The Magic 8-Ball Market

The Magic 8-Ball Market

Last week ended with equity markets taking another dive that accelerated into Friday’s close as the trade war with China intensified heading into its eighteenth month with China announcing that it will impose retaliatory tariffs on US goods. The S&P 500 closed down 2.5% for the third time this month. After the close President Trump launched a twitter storm to announce additional retaliatory tariffs in response to China’s. So that’s going well.

Investors face challenging times as the major market movers have simply been words (tweets) coming from politicians and bureaucrats, the prediction of which is akin to assessing the next missive from a Magic 8-Ball.

While many continue to talk about the ongoing bull market, the major US equity market indices have seen four consecutive weekly declines and are all in the red over the past year with the small cap Russell 2000 down well over 10%, sitting solidly in correction territory. On the other hand, this year has seen the strongest performance out of long-maturity Treasuries since at least 1987.


Source: Bespoke Investment Group

How many bull markets see the total return for the long bond outpace the S&P 500 by over 16%.

This comes at a time when the domestic economy is in it 121st month, the longest is post-war history, which means that many have not lived through a recession as an adult.


Yield Curve

As the adage goes, expansions don’t die of old age, but their footing becomes less sure over time and we are seeing signs of rockier terrain. One sign comes from the yield curve which has been flattening steadily since October 2018 with the spread between the 10-year and the 3-month falling from over 100 basis points to -39. The most widely watched part of the curve, between the 10-year and 2-year, has inverted four times in the past few weeks.


This 2-10 inversion is most closely watched as over the past 50 years it has preceded all seven recessions. Credit Suisse has found that on average a recession hit 22 months after the 2-10 inversion occurred.

The third of August’s four inversions came as Kansas City Federal Reserve President Esther George and Philadelphia Fed President Patrick Harker stated in a CNBC interview that they don’t see the case for additional interest rate cuts following the cut in July. Mr. Market was not looking to hear that.

This past week we also received the meeting minutes from the prior Fed meeting with led to July’s 25 basis point cut which gave the impression of a Fed far less inclined to cut than the market was expecting with most Fed participants seeing July’s cut as part of a recalibration but not part of a pre-set course for future cuts. Keep in mind that central bank rate cuts are a relative game and ECB officials have been signaling a high likelihood of significant accommodative measures at the September meeting, saying the ECB “will announce a package of stimulus measures at its next policy meeting in September that should overshoot investors’ expectations.”

Manufacturing

Another source of bumps on the economic road comes from the manufacturing sector, both domestic and international. A recent IHS Markit report found that the US manufacturing sector is in contraction for the first time in nearly a decade as the index fell from 50.4 in July to a 119-month low of 49.9 in August – readings below 50 indicate contraction.

According to the Institute for Supply Management, US manufacturing activity has slowed to a nearly three-year low in July. By August New Orders (a key leading indicator) had dropped by the most in 10 years with export sales falling to the lowest level since August 2009.

New business growth has slowed to its weakest rate in a decade, particularly across the service sector. Survey respondents mentioned headwinds from weak corporate spending based on slower growth expectations both domestically and internationally – likely caused by the ongoing trade war that got much, much worse this past week.

In a note to clients on August 11th, Goldman Sachs stated that fears of the US-China trade war leading to a recession are increasing and that the firm no longer expects a trade deal between the two before the 2020 US election. The firm also lowered its GDP forecast for the US in the fourth quarter by 20 basis points to 1.8%.

Global manufacturing has also been slowing, with just two of the G7 nations, Canada and France, currently showing expansion in the sector. In July, China’s industrial output growth slowed to the weakest level in 17 years.

Germany is seeing the most pronounced contraction with its manufacturing PMI dropping from 63.3 in December 2017 to 43.6 this month. German car production has fallen to the levels last seen during the financial crisis.

Overall, we see no sign of stabilization in global manufacturing as global trade volumes look to be rolling over, leaving the economy heavily dependent on growth in the Consumer and the Service sectors. Keep in mind that the last time global trade volumes rolled over like this was back in 2008.

The Consumer

The consumer is yet another source of bumps on the economic road. Ms. Pomboy’s tweet is perfect.

As for that debt, Citigroup recently reported that its credit-card delinquency rate had risen to 2.91% in July from 2.56% in June versus its three-month average of just 1.54%. With all the positive stock moves we’ve seen in retail, keep in mind that the story for many has been more about earnings than actual growth.

