THE DAILY EDGE (30 January 2017)

U.S. Service sector expands at fastest pace since November 2015

January data signalled a positive start to 2017 for the U.S. service sector. The latest survey revealed a robust expansion of business activity and another strong increase in incoming new work. Meanwhile, service providers were more upbeat about the business outlook than at any time since May 2015. Inflationary pressures eased since December, but were still among the highest seen over the past year-and-a-half.

Adjusted for seasonal influences, the Markit Flash U.S. Services PMIâ„¢ Business Activity Index picked up to 55.1 in January, from 53.9 in December, which marked 11 months of sustained expansion. The latest reading also pointed to the fastest rate of business activity growth since November 2015. Anecdotal evidence suggested that stronger domestic demand and improving business confidence had led to a robust rise in service sector activity at the start of 2017.

Volumes of new work increased at a sharp and accelerated pace in January. The latest upturn in new business was one of the strongest since late-2015. Survey respondents commented on successful product launches, new marketing initiatives and generally improving client demand. A robust pace of new business growth contributed to sustained pressure on operating capacity in January, although the rate of backlog accumulation remained only marginal.

The latest survey indicated a solid upturn in payroll numbers, although the rate of growth moderated from December’s 15-month peak.

Average cost burdens increased at a solid pace in January, with the rate of inflation down only slightly since the end of 2016. Survey respondents commented on higher fuel costs and increased staff salaries. Meanwhile, average prices charged by service providers also rose at the start of the year, but the rate of inflation was only moderate.

The seasonally adjusted Markit Flash U.S. Composite PMI Output Index picked up to 55.4 in January, from 54.1 in December, thereby signalling a robust and accelerated expansion of U.S. private sector output.

The two PMI surveys collectively point to the economy growing at an annualised rate of just over 2.5% in January, and puts the US on a strong footing to achieve faster growth in 2017.

U.S. Leading Economic Indicators Strengthen

The Conference Board’s Composite Index of Leading Economic Indicators increased 0.5% during December (1.1% y/y) following a revised 0.1% November uptick, initially reported as unchanged. It was the strongest gain since July, and equaled expectations in the Action Economics Forecast Survey. During all of last year, the index rose 1.1%, the weakest rise of the economic expansion.

A steeper interest rate yield curve had the largest positive effect on the leading index last month, followed by higher stock prices, improved consumer expectations for business/economic conditions, a higher ISM new orders index and the leading credit index. Higher initial claims for unemployment insurance contributed negatively. (…)

Doug Short’s charts remain the best on the LEI. The recent uptick is very welcome…

Durable Goods Orders Ease as Aircraft Orders Collapse

New orders for durable declined 0.4% during December (+1.6% y/y) following a little-revised 4.8% November drop. A 3.0% rise had been expected in the Action Economics Forecast Survey.

The decline in orders was prompted by a 2.2% drop (-2.1% y/y) in transportation sector orders, which reflected a 25.5% shortfall in aircraft orders. Motor vehicle & parts orders increased 2.0% (4.3% y/y). Durable goods orders excluding the transportation sector rose 0.5% (3.5% y/y). (…)

Unfilled orders of durable goods declined 0.6% (-1.4% y/y), but excluding transportation, order backlogs rose 0.4% (2.2% y/y). (…)

The line that counts most is Non-def cap goods ex-air: this highly volatile series has been booming lately…

…although it remains very depressed after 5 years of misery…

…Nonetheless, it’s now positive YoY, first time since Oct. 2014.

 

US Auto Industry In Crisis Amid “Inventory Bubble”

Despite record U.S. auto sales last year, the number of vehicles on car-dealer lots remains near record highs, and, as J.D.Power analyst Thomas King warned this week, 2016 ended with an inventory “bubble” that will require less production or more incentives to clear.

With near record high inventories of 3.9 million vehicles…

POLITICS

I generally try to stay away from politics and keep rationality at the forefront. But as I was sipping a Corona at the end of Sunset Pier in Key West, Florida last week, watching the spectacle of that bright orange fire ball slowly sinking into the ocean, I could not resist the thought of being a witness to the “American sun” setting on Mexico. But then, remembering Hemingway’s The Sun Also Rises, I thought that we could actually be living a transformational event for Mexico. In fact, we could well be living a transformational event for the whole world, like it or not.

