Value investing is an old strategy. Value investors have historically outperformed other types of investors over the long term. Stock tips, financial news, and value investing articles. Learn how to invest like Ben Graham, Warren Buffett, and Charlie Munger. The World's Best Value Investing Blog.
After the weak April retail sales and industrial production reports, the estimates for GDP growth fell. We only have one month of hard data which hasn’t been adjusted, so it’s far from certain what Q2 GDP growth will be. The GDP Nowcasts tell us what growth would be if only this data was included. They give us the pace the economy would be growing at if May and June were like April. The results aren’t kind as the Atlanta Fed Nowcast only expects 1.2% growth.
Weak Industrial Production
Just like how the retail sales report was weak because of the adjustment due to the late Easter, there was a quirk in the industrial production calculation. Before we get to that, let’s look at the gruesome numbers as is. Production growth was -0.5% monthly which missed estimates for 0%. Yearly growth was only 0.9% which was the lowest growth rate since February 2017. Historically, when yearly growth is negative, it means a recession is likely. The major exception was in 2015-2016. It will be interesting to see if the economy avoids a recession when the manufacturing sector contracts again to determine if the diversification away from manufacturing makes it more recession resistant. Obviously, that’s not a thesis the bulls want to test any time soon.
As you can see from the chart below, 16 out of 23 industry groups are contracting which is the same level as the peak in the last industrial production recession.
Overall growth is much higher though after it troughed at -4.1% in December 2015. Only 30% of industrial production groups are expanding. A drop below 40% has previously meant widespread weakness that implies a recession.
Manufacturing Data Quirk
Manufacturing doesn’t look great either as monthly growth of
-0.5% was 0.4% below the low end of the consensus range. Also, yearly growth
was 0%. Therefore, the capacity to utilization rate fell from 78.5% to 77.9%.
The economy isn’t near running out of slack. One of the weakest categories was
autos which is consistent with weak auto sales and the increase in delinquency
rates on auto loans. Motor vehicle and parts production was down 2.6% monthly
and 4.4% yearly.
Most of the readings in this report were terrible as
business equipment growth was -2.1% monthly and 0.1% yearly. Consumer goods
production was down 1.2% and construction supplies growth was just 0.1% after
falling 1.7%. Utilities output fell 3.5% monthly and 4.7% yearly. Now let’s
look at the couple good numbers from this report. Selected hi-tech production
was up 0.6% monthly and 3.2% yearly. Mining production was up 1.6% after
falling 3 straight months.
The chart below shows why this weakness might be a quirk in the data.
Industrial production “fell” in April because the data can’t cope – but to a predictable degree – with a couple of calendar quirks. Expect a rebound in May. pic.twitter.com/RJzfsuJlIm
Monthly manufacturing output growth has almost always been below its 6 month average when the 15th is after the payroll survey week and 22 working days. This calendar issue has a strong track record. Let’s see if results bounce back in May. They might bounce back regardless of this because the May Empire Fed and Philly Fed indexes were strong.
Housing Market Index Improves
As you can see from the chart below, most of the recent housing data has been beating estimates.
Bloomberg’s US Housing & Real Estate Surprise Index has been surging, as the housing news comes in stronger than expected. Housing starts, building permits & NAHB are the standouts this week. The upside surprises could be one reason why home building stocks have outperformed. pic.twitter.com/egeJWwhkdu
Some of the data is objectively good while other reports are less bad than expected. In April, purchase applications for newly built homes increased 15.6% yearly. The MBA reports were solid in April, signaling an improvement in the housing market after a terrible end to last year. The applications index in the week of May 10th showed weekly purchase application growth was -1% and yearly growth was 7.7%.
The May Housing market index, which measures home builder sentiment, was very solid. It increased from 63 to 66 which beat estimates for 64. Anything above 50 means growth. This index hit a 7 month high. It has taken a few months to regain the losses made late last year. The present sales and 6 month leading sales indexes had very strong readings of 72. However, the traffic index still showed declines as it was at 49. The decline was less bad. As you can see from the chart below, the Northeast’s reading was historically high at 65; it is the highest reading since May 2005. The South was at 67, the West was at 74, and the Midwest was at 56.
In keeping with the theme of housing data beating estimates,
housing starts and permits beat estimates. However, both showed negative yearly
growth, so this was one of the less bad reports. Specifically, March starts
were 1.235 million which beat estimates for 1.2 million and rose from 1.168 million.
Permits were 1.296 million which beat estimates for 1.29 million and last month’s
reading of 1.288 million. Yearly starts and permits were down 2.5% and 5%.
Single family data was the weakest. It’s tough to get excited about the housing
market if permits are down yearly as permits are a leading indicator of
activity. The good news is this report caused the Atlanta Fed GDP Nowcast’s
estimate for Q2 real residential investment growth to increase from -5.4% to
-3.6%. This reading has been negative (in the official GDP report) for 5
Specifically, single family starts were up 4.5% monthly to a 381,00 annual rate and multifamily starts were up 6.2% to an 854,000 rate. On the other hand, single family permits fell 4.2% to 782,000. The charts below show the weakness by region. Multi-family permits were up 8.9% to 514,000. The West was strong as overall permits were up 5.3% monthly, but they did fall 2.3% yearly. The South was weak as overall monthly permits were down 1.2% and yearly permits fell 10.7%.