For example, Nordstrom (JWN) shares rose 21% after it delivered stronger-than-expected earnings, but that was off of weaker than expected revenue of $3.87 billion versus expectations for $3.93 billion. Nordstrom also slashed net sales guidance for the fiscal year as well as earnings guidance. Management forecast net sales for the year to decrease by about 2%. It previously estimated sales would be flat to 2% down. It also slightly lowered guidance on earnings per share to a range of $3.25 to $3.50, compared with the prior guidance of between $3.25 to $3.65. Did I mention shares rose 21%?

US Consumer sentiment fell to 92.1 in August, the lowest reading for 2019, versus expectations for 97 and down from 98.4 in July. If sentiment continues to degrade, how long will the consumer continue to load up credit cards in order to spend?

Debt

It isn’t just the consumer that is taking on more debt – yet more economic bumps. The federal government deficit rose by $183 billion to $867 billion during just the first 10 months of this fiscal year as spending grew at more than twice the rate of tax collections. The Congressional Budget Office expects the annual budget deficit to be more than 1 TRILLION dollars a year starting in 2022. Total public debt, which includes federal, state and local has reached a record 121% of GDP in 2019, up from 69% in 2000 and 43% in 1980.

Keep in mind that debt is pulling resources out of the private sector and at such high levels, fiscal stimulus becomes more challenging in times of economic weakness. The only time debt to GDP has been higher was after WWII, but back then we had relatively young population and a rapidly growing labor force compared to today.

I’ve mentioned before that I am concerned with the strengthening dollar. Dollar denominated on balance sheet debt is over $12 trillion with roughly an additional $14 trillion in off-balance sheet dollar denominated debt – that’s a huge short USD position. The recent resolution of the debt ceiling issue means that the US Treasury now needs to rapidly rebuild its cash position as I had been funding the government through its reserves. This means that we will see a drain on global liquidity from the issue of over $200 billion in Treasury bills.

I’ve also written many times in the past concerning the dangers that lie in the enormous levels of corporate debt with negative yielding corporate debt rising from just $20 billion in January to pass the $1 trillion mark recently – more bumps on the road.

Bottom Line

As I said at the start of this piece, this expansion is the longest in post-war history which doesn’t itself mean a recession is imminent, but it does mean that the economy is likely to be more vulnerable. Looking next at the economic indicators we see quite a few that also imply a recession is increasingly likely.

The President’s twitter storm in response to China’s tariffs and the continually rising geopolitical uncertainties that create a strong headwind to any expansions in the private sector only increase risks further. Perhaps by the time you read this piece some part of the rapid escalation of the trade war will have been reversed, as foreign policy has become increasingly volatile day-to-day, but either way, the view from here is getting ugly.

More troubling signs at retailers as earnings fall 24% 

More troubling signs at retailers as earnings fall 24% 

As we wind up the most recent barrage of quarterly earnings, we are being left with a sour taste in our collective mouths thanks to retailers, particularly those focused on apparel. While some data points to those mall-based retailers, like The Gap being hard hit, other data suggests retailers are not matching consumer preferences either for the apparel they have or investing in their digital shopping platforms. While the former points to the fickleness of the consumer, or the tone-deaf ears of certain retailers, the latter indicate that not all retailers have accepted the growing importance of digital commerce that is a key tenant of our Digital Lifestyle investing theme.

Is it easier to blame the weather and other items in the short-term for a failed strategy? Sure it is, but the real drivers of falling retailer results will come out in the coming quarters. Those like Target, Walmart and Costco that have been investing in digital commerce are likely to thrive while those that haven’t will likely disappoint further as Amazon begins free one-day shipping for Prime customers. 

Clothing retailers like the Gap, Canada Goose and Abercrombie & Fitch are all experiencing troubling sales reports, the likes of which haven’t been seen since the Great Recession a decade ago, according to a report by CNBC.

Many companies are blaming the weather, slow traffic at malls, bad promotions and product blunders. With the industry as a whole struggling, the S&P 500 Retail ETX was down 2 percent on Friday (May 31), and has dropped almost 13 percent in May, which sets it up to be the worst period since November of 2008, when it lost 20.25 percent.

