Market Minutes for the week of May 28th:
“It is okay to fail, but it is not okay to quit.” — Jim Cramer to the Class of 2018 at Bucknell University
Here’s what I am thinking and hearing: 1.) It looks like OPEC and Russia may want the price of oil down and are willing to consider an output increase. The Saudis have about 2 million barrels per day of spare capacity according to Energy Minister Khalid Al-Falih. 2.) Apparently, nothing but a rumor of production increases from OPEC has worked (for now) to stop the acceleration of crude prices. In just 4 trading days, the price of WTI (West Texas Intermediate) crude has fallen from $72.13 per barrel to $66.81 per barrel. 3.) What’s up with Italy? Well, their politics are a mess. They currently have no functioning government (the country has had more than 60 different governments since WWII). They have the third-largest bond market in the world (hard to believe — but true). Their public debt is 130% of GDP. The yield on Italy’s sovereign 2-year note has gone from a -0.31% in April to 2.55% currently, rising 0.90% overnight! Unemployment is running at 11%. 4.) What does all this mean? The economic chaos is sowing the seeds for the potential support of an anti-euro, “Italexit.” The anti-establishment Five Star Movement, Italy’s biggest party, and the far-right League party, won more than half the votes in March’s parliamentary elections and both are highly critical of Europe’s single currency. 5.) Add to that, Spain’s Prime Minister Mariano Rajoy is the subject of an upcoming no-confidence vote because of a campaign scandal. The vote could force a new election where if Rajoy is ousted, the Left-leaning anti-euro, Socialist party stands a chance of coming into power. Update! Rajoy loses vote, Socialist Party’s Pedro Sanchez is new Spanish PM. 6.) The global markets are once again, awash with uncertainty over the euro’s survival and when there is uncertainty, investors sell. 7.) Here is another “war” story from the front lines of the trade war by Bloomberg’s Jen Skerritt, discovered by 361 Capital: The bulk carrier RB Eden was loaded with the grain [sorghum] at Archer-Daniels-Midland Co.’s terminal in Corpus Christi, Texas, and was initially bound for Shanghai. When China announced a 179% tariff on imports of sorghum in mid-April, it performed a U-turn in the Indian Ocean, according to vessel data tracked by Bloomberg, and sailed back around southern Africa towards Europe. The vessel’s destination was changed to Cartagena, Spain, but according to the data, it never docked. On May 18, China scrapped its anti-dumping and anti-subsidy probe into sorghum. The same day, the RB Eden began sailing back toward the Atlantic. It is currently bound for Singapore [see the map at the end of Market Minutes]. 8.) Former bond guru Bill Gross has had a tough week and a tough year so far. On Tuesday, his $2.1 billion Janus Henderson Investors Global Unconstrained Bond Fund fell by nearly 3% as bond market volatility jumped on geopolitical concerns in Italy. Year to date, his bond fund was down 5.9% through Tuesday. That’s kind of like last year’s National League Batting Champion now hitting .125. 9.) Mary Meeker, partner at Kleiner Perkins Caufield & Byers observes that industry leaders Apple, Google, Amazon and Facebook — accounting for a combined market valuation of nearly $3 trillion — were all founded by first or second-generation immigrants. Apple founder Steve Jobs was the son of a Syrian immigrant, Amazon founder Jeff Bezos is a second-generation Cuban immigrant, Google founder Sergey Brin was born in Russia and Facebook co-founder Eduardo Saverin is a Brazilian native. Oracle tallies two children of immigrants as founders. All four of PayPal’s founders are immigrants. 10.) For the month of May: the DJIA +2.03%, YTD –1.23%. The S&P 500 +2.87%, YTD +1.18%. The NASDAQ +4.99%, YTD +7.80%.
Payroll processor ADP said that private payrolls grew by 178,000 in May. Hiring was strong in construction, education, health care and professional and business services. Jobs were cut by retailers.
The Labor Department announced that the U.S. economy generated 233,000 nonfarm jobs in May and pushed the unemployment rate to an 18-year low. A separate level of unemployment which includes discouraged workers and part-time positions, fell to 7.6%, the lowest level since May 2001. The average hourly wage rose by $0.08 to $28.92 per hour. Wages are up 2.7% year over year.