The industrial production report signaled a recession could
be coming. The two things that can save the economy is that it is well-diversified
and that this report may have been week because of a calendar quirk. Most of
the housing data has been beating estimates, but we can’t be extremely excited
about a market where single family permits fell 4.2% monthly and overall permits
fell 5% yearly. That’s even with declining interest rates.
Are you wanting to join the investing world, but think you don’t have enough money to begin? Think again.
You don’t need a crazy amount of money to start investing. Although the more you have, the more you can earn back, and you have your safety net to fall back on, that doesn’t mean you can’t get yourself started. It’s possible to start investing with only tens of dollars, rather than thousands of dollars.
If you’re a beginner investor but think you don’t have enough money, we have five tips that will get you going.
Get Started With Saving
Before you being, you do need to have a bit of money set aside to toss into an investment account. Again, it doesn’t have to be much, but it does have to be something.
Spend a few months setting money aside, even if it’s only $10 a week. Every week you’ll watch that dollar amount grow, and you can use that as your initial investment. Remember, you’ll have to adjust your budget or spending to make up for the money you’re setting aside.
Read Up on Investment Newsletters
Investment newsletters through popular websites are an excellent way to understand the market, and to get stock recommendations. If you’re planning to buy individual stocks, then staying up-to-date with these newsletters will be a huge asset for you. Take a look at some of the best investment newsletters out there to gather information.
Use an Investment App
If you’re unsure on how to invest but still want to give it a try, consider using an investment app. These apps will link to your bank account and credit card. Every purchase you make, the app will round it up to the dollar amount you select and invest that money. It may not be a lot, but it’s an excellent way to start. Look for ones that have a portfolio set up with an account manager.
Use an Online Brokerage
Part of the process of learning to invest is to find the right platform and company to use in the beginning. The more comfortable you get with investing, then you can start to go on your own. As you start though, it’s better if you get help through an online brokerage.
These online platforms help guide you through your first investment and are typically quite affordable. They are user-friendly, and lots offer advice and information to help.
Keep Tabs on Your Investment
Once you get your first few dollars into an investment account, don’t ignore it. You want to keep track of your investment portfolio. It’s important to monitor it because you may not to change what you’re investing, or put more money into your current investment.
There’s a line between monitoring your investment and going crazy with over checking it. You don’t want to check your investment every hour of the day. All you’ll see are the small movements that won’t affect you very much. However, you do want to get in the habit of regularly monitoring it, so you know you’re working towards your goal.
Don’t shy away from investing because you think you don’t have enough money. Everyone has to start somewhere.
To put it bluntly, investors are concerned about the future of investing. With a trade war with China looming overhead, most are checking their cell phones or the television with trepidation each morning in fear of what might have happened overnight. Losses are accelerating, and the world is on edge, but there are ways to navigate the stock market safely in a sticky situation.
Stick with the Known
When it comes to investing and depositing funds, the current market is prone to fluctuations. Goldman Sachs chief U.S. equity strategist, David Kostin, suggests sticking with dividend growers, companies with low labor costs, and domestic-facing service sectors. In other words, stick with stocks that have proven immune to trade wars.
High dividend-yielding stocks like AT&T are usually steady during tough times. In contrast, companies with low labor costs like Facebook and Netflix will tend to do quite well “as wages remain a margin headwind,” Kostin revealed in an interview with CNBC. Service companies aren’t nearly as sensitive to tariffs as goods companies, so investing in Disney, Wells Fargo, and McDonald’s is a wise choice.
Stick with Domestic
Kostin noted that “70% of the revenues of U.S. companies are domestic, so while tariff is an issue, it’s concentrated in some industries and some sectors [more] than others.” Adding up the facts, it appears the take-home is that domestic service companies are a solid bet if you’re a betting man right now. Utility and telecom companies are good examples, as is Amazon.
Companies like Apple, on the other hand, won’t fare as well. Service-providers like Google and Microsoft have more stable gross margins. Apple, with billions in sales overseas in China, is much more exposed to any retaliation China dishes out.
Hard Times at Home
Automakers have been hit especially hard by tariffs and will likely continue to struggle. GM, Volkswagen, and BMW have plants in the U.S. and depend on China for sales and parts. Many have had to raise prices on vehicles they sell in China as a result of earlier U.S.-imposed tariffs.
Meanwhile, farmers and retailers are facing their own set of challenges. The U.S. government has already provided billions in aid in an attempt to soften the blow. Warren Buffett, chief executive of Berkshire Hathaway, told CNBC that this trade war “is bad for the whole world.” It seems he’s right, as usual. With time and patience, though, the whole world will recover.