As a group, apparel retail earnings are down 24 percent, although earnings had been growing since Q3 of 2017. In Q1 of 2018, earnings gained 26 percent. In Q1 of 2008, earnings fell 40 percent.

“These are all mall-based retailers experiencing traffic issues,” Retail Metrics Founder Ken Perkins said. “The consumer is holding up … sentiment numbers have been really high.” The problem, he said, is that some companies aren’t investing in attracting customers to their stores and websites.

There are some bright spots. Target and Walmart both had good first quarters, and have been investing in apparel, with positive results.

“It’s not that people are buying fewer clothes,” CGP president Craig Johnson said. They’re going to different places, he said, and some older companies, like Chico’s and Talbots, which are “classic, women’s, missy retailers,” are victims of changing popular culture and taste.

“The demand for that product is a fraction of what it used to be a generation ago. Women aren’t dressing like that,” he said.

Another issue facing the industry is the threat of tariffs, which could worsen the outlook.

There’s the consideration of a 25 percent tax on clothing and footwear from China, and many companies haven’t factored in the effect this could have. There’s also the possibility of a 5 percent duty on Mexican imports on June 10, which would raise to 25 percent by October.

Source: Retail Clothing Sales Down 24 Percent | PYMNTS.com

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

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WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

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Ep 73: Can the Market Continue Its Run Through the End of 2018?

Ep 73: Can the Market Continue Its Run Through the End of 2018?

 

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This week brings us to the midpoint of the September quarter, and there is quite a bit going on despite it being the dog days of summer. From contagion concerns spilling over from Turkey to escalating tariffs between the US and China, more signs of inflation heating up even as more economic data of late has missed expectations, it’s not the ho-hum end of summer many had been hoping for. That’s why we called in long-time friend Keith Bliss of DriveWealth for a conversation on all of those things as well as where he sees the markets heading by year end.

You’ve probably listened to Keith on CNBC, Fox Business, Yahoo! Finance and other financial media. In our conversation, not only does Keith bring the experience and wit of an NYSE floor trader, but the deep thought and perspective that makes him a sought-after market commentator. We cover the three “T-s” that are driving the market – Turkey, Tariffs and Trump – and much more in this episode of the podcast. There’s a quite a bit to cover, and we do it with some laughs mixed in along the way.

 

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A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

We’ve been witnessing inflationary pressures in the monthly economic data over the last several months. Some of this has been higher raw material due in part to trade tariffs and other input costs, such as climbing freight costs, as well as the impact of increased minimum wages in certain states. Habit Restaurant (HABT) noticeably called out the impact of wage gains as one of the primary drivers in its recent menu price increase.

This June 2018 earnings season, we’ve heard from a growing number of companies – from materials and food to semiconductor and restaurants –  that contending with inflationary pressures are looking to pass it through to consumers in the form of higher prices as best they can. The thing is, wage growth has been elusive for the vast majority of workers, especially on an inflation-adjusted basis. Keep in mind that is before we factor in the inflationary effect to be had if these escalating rounds of trade tariffs are in effect longer than expected.

As these price increases take hold and interest rates creep higher, it means consumer spending dollars will not stretch as far as they did previously.  Not good for consumers and not good for the economy but it offers support for the Fed to boost rates in the coming quarters and keeps our Middle-Class Squeeze investing theme in vogue.

 

U.S. average hourly earnings adjusted for inflation fell 0.2 percent in July from a year earlier, data released on Friday showed, notching the lowest reading since 2012. While inflation isn’t high in historical terms, after years of being too low following the 2007-2009 recession, its recent gains are taking a bigger bite out of U.S. paychecks.

“Inflation has been climbing and wage growth, meanwhile, has been flat as a pancake,” said Laura Rosner, senior economist at MacroPolicy Perspectives LLC in New York. “In a very tight labor market you would expect that workers would negotiate their wages to at least keep up with the cost of living, and the picture tells you that they’re not.”

Source: American Workers Just Got a Pay Cut in Economy Trump Calls Great – Bloomberg

Silver Screen

Coming soon to theaters: higher prices. Movie theater operator Cinemark Holdings Inc. plans to pass costs along to customers, partly due to seating upgrades.