• MEXICO

Trump Threatens to Undo Nafta’s Auto Alley

Trump’s Mexico Tax Would Hammer Firms in $580 Billion Market

(…) Hostilities between President Donald Trump and his counterpart, Enrique Pena Nieto of Mexico, could derail $584 billion in trade between the border nations. The relationship has made supply chains densely interconnected. American-made materials and parts make up 40 percent of the products Mexico exports to the U.S. Meanwhile, Mexico is America’s second-largest export market and third-largest supplier of imported goods.

“Because the economies are so far integrated, the industries that would be impacted are extremely broad,” said Caitlin Webber, a trade analyst for Bloomberg Intelligence. “It’s hard to think of a U.S. sector that wouldn’t be touched if there was a full-scale trade war with Mexico. It would really wreak havoc on the economy.” (…)

(The Daily Shot)

• Avocados, Chili Peppers, Beer: Where Mexico Border Tax Would Hit

In fight with Trump, Mexico has plenty of ways to punch back While the United States is the stronger power, Mexico is not without leverage if the dispute over the border wall and tariffs escalates into a full-blown trade war.

(…) Top economic officials have already said that Mexico would “mirror” any additional taxes or tariffs that the United States imposes. Former officials have said that Mexico could also tax corporate profits from the many American companies with operations in Mexico. (…)

Last year, Mexico deported nearly 150,000 migrants bound for the United States, most of them from Central America. Without this cooperation, officials predict that the number of migrants turning up at the U.S. border could double. (…)

Mexican authorities help fight the heroin epidemic in the United States by going after local producers.

At the border, Mexican officials have been important partners on a variety of tasks, including gathering intelligence on drug cartels and facilitating food inspections, often working side by side with their U.S. counterparts. Mexico has also apprehended foreigners from other countries that pose a potential national security threat and has allowed U.S. authorities access to them. That cooperation could change. (…)

Mexico has free-trade agreements with dozens of other countries and could look to expand its relationships outside of the United States if that market turns inward.

“It’s very curious that he would want to punish the American consumer,” Luis Foncerrada, the director of an economic studies institute in Mexico City. “Mexico can compensate with exports to other countries, deepening those agreements.”

That Trump seems not to be considering the ramifications of a trade war with Mexico might be the most worrisome aspect of the current crisis, said Fernando Turner Dávila, secretary of the economy in the industrial state of Nuevo Leon.

“This is worrying not only for Mexico but for the entire world,” he said. “They should be scared that there is no contemplation in the president of the most powerful country in the world.”

Ernesto Zedillo: Mexico can thrive without Trump

(…) In retrospect, the probability of reaching a mutually beneficial agreement on the topics on President Trump’s Mexico agenda was always small, considering that his demands have defied legal and economic rationality all along. (…)

Given its amazing technological and entrepreneurial capacity, the United States has been the main beneficiary of this new way of organizing international production and trade. Many American firms are able to compete successfully around the world with those from Europe and Asia, and therefore can provide high-quality, good-paying U.S. jobs, precisely because they are free to develop links along their supply chains in places such as Mexico — in this case thanks to NAFTA. (…)

Mexico can create new conditions that will keep, and even enhance, our standing as a good place for global companies to produce for our own and other important markets, not least the United States. We should reassure global companies, with concrete actions, that Mexico will remain open for business and that our government will not try to intimidate them or tell them what, where and how to produce. (…)

Auto Parts Maker Would Raise Prices to Offset Trump’s Proposed Mexico Import Tax

An import tax on goods from Mexico could lead to substantial price increases for U.S. customers of Continental AG, said Wolfgang Schäfer, finance chief for the German auto-parts supplier. (…)

Some of extra cost burden from an import tax could be compensated by currency fluctuations, should the Mexican peso weaken against the U.S. dollar, he said. The peso is down 12.6% since Election Day.

Should new legislation render it impossible for Continental to cover its production costs in Mexico, the company will consider moving some of its production to the U.S. to be close to those carmakers, Mr. Schäfer said. (…)

Tycoon Slim says Trump not ‘Terminator,’ sees opportunities for Mexico

GM to cut 625 jobs at Ontario plant, union says

The furore over NAFTA and job creation in Mexico swept into Canada Friday as General Motors Co. said it will eliminate 625 jobs at one of its Canadian assembly plants when it shifts production of a vehicle to Mexico this summer.

GM, whose Cami Automotive Inc., plant in Ingersoll, Ont., has been on a hiring spree and cranking out vehicles on overtime, shocked the union that represents its workers by revealing the job cuts months after adding Sunday overtime shifts to a plant that was already operating three shifts a day during the week and running overtime on Saturdays. (…)

‘Trump Country’ Might Suffer More in a Trade War, Study Says Should the U.S. get embroiled in a trade war, communities that voted for Donald Trump are likely to take a bigger hit than those that voted for Hillary Clinton, according to a study by the Brookings Institution.