The April seasonally adjusted retail sales report was a
major disappointment as headline monthly growth fell from 1.7% to -0.2% which
missed estimates for 0.2%. It even missed the low end of the consensus range by
0.1%. Yearly growth was 3.1% which is near the low end of this cycle’s readings
but not nearly as bad as the terrible December 2018 report. Ex-autos sales were
up 0.1% monthly and 3.3% yearly. This is better than the headline reading
because auto sales were weak as they fell 1.1% monthly. Ex-autos and gas sales
fell 0.2% which is worse than just ex-autos because gasoline station sales were
up 1.8% as they were driven by higher gas prices. The control group’s monthly
growth was the only reading that didn’t miss the low end of estimates as it was
0%. It missed the consensus of 0.4% and fell from 1.1% in March. Yearly growth was
One excuse for this weak report was that consumers received
lower tax refunds than they may have expected. Lower tax rates mean lower
refunds. Consumers often are subject to mental accounting bias which is when
they put money in boxes even though it is fungible. This ‘found money’ from a
tax refund is often spent right away rather than saved.
The other reason results were poor is the timing of Easter. The
holiday was on April 1st last year and April 21st this
year. That means there was more spending in March last year and this year had
more spending in April. The results are switched during the seasonal adjustment
process, but it’s possible that the adjustment went overboard.
To find out more, let’s look at non-adjusted yearly retail sales growth seen in the chart below.
Unsurprisingly, yearly growth was very weak in March as it was 1.6%. It was strong in April as it was 5%. To counteract the effect of seasonal adjustments, we can look at March and April’s 2 year unadjusted growth stack. The 2 year growth stack was 7.37% in March; it was 8.58% in April. The eye test, which tells us the jumbled data may have been catalyzed by seasonal adjustments, is correct. The Easter excuse is a valid concern.
Further Retail Sales Details
Because of the 0.1% higher revision in March retail sales, there might be an uplift in the Q1 GDP revision. That revision comes out on May 30th. Q2 GDP growth will be hurt by this April report. This report caused the Atlanta Fed Nowcast’s estimate for real Q2 consumer spending growth to fall from 3.2% to 3%. That was partially why the Q2 GDP growth estimate fell from 1.6% to 1.1% on May 15th.
Most of this report shows weakness which isn’t a surprise based
on the headline reading. It was hurt by spending on consumer electronics and
home improvements. The somewhat weak housing market has a big role to play in latter
category’s weakness. The chart below basically takes every weak part of this
report and combines it, showing a problematic result. It’s fair to call this
cherry picked data, but it’s also fair to say if the economy was strong, spending
growth in these categories would be stronger. This group’s growth also was
negative last month which had a good headline reading. Specifically, monthly
sales at electronics and appliance stores fell 1.3% after falling 4.3%. Furniture
sales were flat after falling 3.1%. Building materials sales fell 1.9% after
Besides gasoline, there were a couple good parts to this report.
Department store sales growth was 0.7% which pushed general merchandise sales
growth up to 0.2%. Restaurant sales growth was 0.2% which builds on the 5.7%
growth in March. It would have been easy to give some of that gain back.
Q1 Household Debt & Credit Report
In the NY Fed’s Q1 report, total household debt increased from $13.55 trillion to $13.67 trillion. Don’t be fooled by the bearish investors into thinking that household debt being at a record high means the consumer is in trouble. Wealth is also extremely high because of the rise in asset prices like the stock market. For example, total debt increased from $12.68 trillion in Q3 2008 to $13.55 trillion in Q4 2018. In that period, the net worth of households and non-profits increased from $61.689 trillion to $104.329 trillion. That’s a much bigger increase than there was in household debt; the consumer has deleveraged in this expansion, as we have pointed out before.
This cycle has been driven by student and auto loans. They increased from $1.46 trillion and $1.27 trillion to $1.49 trillion and $1.28 trillion. Now let’s look at delinquency rates to check the health of the consumer. The best improvement in the chart below, which shows the percentage of balances 90+ days delinquent, was student loans which fell from 11.4% to 10.9%.
Unfortunately, the percentage of loans in transition to 30+ day and 90+ day delinquency both increased. The 90+ day credit card delinquency rate increased from 7.8% to 8.3% which is the highest rate since Q2 2015. This explains why the net percentage of banks reporting tightening lending standards for credit card loans increased from 6.4% to 15.2%.
The 90+ day delinquency rate on auto loans increased from 4.5% to 4.7% which is the highest rate since Q4 2011. This high delinquency rate is in tune with the weak auto sales we mentioned when discussing the retail sales report. As you can see from the chart below, auto loan growth for borrowers with credit scores below 660 is higher than growth of borrowers with FICO scores above 660.
Auto dealers are starting to lower their lending standards to make up for weak sales. That will lead to higher delinquency rates.
The April retail sales report was bad as it missed estimates
across the board. However, it was hurt by the seasonal adjustment which was
made because of the timing of Easter. The consumer deleveraged this cycle. However,
issues are creeping up in auto loans and credit card loans. This data is
supported by weak auto sales and tightening lending standards for credit cards.