“Our average ticket price also increased 3.7 percent to $8.08, largely as a result of inflation, incremental pricing opportunities associated with recliner conversions, and favorable adult-versus-child ticket type mix,” said Chief Financial Officer Sean Gamble. “As we’ve continued to roll out recliners, our general tactic has been to go forward with limited pricing upfront and then when we see the demand opportunity increase there, and I’d say there’s still — we still believe there is further opportunity as we look to the back half of this year and forward in that regard.”

To be fair, movie ticket prices have been marching steadily higher in recent years. But theaters aren’t the only ones planning to pass on costs.

Sugar Boost

The maker of Twinkies and Ding Dongs wants to charge more for its sugary snacks.

“We will implement a retail price increase and incremental retailer programs to help offset the inflationary headwinds we and others in the industry are experiencing,” Hostess Brands Inc. Chief Executive Officer Andrew Callahan said on a call, explaining that the company is researching how to do so without choking off growth. The majority of the change will come in 2019, he said.

Bubble Wrap

Sealed Air Corp., the maker of Bubble Wrap and other packaging materials, is trying “to do everything we can operationally to keep our freight costs low,” Chief Financial Officer William Stiehl said in apresentation. “Where I’ve been very happy with the company’s success is our ability to pass along price increases to our customers for our relevant input cost.”

Steel Prices

Tariffs are hitting home at Otter Tail Corp.’s metal fabrication unit BTD, but leadership doesn’t sound especially concerned. Thank pricing power.

“We do not anticipate higher steel prices from tariffs having a significant impact on BTD’s margins as steel costs are largely passed through to customers,” Chief Executive Officer Charles MacFarlane said on a call. “BTD is working to enhance productivity in a period of increased volume and tight labor markets.”

Tariff Tag

The trade impact pass-through is equally real at semiconductor device maker Diodes Inc.

“Products that we import into the U.S. from China, all of those products are going to be ultimately affected by the tariffs,” Chief Financial Officer Richard White said on a call. Between U.S. levies that began July 6 and additional rounds planned to follow, “it’s about $3.6 million per quarter, but we plan to pass these tariff charges on to our customers.”

Home Costs

Housing developer LGI Homes Inc. is “consistently” seeing sales price increases as costs bump higher — a sign that pricing power exists even in big-ticket markets like housing.

“We’re able to and need to raise our prices to keep our gross margins consistent,” Chairman Eric Lipar said on a call. “In the market that we’re in, which I’d characterize as a good, solid, strong demand market with a tight supply of houses and the labor challenges, the material challenges that we all face, we see at least for the next couple quarters, that trend continuing. Prices are going to have to increase on a same-store basis if you will in order to offset increased costs.”

“We’re dealing with a higher monthly payment for the buyer now because of the rising interest rates from nine months ago. Demand seems to be there,” he said, adding that the company may need to examine ways to address the situation. “Rather than reducing the price, we may have to look at smaller square footages. The buyer may have to choose.”

People Problems

Not everyone is finding opportunities to pass along costs: Civitas Solutions Inc., a health and human services provider that caters to those with disabilities and youth with behavioral or medical challenges, is seeing slimmer margins.

“The number of people that are exiting the company are still a concern to us and I think it’s driven largely by the full, robust economy,” Chairman Bruce Nardella said on a call, citing workers seeing opportunities to leave to get higher wages. “Over the last two years, our margins have eroded because of that labor pressure.”

Pizza Pain

As if a leadership feud and sales slump weren’t problematic enough, pizza chain Papa John’s International Inc. also has to deal with wage pressures and rising costs. It’s responding by attempting to eke out efficiency gains, rather than by raising prices, to defend its margins.

“We have employed third party efficiency experts to review the potential for improvements within our restaurants,” Chief Executive Officer Steve Ritchie said on a call. “They are also conducting time and motion studies. Their work will directly supplement the work we are doing within our restaurant design of the future.”

Addressing Pressures

As some companies maintain profits by pushing costs to customers, Flowers Foods Inc., the maker of Tastykake pastries and Mi Casa tortillas, is finding work-arounds. It increased prices in the first quarter to help offset input inflation, but has also eaten some of the cost.

“Our margins were impacted by inflationary pressures from higher transportation cost, a tight labor market, and increasingly volatile commodity markets,” Chief Executive Officer Allen Shiver said on a call. “To address these inflationary pressures, we are aggressively working to capture greater efficiencies and cost reductions.”

 

Source: Inflation Is Coming to Theater Near You as U.S. Companies Flex Pricing Power – Bloomberg