export Index at 20-month low as Washington and Beijing tussle over trade

(…) The FTCR China Export Index fell 1.1 points to 54, the lowest level since August 2016 (52.5) as respondents reported a gloomier outlook and slower volume growth. Our April freight, consumer and labour readings also weakened.  This was the 22nd month in a row that the index has been above 50, signalling improving conditions among exporters. However, key sub-indices such as those tracking volumes and prices had been trending lower even before tension between Washington and Beijing flared up over Chinese trade policies. (…)

The BlackRock Investment Institute tracks China’s economy using high frequency indicators. Bothe the GPS and Nowcast levels are pointing to slower growth:

China’s slowdown is inevitable but it must be orderly given high debt levels. HNA is one of China’s gigournous zombies scrambling to deleverage:

• China’s HNA reports debts have soared to $94bn Figures reveal full extent of pressures that led to sell-offs to cover buying spree

Borrowing costs surged to about $5bn for the full year, up from $2bn in the first half of 2017, triggering the liquidity crisis that rippled through the conglomerate between November to late January. Borrowing costs exceeded its earnings before interest and taxes, and topped the ranks of non-financial companies in Asia during that period, according to Bloomberg data. 

BTW, BlackRock’s GPS for the Eurozone has also crested:

…unlike that for the U.S.:

While Japan looks weaker as The Daily Shot illustrates:

 Britain and the EU Are Pulling Back From the Cliff—For Now The moment of greatest risk for post-Brexit trade disruption looks like it will be pushed off to 2021

Fears have receded that economic relations between Britain and the European Union will fall off a cliff edge in 11 months’ time when the U.K. leaves the bloc. The risk of big trade disruption has been lessened because negotiators have agreed on a 20-month transition period post-Brexit during which the rules of U.K.-EU engagement will remain essentially unchanged. (…)

SENTIMENT WATCH

SentimenTrader’s AAII Bull Ratio moving average has reached the “excessive pessimism” area:

@sentimentrader

Tiho Brkan (The Atlas Investor) uses SentimenTrader’s AIM Model which combines the advisor and investor sentiment models.

(…) The two standard deviations, negative below the mean. In other words, when the sentiment drops into a ridiculously low bearish territory, relative to where it was, let’s say three to six months ago, the way that it compiles the indicator I’m sure, that’s about 10% or below single digits. And we just had that.

So over the last decade in particular, whenever sentiment dropped to single digits, and the economy continued to expand as it has over the last nine years, that was a buying opportunity. So that happened during the Flash Crash in May to July 2010. And in July, the sentiment indicator signaled a buying opportunity. And then the same thing happened once again in August 2011, during the Eurozone debt crisis. And the debt ceiling saga that was going on in the U.S. Congress, that was a buying opportunity. And then we had the Chinese devaluation and the oil bottom, in August 2015, and January to February of 2016. Those were single digit readings, and those were great buying opportunities too. And we just got one last week.

So it remains to be seen whether this one is going to give us the same results as the previous ones during this bull market. One thing that I want to note, is that during 2007 to 2009, sentiment would drop to ridiculously low levels as well. But when the downtrend is in full force, all that sentiment can really indicate is just a really oversold condition, to the point where we will have some kind of relief rally. But it didn’t stop the bears continuously pushing prices lower, and lower, lower, until we finally got to some kind of decent valuation, relative to where we were.

For its part, Lowry’s Research argues that the transition from bull to bear has followed a very consistent pattern of investors selling over-extended stocks near peaks over the last 100 years, which pattern is nowhere to be seen this time.

But the day of reckoning is approaching as the SPY is nearing the end of the wedge, surfing on its 200d m.a….

The 200-day moving average remains positive across the world:

Here’s a nice challenge via Lance Roberts:

May Begins Worst 6-Months Of The Year

Jeffrey Hirsch of “Stocktraders Almanac,” recently penned the following note:

“May officially marks the beginning of the “Worst Six Months” for the DJIA and S&P. To wit: “Sell in May and go away.” May has been a tricky month over the years, a well-deserved reputation following the May 6, 2010 “flash crash” and the old “May/June disaster area” from 1965 to 1984. Since 1950, midterm-year Mays rank poorly, #9 DJIA and NASDAQ, #10 S&P 500 and Russell 2000, #8 for Russell 1000. Losses range from 0.1% by Russell 1000 to 1.9% for Russell 2000.

For the near term over the next several weeks the rally may have some legs. But as we get into the summer doldrums and the midterm election campaign battlefront becomes more engaged, we expect the market to soften further during the weakest two quarter stretch in the 4-year cycle.”