The Fed’s two mandates are stable prices and maximum employment. Skeptics think the third, most powerful mandate, is to keep the S&P 500 up. To be fair to the Fed, the stock market is a leading indicator of the economy, so if the stock market falls it could be a warning that the economy may be deteriorating. Also, if the stock market falls significantly, that could hurt the economy further through reflexivity. Bearish investors hate the concept of the Fed helping the stock market, but they are in a difficult position of managing not only the cost of currency, but perception and confidence in their ability to do so. None of us can control whether the Fed helps the market. We can only react to policies and changes to the economy. If you have been angrily short stocks since December because you are mad the Fed turned dovish, you have lost money trying to prove a point. You can utilize free speech to criticize any policy decision, but don’t involve your portfolio in philosophical arguments. Reality, just or unjust, and perception of reality, is what matters for portfolio returns.
When Will The Fed Cut Rates?
As you can see from the chart below, Merrill Lynch asked fund managers where the S&P 500 would need to fall to for the Fed to cut rates. The most popular answer was 2,350.
The S&P 500 was at 2,834 as of May 14th. We think this question is attempting to figure out when the market alone would cause the Fed to cut rates, because even with the stock market this high, the odds of a rate cut by the end of the year are 74.2%. It’s also possible fund managers don’t agree with those odds.
The Biggest Tail Risk
The stock market is stuck in a cycle. The good news is the stock market corrections make tariffs less likely. The bad news is a bull market gives policy makers more confidence to apply more tariffs. Even though the bulls don’t like this trade war, it’s a positive for them that policy makers respond to the stock market.
As you can see from the chart below, the trade war was considered the market’s biggest tail risk.
A tail risk is supposed to be a relatively low probability event that can cause big problems. This risk must refer to a global trade war because the trade war with China is already underway.
As you can see, in the May survey, less fund
managers mentioned a Chinese slowdown as a tail risk. The Chinese slowdown has
been underway for a few years, so this tail risk must refer to much more
weakness. It appears fund managers were wrong in May to stop picking this as
the biggest tail risk as the April economic reports from China were terrible.
Specifically, industrial output growth was 5.4% which fell from 8.5% in March
which was a 4.5 year high. The April reading missed estimates for 6.5%. Chinese
retail sales growth fell from 8.7% to 7.2% which missed estimates for 8.6%.
As you can see from the chart below, this was the lowest growth rate since May 2003. This chart truly highlights how long the Chinese slowdown has been going on for.
Chinese auto sales fell 14.6% in April which was the 10th straight month of declines. Fixed asset investment growth was 6.1% in the first four months of 2019. Estimates were for 6.4%; growth was 6.3% in the first quarter. Private fixed investment growth fell from 6.4% in Q1 to 5.5% in the first 4 months of 2019. Finally, infrastructure spending growth was stagnant at 4.4%. As you can see, this was an across the board sharp slowdown which could signal the trade war is hurting China. It definitely signals the global economy is still weakening. This is a score for America in the trade war, but increases the cyclical headwinds for the economy.
Very Poor Cass Freight Index
The April Cass Freight shipments reading was terrible, signaling the American economy is in a slowdown. The movement of tangible goods is a great indicator for the health of the economy. Shipments growth is getting closer to the weakness seen in the 2015-2016 slowdown. As you can see from the chart below, shipment volume growth has been negative for 5 straight months. Shipments were down 3.2% and expenditures were up 6.2% yearly. The Cass Freight report stated, “we see material and growing downside risk to the economic outlook.” Furthermore, it stated, “the Cass Shipments Index has turned negative and is now signaling economic stagnation with the potential for contraction.” This is the exact weakness the ECRI leading indicator forecasted would happen in Q2 and Q3 at the start of the year.
FactSet’s data shows less EPS growth than The
Earnings Scout’s data. If you follow FactSet, it’s possible EPS growth could be
negative for 2 straight quarters (Q1 and Q2). With 90% of S&P 500 firms
reporting earnings, EPS growth was -0.5%. Estimates for Q2 EPS growth are for
-1.7%. The good news, which we mentioned in a previous article, is Q2 EPS
estimates fell less than average in April.
As you can see from the chart below, the main catalyst for the potential EPS contraction in Q1 was multinational firms.
Firms with more than 50% of sales coming from outside America saw earnings decline 12.8% and sales only increase 0.2%. Firms with more than half of their sales coming from America had EPS growth of 6.2% and sales growth of 7.3%. The trade war will only increase the divide between domestic and multinational firms.
If the stock market declines, the Fed will be more likely to cut rates, but the market already expects a cut anyway because the American economy is in a slowdown. The stock market rallied earlier in the year on the basis of a trade deal and the slowdown not leading to a recession. Unfortunately, tariffs are increasing soon and the slowdown has only gotten worse according to the Cass Freight index. The only positive left is the dovish Fed. However, a rate cut won’t save the economy or the stock market. Chinese economic growth weakened rapidly in April; Q1 S&P 500 EPS growth was significantly hurt by multinationals.