• THE FIRST WEEK

The WSJ:

The new president seems to be running his administration much like he ran his company and campaign, eager to weigh in on every issue and willing to make last-minute calls; many top aides and congressional allies have been left flummoxed.

(…) Mr. Trump’s first week as president suggests he is planning to run his administration much like he ran his company and his election campaign: eager to weigh in on every issue—both matters of state and matters of perceived slight—and willing to make impulsive calls in a way that is at odds with a city that usually tries to run on a script. During one meeting with the congressional leadership, he mused about getting rid of the Electoral College. (…)

Two weeks ago, Mr. Trump criticized a “border adjustment” tax being discussed by Republicans in Congress. On Thursday, his spokesman Sean Spicer suggested the Southern border wall would be paid by a 20% levy on imports, including goods from Mexico, an idea that is close to the congressional proposal. Later that day, Mr. Spicer said that wasn’t in fact a plan, but rather a way to “demonstrate that paying for the wall can be done.” (…)

The steady stream of meetings, announcements, tweets and decisions suits a president who is “easily bored,” said Chris Ruddy, a longtime friend of Mr. Trump and chief executive of Newsmax Media, a conservative outlet. “He gets credit and applause for being a man of action. On the other hand, they’re moving a little too quickly and they may not be thinking things through completely.”

Contributing to the confusion, even among the president’s allies, are rival power centers orbiting the president, White House officials say. In the inner circle are those who served prominently on his campaign: son-in-law and counselor Jared Kushner; Chief of Staff Reince Priebus; chief strategist Steve Bannon, and Ms. Conway. Mr. Kushner has in the past tried to limit Ms. Conway’s exposure to Mr. Trump, according to people familiar with the relationship. Ms. Conway denies any friction.

Those four are among 10 senior advisers, according to news releases, and were part of a group of more than 30 people the White House said were sworn-in on Sunday with the title of “assistant to the president.” George W. Bush’s White House had 18 with that status in 2005. Barack Obama had 25. Ronald Reagan had 11.

Mr. Kushner and Mr. Bannon are forming another internal group that aims to define the administration’s strategy and long-term priorities, according to several officials familiar with the initiative.

Tentatively named the Strategic Development Group, it is described by one official as an “internal McKinsey”—a reference to the global management-consulting company. It is expected to include about a dozen staffers and outside advisers and primarily report to Mr. Bannon and Mr. Kushner.

(…) People who deal with White House say the lines of responsibility at the Trump administration are unusually blurred. Also, there is Mr. Trump’s penchant for weighing in personally—both on Twitter and in meetings and by phone—sometimes without the knowledge of his aides or Republican allies on Capitol Hill. (…)

Legislators say Mr. Trump’s interventions on Twitter and in calls can catch them by surprise and instantly reshape major issues, though they say it is more important that the issues move forward. (…)

The FT:

Donald Trump’s first week: character over content

(…) Donald Trump often says things that are not true, a pattern that has continued right into the presidency. Much has been made of this, but it should not obscure the fact that his official actions thus far have been perfectly consistent with the principles and priorities he broadcasted during the campaign.

He is what he said he was: an enemy of free trade, immigration, regulation, abortion rights; a defender of the American fossil fuel industry and the use of torture. He won an election on these foundations, and his energetic pursuit of them as president is fitting and legitimate. The idea that Mr Trump is to be taken “seriously but not literally” — now worn smooth with repetition — was a canard all along. (…)

If the president’s policy has been surprisingly consistent, his behaviour has been predictably erratic. In his first week, Mr Trump has told and retold a dangerous falsehood that delegitimises the electoral system and could open the way to disenfranchising eligible citizens, and talked himself and the US into a desperately tense stand-off with Mexico. There is, as yet, no evidence that either of these actions resulted from planning, strategic intent, or consultation with advisers. The president is impulsive, thin-skinned, and combative. This is already affecting how the US is governed and how the world works. (…)

The president styles himself as a master dealmaker. Perhaps there is negotiating wizardry concealed beneath this apparent shambles. A more plausible interpretation is that the president is not seeking a deal, does not care about Mexico, and thinks the US can do without its friendship.