Just as a reminder, it pays to be more cautious in summer months.

EARNINGS WATCH

Factset’s summary:

Overall, 53% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 79% have reported actual EPS above the mean EPS estimate, 6% have reported actual EPS equal to the mean EPS estimate, and 15% 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.

If 79% is the final percentage for the quarter, it will mark the highest percentage of S&P 500 companies reporting actual EPS above estimates since FactSet began tracking this metric in Q3 2008.

In aggregate, companies are reporting earnings that are 9.1% 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, 74% of companies have reported actual sales above estimated sales and 26% 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 1.7% 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 23.2% today, which is higher than the earnings growth rate of 18.5% last week.

The blended, year-over-year sales growth rate for the third quarter is 8.4% today, which is higher than the growth rate of 7.6% last week.

At this point in time, 47 companies in the index have issued EPS guidance for Q2 2018. Of these 47 companies, 26 have issued negative EPS guidance and 21 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 55% (26 out of 47), which is well below the 5-year average of 74%.

Thomson Reuters’ tally shows blended earnings up 24.6% in Q1, 22.7% ex-Energy. Amazing! (Chart below from Bloomberg)

So! What to do?

On the one hand, sentiment, technicals and earnings tracking say go…on the other hand, rising inflation and interest rates, high volatility, so-so valuations, sell in May and go away say no…

• This highly volatile market is not comfortable. People are obviously nervous about interest rates, inflation and profit margins amid an apparent cost push cycle.
• But valuation has improved to a neutral Rule of 20 P/E while earnings are truly booming thanks to a lot more than tax reform. Overall, margins are still rising even excluding tax reform.
• Technicals are not negative per the EMA and the 200d m.a. (holding and still rising) and per Lowry’s analysis (favorable supply/demand and breadth).
• We got sentiment back on the plus side but it is very volatile.

Sentiment and technical factors play on the short term volatility of equities. Fundamentals dictate the medium to longer term trends: inflation and interest rates are currently troublesome so late in the cycle (oil, wages, commodities and a tightening Fed). But profits are very, very strong and are not showing peaking signals just yet. Based on current evidence, profits will be winning the race against inflation and interest rates for at least another 3-6 months and we have yet to get negative signals from credible recession indicators.

The S&P 500 Index has declined 7% from its January 26 peak of 2866 (it actually corrected 11.8% from top to bottoms reached Feb. 9 (2529) and Apr. 4 (2547)). Since then, trailing earnings have increased 13% from $128 to $145 (tax-reform adjusted) and seem set to reach $152 by mid-summer after Q2. This is a very powerful backwind from the most fundamental variable for equities: profits.

The headwinds are rising inflation and interest rates, impacting earnings multiples. Inflation is up from 1.8% to 2.1%, a 16.7% advance while interest rates are up 30% (3m bills) and 25% (10Y Ts) since yearend.

And we have a fragile consumer with little savings, slow real wage growth, rising fuel prices and a tightening Fed.

And we have a highly indebted corporate America facing rising interest rates through 2019, hoping the fragile consumer keeps consuming and costs remain manageable.

But we also have tax reform which provides a bounty of cash to profitable companies and strong fiscal incentives to boost capex, do M&A and/or buy back equities (share repurchases for the quarter were up about 34% vs Q4’17, and up 43% YoY, based on the 25% of S&P 500 companies filing quarterly reports so far, according to data from S&P Dow Jones Indices).

In all, this does not look like a cycle end just yet. Maybe the best scenario would be a slowing economy leading to contained inflation and a more cautious Fed. Corporate America has shown it can grow profits in a slow-mo economy.

Cautiously positive. But also read TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL 

No Volatility Here: Cash Makes a Comeback After years of producing pitiful returns, money-market funds and even bank savings accounts offer improved yields…and a safe place to park funds.

Yields on money-market funds and other cash sanctuaries are approaching 2%, levels not seen in almost a decade. (…)

The average is 1.5%, almost a point above the level a year ago, according to Crane Data. Taxable funds now have a 0.50 percentage point yield edge over bank deposits, reports iMoneyNet. Investors have noticed—money-fund assets went from $2.6 trillion to $2.8 trillion over the past year. (…)

Another good cash proxy: Treasury bills. A three-month yields 1.78%; a six-month, 1.96%, and a one-year, 2.23%. Brokers such as Fidelity and Schwab don’t charge commissions or fees to buy T-bills, and interest is exempt from state and local taxes. (For direct purchases, go to Treasurydirect.gov.) (…)

@trevornoren

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