Since our last article on the U.S. China trade war, China officially retaliated against America’s 25% tariff on $200 billion in goods with its own tariff on $60 billion of American goods. Over 5,000 goods will be taxed at a 25% rate. Other goods will be taxed at a rate of 20% which is an increase from 5% and 10%. On the possibility of taxing just about all Chinese imports at a 25% rate, President Trump stated, “We have the right to do [tariffs on] another $325 billion at 25% in additional tariffs. I have not made that decision yet.”
This is consistent with how Trump’s negotiation process has
gone. When he takes action, he threatens more action, but doesn’t deliver until
first trying to negotiate. He has been talking about this tranche of tariffs
for a while. It’s less clear what could happen after that tranche of goods is
tariffed. One of the most hotly discussed topics on trade has been if China
would stop purchasing U.S. treasuries or worse sell them. At a certain point
when economic wars become extremely fierce, there is risk of a real war. While
that’s unlikely, even the increased threat of a war would send stocks crashing
and could push up inflation.
As we discussed in a previous article, bold promises on big legislative achievements and deals need to be taken with a grain of salt. A deal with China could last for decades or it could be broken before it’s agreed upon, like what just happened. Any timeline should be questioned. That being said, when asked about a timeline on these negotiations, Trump stated, “We’ll let you know in three or four weeks if it’s successful.” There seems to be market moving news every few days, if not every few hours. However, actual negotiation progress is difficult to come by.
Impact Of Trade War On Households
As you can see from the chart below, the current 25% tariff rate on $200 billion worth of goods from China will cost GDP $62 billion, employment 200,000 jobs, and households $490.
If tariffs are levied on all imports from China, it will cost GDP $100 billion, employment 360,000 jobs, and each household $800. The trade war’s impact to GDP could push America into a recession if cyclical weakness continues, but it won’t if the cycle turns up. A 360,000 decline in employment wouldn’t be a major disaster since the labor market is close to full. The real question is if the cycle is turning and the labor market is about to have sustained weakness.
We’re most concerned about the trade war’s impact on
households because real quarterly consumption growth was already weak in Q1 as
it was 1.2% based on the initial GDP report. That weakness caused real final
sales to domestic purchasers to grow at the weakest rate in 6 years. GDP growth
will be terrible if consumption growth stays low and if trade and inventory
investment don’t bail out growth.
The stat that the trade war would cost households $800 reminds us of the Bankrate survey seen in the chart below which asked Americans how they would deal with a $1,000 unexpected expense.
40% stated they would pay the expense with savings. That means the rest of Americans don’t have $1,000 in emergency savings. While tariffs aren’t a new expense like a car repair or an emergency room visit, they will cost households money by making many goods more expensive. The $200 billion tranche of tariffs will have more consumer goods than the previous tranches. The final $325 billion tranche has the most consumer goods. Added expenses will cause consumers to take on more credit card debt, reduce spending, borrow from their friends and family, and take out personal loans.
Trade War’s Effect On Inflation
Increased costs for households mean increased inflation. As you can see from the table on the right, the Fed is projecting a 0.4% lift in inflation if a 25% across the board tariff on Chinese goods is implemented.
Goldman Sachs estimates that if these tariffs on China, plus tariffs on imported autos are implemented, inflation will increase 0.9%. Trump is negotiating with Europe and Japan on a trade deal as well. Reports are showing it’s likely the May 18th deadline to make a decision on auto tariffs will be postponed. It doesn’t make economic sense to take a ‘no holds barred’ approach to negotiating with Japan and Europe with the trade war with China heating up quickly. The chart on the left shows the huge jump U.S. tariffs would take if there is a 25% tariff on all Chinese goods and tariffs on auto imports.
The Reason Behind The Trade War With China
President Trump has targeted China not just because it is the nation America has its biggest trade deficit with. He has targeted China because of its alleged violation of intellectual property laws. This alleged violations and China’s willingness to back out of a deal are why it has been tough to make one even after a couple years. As you can see from the chart below, 80% of all the counterfeit and pirated goods in the world come from China and Hong Kong.
China isn’t in the catbird’s seat (advantage) where it can just stop buying treasuries and let America fail. It relies on America to buy its products. Neither side wants to be too aggressive because they need each other economically and because an actual war would be devastating.
As we mentioned, China is has been alleged to infringe on American intellectual property by making counterfeit and pirated goods. As you can see from the chart below, almost 25% of seizures of counterfeit goods are infringing upon American intellectual property.
China and Hong Kong, according to this chart, steal the most and America gets stolen from the most. China and America are naturally on the opposite side of the discussion. It’s not a surprise America is the one initiating tariffs on China.
We’re not here to judge the effectiveness of President Trump’s
negotiations because we don’t know what is going on behind closed doors. We only
need to measure the impact of the trade war and figure out the various possibilities
and the odds of each occurring. An all-out trade war with China will slow
growth in both countries and increase inflation. The Fed is more likely to
respond to this trade war with a rate cut than a rate hike even though
inflation will increase because it needs to support the economy. It’s not a
surprise negotiations aren’t going smoothly because intellectual property infringement
isn’t an easy issue to solve.