This newspaper believes Mr Trump’s views on both trade and immigration are comprehensively wrong-headed and will leave America and the world poorer and less safe. It is possible we will be proven wrong and Mr Trump proven right. What is beyond debate is that friends and allies — which is what the US and Mexico have been and should aspire to always be — do not subject one another to casual humiliation. This is what Mr Trump has done, for no apparent gain.

In questioning the election result and in insulting a crucial neighbour, Mr Trump has prioritised chest-beating over cultivation of the country’s best interest. Whatever you call this behaviour, it is not putting America first.

The WaPo:

Trump’s erratic first week was among the most alarming in history It was unlike any other that the country has witnessed.

(…) Anyone who paid even glancing attention to the 2016 campaign already understood Donald Trump to be undisciplined, easily provoked and self-absorbed to the point of narcissism. But it was one thing to know that in theory; it was much more unsettling to witness President Trump in action. (…)

That was followed by Trump’s extraordinary performance at the CIA where, before a wall honoring fallen employees, of his intellect (“trust me, I’m, like, a smart person”); falsely blamed the media (“among the most dishonest human beings on Earth”) for inventing his feud with the intelligence community; complained about coverage of his inauguration crowds (“We caught them, and we caught them in a beauty. And I think they’re going to pay a big price”). And, oh yes, lamented that the United States did not “keep the oil” in Iraq even as he dangerously observed, “Maybe you’ll have another chance.”

And so it went, each day feeling scarier than the one before, and Trump’s sycophantic aides modeling his own fact-free rants — press secretary Sean Spicer’s falsehood-filled briefing-room tirade, counselor to the president Kellyanne Conway’s brazen defense of “alternative facts,” chief strategist Stephen K. Bannon’s brutish admonition to the media to “keep its mouth shut.”

Trump himself outdid his petty obsession with crowd size with his delusional obsession with popular-vote fraud, first behind closed doors with incredulous congressional leaders , then for all the world to watch in his ABC interview. What was once delusional ego-salving now appears headed for official inquiry.

This is ominous not only for the implicit threat of imposing new and unnecessary obstacles to voting, but also because it means that no one, neither American citizens nor foreign leaders, can believe the president of the United States when he makes an assertion. (…)

But you don’t have to disagree with Trump’s policies to be rattled to the core by his unhinged behavior. Many congressional Republicans privately express concerns that range from apprehension to outright dread. (…)

The leaks coming out of the Trump White House cast the president as a clueless child

The WSJ’s Peggy Noonan:

Trump Tries to Build a ‘Different Party’

(…) All this marked more than the keeping of political promises, though that’s startling enough. It was a programmatic expression of the central assertion of President Trump’s inaugural address: I am a populist independent, allied not with the two major parties but with the working men and women of America. (…)

More important still—the most important moment of the first week—was the meeting with union leaders. Mr. Trump gave them almost an hour and a half. “The president treated us with respect, not only our organization but our members,” said Terry O’Sullivan, general president of the Laborers’ International Union of North America, by telephone. (…)

The lengthy, public and early meeting with the union leaders was, among other things, first-class, primo political pocket-picking. The Trump White House was showing the Democratic Party that one of its traditional constituent groups is up for grabs and happy to do business with a new friend. It was also telling those Republicans too stupid to twig onto it yet that the GOP is going to be something it’s actually been within living memory: the party of working men and women, a friend of those who feel besieged. (…)

It’s a mistake for observers in Washington and New York to fixate on Mr. Trump’s daily faux pas at the expense of the political meaning of what he’s doing. He’s changing the face of the GOP. (…)

Trump Immigration Ban Sows Chaos President Donald Trump defended his executive order restricting immigration from seven Muslim-majority countries as his plan to tighten national security spawned legal challenges, congressional criticism, widespread protests and confusion at airports.

CETERIS NON PARIBUS

I wrote this essay in July 2016 trying to assess whether corporate profit margins could remain historically high:

The mean reversion of profit margins may thus not be underway just yet, ceteris paribus…

However

the tides of change are numerous and varied, however. Maybe this is not ceteris paribus.

Concluding and explaining that

Returns on capital in the 15% range are unsustainable. Low cost capital will naturally migrate towards the highest return markets, intensifying competition and gradually “normalizing” margins and returns.