While jobless claims fell in the week of May 4th to 228,000 from 230,000, this report was highly disappointing. 3 weeks prior, when claims increased to 230,000, economists said they jumped because of the Easter holiday season. However, now we have 3 weeks of elevated claims which have caused the 4 week moving average, seen in the chart below, to increase from 201,500 to 220,250.
This isn’t a recessionary warning, but it is something to follow closely as jobless claims are finally following the boost in layoff announcements seen in Q1. On a yearly basis, growth in the 4 week moving average of claims increased from -10.6%, 3 weeks ago, to 2.3%.
Claims of 228,000 were 13,000 higher than the consensus as
economists keep waiting for claims to drop after the Easter holiday season
which is now far in the past. To be fair, there is still hope seasonally
adjusted claims might come back down because non-seasonally adjusted claims
aren’t elevated much sequentially. In the same 3 week period, non-seasonally
adjusted weekly claims increased from 196,000 to 204,000. That’s a small blip
in this volatile reading. It’s nowhere near the peak in January. However, that
peak occurred because of seasonal weakness in the labor market. Year over year
non-seasonally adjusted growth in weekly claims once again favors the bears. Yearly
growth was 7% in the week of May 4th as you can see from the chart
below. The yearly growth of 9.8% in the previous week was the highest since September
Even with all this analysis, we still aren’t sure about the
labor market because claims have lost correlation with the labor market since states
have lowered the amount of unemployment benefits and how many people qualify. That
being said, jobless claims are still in the Conference Board’s leading
indicators index. Claims won’t hurt the index in April, but they could hurt it
in May if the results stay where they are now. If claims show a few more weeks
of weakness, investors will take note. Because adjusted claims were 198,000 in
the week of April 13th, if claims don’t crash in next week’s report,
the 4 week average will explode higher. It’s very likely that claims will be
above 198,000 next report.
Modest April CPI Report
The April CPI report was weak even though technically core CPI increased from March. Monthly headline CPI was 0.3% which missed estimates and last month’s reading of 0.4%. Yearly CPI was 2% which increased from 1.9%, but missed estimates for 2.1%. Monthly core CPI was 0.1% which was the same as March, but missed estimates for 0.2%. Yearly core CPI was 2.1% which met estimates and was up from 2%. However, this is all about rounding. Core CPI only increased from 2.04% to 2.07%. That’s hardly a big deal even for the Fed which likes to focus on getting core inflation to 2%. This slight increase won’t make the Fed hike rates in June. The Fed is far from hiking according to the Fed funds futures market. There is a 10% chance the Fed cuts rates in June and a 71% chance the Fed cuts rates at least once by the end of the year.
Shelter Inflation Stays High
As per usual, inflation was driven by medical costs and
shelter. Those make up about half of CPI. The fact that housing is the most important
component of inflation and is above overall inflation makes it the number one
category to follow. Specifically, on a non-seasonally adjusted basis, shelter
inflation was 3.4% and medical care services inflation was 2.3%. Rent of
primary residence inflation was 3.8% and owners’ equivalent rent of primary
residence inflation was 3.4%.
It’s a surprise to those who aren’t experienced with shelter
inflation that it is hasn’t fallen recently because home price growth has
cratered. As you can see from the chart below, the national home price index’s
growth rate has fallen from 6.47% last February to 4% this February. That’s
while shelter inflation hasn’t moved much. In that period, it went from 3.13%
to 3.37%. Shelter inflation actually increased while home price growth fell. If
the recent trend in home price growth continues, it will fall below shelter
inflation for the first time since August 2012.
Further Details On The CPI Report
As you can see from the chart below, commodities inflation has perked up slightly as it is now at 0.9%. It still lags services inflation which is 2.7%. Commodities are 37.3% of CPI and services are 62.7%.
Core inflation is in a similar position as core commodities inflation was -0.2% and services less energy services inflation was 2.8%. Core commodities inflation was pushed lower by apparel which saw prices fall 3%. At the May press conference, Jerome Powell mentioned that apparel price inflation was low in March because of a change in methodology and transitory issues. However, apparel is a small portion of core inflation, so it would need to spike significantly to matter. Prices fell sharply in the April CPI reading.
Similarly, he mentioned airfare prices hurting core PCE inflation.
In the CPI report, airfare prices fell 1.8%. These “transitory” negative impacts
to inflation continued in April. He also mentioned how portfolio services
inflation was weak because stocks fell. He said there is a lag between stock
price performance and inflation. Therefore, he said this component will see increased
inflation in the future.
Energy commodities prices were up 2.9% yearly. This increase
was caused by gas which had a 3.1% increase. Fuel oil prices fell 0.9%. Food inflation,
which made a multi-year high last month, fell from 2.1% to 1.8%. The crash in
soybean prices caused by the trade war hurt food inflation. New vehicle
inflation was only 1.2%; used car and truck inflation was just 0.8%. With the recent
weak auto sales report, it’s no surprise inflation wasn’t elevated.
Rising jobless claims need to be monitored closely. You can look at weekly claims, yearly growth in claims, unadjusted claims, and the 4 week average to get the full picture. CPI wasn’t strong as core CPI only increased 4 basis points. The Fed won’t be hiking rates anytime soon. The April CPI report showed Powell was wrong to expect airfare and apparel inflation to increase. Shelter inflation is steady, unlike national home price growth which is crashing.
Heading into May, the trade talks appeared to be headed in a
positive direction, albeit very slowly. We’re hesitant to trust politicians/officials
when they discuss major dealings because history has shown us more often than
not politicians kick the can down the road rather than getting anything done.
In America, politicians face elections every 2-6 years which makes tough votes and
decisions not in their best interest.
This healthy skepticism of an all-encompassing trade deal with China being done in the near term was accurate as according to President Trump, Chinese leaders now want to renegotiate part of the deal that was agreed upon. America’s goal had been to strike a deal with China that could be enforced.
Trade Talks Turn South
America is having a difficult time agreeing with China to standards on intellectual property rights and potentially lower its trade surplus with America. In April, China’s trade surplus with America was larger than its total surplus, meaning it had a deficit with the rest of the world. Specifically, China’s total trade surplus was $13.84 billion; it was $21.01 billion with America. Total exports fell 2.7% and imports rose 3.6%.
Recent Market Decline
It’s fair to be skeptical of the reasons the media gives you as to why stocks moved. In this case, the stock market was overbought and there have been a few negative economic reports recently such as the ISM PMIs. Hiring in the JOLTS report also fell 0.6% monthly in March. You can look at which stocks declined to determine if the sell off is trade related. We like to look at the Dow versus the Russell 2000, the semiconductors, and stocks like Emerson Electric to determine trade’s effect on the market. You can also use soybean prices which are a key export from America to China.
On May 5th, Trump tweeted that America would be raising the tax rate on $200 billion worth of Chinese goods from 10% to 25%. This occurred on Friday the 10th. He also threatened to tax an additional $325 billion worth of Chinese exports at a 25% rate. One nuance, is the tariffs go into effect when goods reach America. Anything that left China already won’t be taxed at the new rate. It takes 21 days for ships to go from China to America. With the direction these negotiations are headed in, there may not be a deal within that timeframe. China already plans to negatively react to these new tariffs according to some news stories.
Since the close on May 3rd, the Dow is down about 2.6% and the Russell 2000 is down 2.7%. That doesn’t indicate trade weakness. We used this metric because the Dow contains international industrials affected by trade and the Russell 2000 contains small caps, which aren’t as affected by trade. The SOXX semiconductor ETF signals trade is an issue as it is down 5.92%. That’s much worse than the S&P 500’s decline of 2.5%. Emerson stock also signals trade is an issue as it fell 6%.
Emerson Electric’s CEO stated trade is “something we have to manage. I can’t sit here and cry and hold my breath. I’ve got to deal with them. I still believe we’ll get a deal done. I think the issue really boils to — I think both parties are testing each leader on the give and take.”
Source: Amenity Analytics
As you can see from the chart above, through February 2019, earnings call sentiment on trade was the most negative for consumer discretionary, industrials, tech, and materials. It’s the least negative for consumer staples and energy. One thing to keep in mind with the trade war’s effect on the market is it was performing well until now; there are corrections almost every year. Specifically, in the past 40 years, 38 have had declines of at least 5%. There haven’t been any in 2019.
Estimate Of Economic Impact Of Trade War
In a previous article, we mentioned a full blown trade war between America and China could hurt global GDP growth by 45 basis points. With the global economy already facing cyclical headwinds, this could be a fatal blow to the expansion. The chart below shows Oxford Economics’ estimate of the effect of U.S. China tariffs of 25%.
We just published our latest #TradeWars report looking at the impact of:
As you can see, the effect on real GDP growth in 2020 could be 0.3% in America, 0.8% in China, and 0.3% globally. China’s economy has seen a modest pickup recently because of its stimulus. That might not save its economy next year. It’s possible China wants to wait out President Trump’s presidency which could end in less than 2 years. However, Senate Minority leader Chuck Schumer tweeted in support of the President. Schumer is a key Democratic leader. This trade war may not end if Trump isn’t re-elected. On the other side, Trump is motivated to get a deal done so he can use it to run on in his re-election bid.
Where Tariffs Will Hit
As you can see from the chart below, the new tariffs, which is tranche 3, will hit consumer goods which is obviously a negative because the consumer drives about 2/3rds of U.S. economic growth.
Source: Goldman Sachs
The final tranche of tariffs, which could be announced in the next few weeks if the negotiations continue to go poorly, is mostly consumer goods.
Too Much For Chinese Firms
The chart below shows most listed Chinese firms have profit margins below 25% which means the tariffs could destroy their businesses. Just like how China switched to Brazilian soybeans, American firms will need to switch to cheaper alternatives with this new tariff rate.