In that essay, I looked at the many sources of pressures on future returns but an unexpected one appeared on Nov. 9th as per the WSJ last weekend:

Defense-industry executives had expected military spending would rise under the Trump administration. During the campaign, Mr. Trump’s stump pledges to boost outlays pushed defense contractors’ share prices to record levels. The spending pledge remains, but Mr. Trump—through negotiation—is attempting to help pay for it in part by stoking competition and bringing costs down overall in the process. (…)

“The F-35 program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after January 20th.” Lockheed Martin executives were alarmed, a person familiar with their reaction said. (…)

Mr. Trump tweeted that he had invited Boeing to submit a counterproposal to challenge Ms. Hewson’s company.

Mr. Trump had asked Mr. Muilenburg to price out an upgraded version of its F/A-18 Super Hornet jet as a potential substitute for some of the planned Lockheed purchases. (…)

Lockheed tweeted that Ms. Hewson phoned Mr. Trump and pledged to “aggressively” cut F-35 costs.

Another round of meetings took place in January, this time at Trump Tower in New York. On Jan. 13, Ms. Hewson met Mr. Trump and said Lockheed was trimming $600 million from its previous price for the next batch of 90 F-35 jets, people familiar with the transition team said. (…)

On Friday, new Defense Secretary Jim Mattis announced twin reviews of the costs of the F-35 and Air Force One replacement programs, targeting “significant” savings from both.

These programs are enormous and no doubt that Boeing and Lockheed will exert significant pressures on their numerous suppliers to achieve the cost cuts demanded. And there is more:

• China’s Jetliner Dream Built With U.S., European Parts A Chinese prototype jetliner is set to make its maiden flight early this year, in what the country hopes to be a big step toward realizing its ambition to rival Boeing and Airbus in commercial aviation’s big-leagues.

• Chinese Carmakers Think They Can Finally Win America Over With an SUV

EARNINGS WATCH

Factset’s weekly summary:

Overall, 34% of the companies in the S&P 500 have reported earnings to date for the fourth quarter. Of these companies, 65% have reported actual EPS above the mean EPS estimate, 13% have reported actual EPS equal to the mean EPS estimate, and 22% have reported actual EPS below the mean EPS estimate.

The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year (71%) average and below the 5-year (67%) average.

In aggregate, companies are reporting earnings that are 2.7% above expectations. This surprise percentage is below the 1-year (+5.0%) average and below the 5-year (+4.5%) average.

In terms of revenues, 52% of companies have reported actual sales above estimated sales and 48% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is equal to the 1-year average (52%) but below the 5-year average (53%).

In aggregate, companies are reporting sales that are equal (0.0%) to expectations. This surprise percentage is below the1-year (+0.1%) average and below the 5-year (+0.5%) average.

The blended earnings growth rate for the fourth quarter is 4.2% this week, which is higher than the earnings growth rate of 3.7% last week. Upside earnings surprises reported by companies in the Information Technology and Industrials sectors, partially offset by downside earnings surprises in the Energy sector, were the largest contributors to the increase in the overall earnings growth rate for the index during the past week.

The blended revenue growth rate for Q4 2016 is 4.7%.

At this point in time, 33 companies in the index have issued EPS guidance for Q1 2017. Of these 33 companies, 17 have issued negative EPS guidance and 16 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 52%, which is below the 5-year average of 74%.

Note that 17 of the 33 companies that have guided for Q1’17 are from the IT sector and 11 of the 17 have guided positively. Ex-IT, 11 of the 16 companies (69%) having guided for Q1 have guided negatively.

Thomson Reuters/IBES sees fourth quarter earnings increasing 6.83% from Q4 2015. Excluding the Energy sector, the earnings growth estimate improves to 7.4%. Looking at 2017, TR says that EPS revisions by analysts are running about 50-50 in the past 2 weeks.

Meanwhile, the ESI is hanging in there…

…helping keep sentiment high…

…although Joe Public is getting the kittles in spite of all the hype behind Dow 20k: (Yardeni charts)

And how about that? Nobody seems to care.

Partly because the Gallup Economic Confidence Index keeps hitting new highs. Confidence can be very fickle..

 

• Next Stop, Dow 30,000 The DJIA looks strong as it passes 20,000. History suggests that this aging bull market can live on.

(…) There is plenty of opportunity for positive economic-policy change from the Trump administration, and we’re warily optimistic. But execution risks abound. For our part, we think a steady rise for stocks in the near term is better than the alternative: a flash and a bang.

• 20,000 Reasons to Be Wary of the Market

FYI:

Greg Valliere, chief strategist at Horizon Investments and a four-decade Washington watcher: “Make no mistake—[House Speaker] Paul Ryan and [Senate Majority Leader] Mitch McConnell can’t stand Trump, and the feeling is mutual.”