As we mentioned in a previous article, the market is in a
tough position because it is overbought, the positive catalyst that is earnings
season is over, the trade war is getting worse, and economic reports are coming
in soft. This is far from a disaster, however, as there is at least a 5%
correction almost every year. The trade war isn’t the main catalyst of a
potential global recession as the global economy isn’t in good shape for cyclical
The difference between the U6 unemployment rate and the U3 unemployment rate, seen in the chart below, measures the percentage of marginally attached workers and workers who are part time for economic reasons.
We were motivated to make the chart above because the U6 rate hasn’t moved in 3 months as it is stuck at 7.3%, while the U3 rate recently fell to 3.6% which is a 49 year low. The 0.2% drop in the U3 rate caused the difference between the two to increase to 3.7% from 3.5%.
As you can see, the recent bottom in February and March is just 0.1% above last cycle’s bottom and 0.6% above the previous cycle’s bottom. Avoid hindsight bias when reviewing this chart because it was difficult to determine if the past two bottoms were the end of the cycle at the time. The rate meandered a bit before soaring as the economy weakened. This chart exemplifies the point of how a great jobs market that is weakening is the worst case scenario for stocks and the economy.
At the last bottom in April 2006, average hourly earnings
growth for production and non-supervisory workers was 3.94%. It was 3.89% in
October 2000. This cycle has had lower wage growth as it was 3.44% and 3.33% in
February and March of this year. (It increased 4 basis points in April.) That’s
one indication that the labor market isn’t as full as it was then.
Prime Age Participation Not Showing A Full Labor Market
The prime age labor force participation rate falling from 82.5% to 82.2% in April tells us that the decline in the number of employed people and the decline in the number of people in the labor force wasn’t mainly caused by workers retiring. In October 2000 it was 83.6% and in April 2006 it was 82.8%. Because of the decline in April, if the rate continues increasing at the current pace seen in the past year, it will take 5.78 years to get to the past 3 cycle’s average peak. The big decline increased the difference between the current rate and the average peak as well as lowered the recent pace. This all could easily reverse next month. There have been a few months where this rate has fallen in the midst of its rise which started in September 2015.
Low Wage Growth
As we’ve highlighted in previous articles, low wage
industries have seen accelerating wage growth in the past few months relative
to others. Low wage growth is being helped by minimum wage hikes at the state
level and because the employment to population ratio for people without a high
school diploma is near a historic high. Low wage workers are usually crushed by
recessions and outperform at the end of expansions. Keep in mind, that not only
does wage growth underperform in recessions, the unemployment rate for low wage
workers also spikes higher than it does for mid and high wage workers. It’s
tough to get a job and when you get one, the pay growth isn’t great.
General Merchandise Industry’s Effect On Low Wage Growth
One new point we hadn’t previously considered is the effect
of general merchandise stores’ wage growth on the calculation of low wage
industry growth. As you can see, while low wage growth excluding general merchandise
stores is elevated, it’s not nearly as high as the calculation that includes
them. The effect general merchandise stores have had on low wage growth has
been heightened in the past 12 months.
As you can see from the chart below, average hourly earnings
growth at general merchandise stores has soared, but weekly hours growth has plummeted.
This decline in hours growth is similar to, but more pronounced than the decline
in hours worked in the overall labor market. This chart is subject to
composition bias worthy of noting. The lowest productivity and lowest paying
firms in the general merchandise industry, which is shrinking, are laying off
the least productive workers first. That explains why average hourly earnings
growth went up and hours worked fell. This chart explains why we review weekly
earnings growth closer than average hourly earnings growth when reviewing the
overall labor market.
In the week of May 2nd, the 30 year mortgage rate
fell from 4.2% to 4.14%. While that specific decline probably isn’t the reason
for the mortgage applications growth improvement in the past week, the decline
in the past 6 months is the main reason the housing market has stabilized. The MBA
applications composite index increased 2.7% weekly on top of -4.3% growth in
the week of May 3rd. The purchase index had growth of 4% on top of -4%.
That equates to 5% yearly growth instead of 1% growth. As the chart below shows,
purchase applications are near recent highs. 2019’s average growth rate is
3.7%. There have been 15 positive prints and 3 negative yearly growth prints.
Q1 earning season was great because the average earnings beat was above average and the Q2 estimate decline was less than average. As the table below shows, the average EPS surprise was 6.17% which beats the 3 year average of 5.26%.
While EPS growth was less than half the 3 year average, it was positive which ends the fears of an earnings recession in the near term. The only issue with earnings season is it’s almost over. Earnings won’t provide much of a catalyst for the overall stock market for the next 2 months. That means investors will focus more on trade worries and economic reports which have been weak. That’s a toxic cocktail which could lead to a correction, depending on how badly negotiations go and how weak economic reports are. To be clear, if economic reports stay weak, Q2 earnings are likely to beat estimates less than expected.
The labor market is full according to the U6 rate minus the
U3 rate. However, the prime age labor force participation rate disagrees. Low
wage growth is high, but it’s not as high as indicated because the general
merchandise store industry is manipulating growth due to composition bias. MBA purchase
applications rebounded in early May. Q1 earnings growth was great, but earnings
season is now 85% over. That means more focus will be on economic reports which
is bad if they continue to be weak.