The Commerce Department said that final 1st quarter GDP was revised down to +2.2% from +2.3% in the original report. Inventory investment and consumer spending were the driver behind the downward revision.
The Chicago PMI (purchasing managers index) for May jumped 5.1 points to 62.7, the highest level since January.
The Commerce Department reported that the U.S. trade deficit (goods) fell by 0.6% in April to $68.2 billion. In the month, the U.S. exported fewer autos but imported fewer consumer goods like electronics.
The Conference Board announced that consumer confidence rebounded in May to 128 from 125.6 in April. The reading continues to hover around 18-year-time highs set in February of this year.
The Commerce Department said that consumer spending rose by 0.6% in April, the biggest gain in five months. Personal incomes for the month rose by 0.3% and wages increased by 0.4%. The jump in consumer spending is good news for the economy as it accounts for more than two-thirds of total economic activity.
The Institute for Supply Management (ISM) said that its manufacturing index hit 58.7 in May for the 21st consecutive monthly expansion of the manufacturing sector.
Comments from the Fed’s Beige Book for May: “Economic activity expanded moderately in late April and early May with few shifts in the pattern of growth. The Dallas district was an exception, where overall economic activity sped up to a solid pace. Manufacturing shifted into higher gear with more than half of the Districts reporting a pickup in industrial activity and a third of the Districts classifying activity as ‘strong’. Fabricated metals, heavy industrial machinery, and electronics equipment were noted as area of strength…By contrast, consumer spending was soft. Nonauto retail sales growth moderated somewhat and auto sales were flat.”
The Atlanta Fed’s GDPNow model used for forecasting GDP growth, is now showing a 2nd quarter growth rate of 4.7%, revised up from 4.0% after the most recent consumer spending figures.
Baker Hughes said that last week’s total U.S. rig count increased by 13 rigs to 1,059, the highest level since March of 2015. Oil rigs grew by 15 to 859 while gas rigs declined by 2 to 198.
The European Central Bank (ECB) said that inflation in the 19 countries using the euro, climbed to 1.9% in May from 1.2% in April. Higher energy costs were to blame.
The S&P/Case-Shiller 20-City Home Price Index advanced by a seasonally adjusted 0.4% in March and was 6.5% higher than a year ago in March. The index has accelerated every month since last June and the March three-month period was the strongest since mid-2014. The usual hot markets were: Seattle, San Francisco, Las Vegas, Denver and Los Angeles. In Washington D.C., the average home price is up 13% from April of last year and half of the homes on the market sold in eight days or less according to the Greater Capital Area Association of Realtors.
Lawrence Yun, chief economist for the NAR (National Association of Realtors) says: “The continuing run-up in home prices above the pace of income growth is simply not sustainable. From the cyclical low point in home prices six years ago, a typical home price has increased by 48% while the average wage has grown by only 14%.”
The National Association of Realtors (NAR) said that pending home sales for April fell by 1.3% to the third lowest level of the year. Weakening affordability along with chronic short supply, especially at the lower end of the market, continues to pressure sales.
Goldman Sachs chief economist Jan Hatzius says that his forecasting models estimate that the federal deficit will increase from $825 billion (or 4.1% of GDP) in 2019 to $1,250 (5.5% of GDP) in 2021 and to $2.05 trillion (7% of GDP) by 2028. According to Hatzius, the build-up of such public debt could create a precarious situation for Congress if the economy faces a downturn in the near term: “Lawmakers might hesitate to approve fiscal stimulus in the next downturn in light of the already substantial budget deficit. While we would expect some additional loosening of fiscal policy during the next downturn, there is a good chance in our view that it would be less aggressive than it was in the last few recessions.”
Goldman Sachs goes on to say that rising deficits put upward pressure on interest rates as the Treasury must offer higher yields to sell the new debt. Goldman estimates that a 1% increase in the federal budget deficit, raises the 10-year Treasury yield by 20 basis points (or 0.2%) when the economy is at or beyond full employment where it currently stands.
Brian Wesbury, chief economist for First Trust sees it a bit differently: “For decades, investors have feared the national debt growing to unsustainable levels and destroying the U.S. economy. Back in 1981, the public debt of the federal government was $1 trillion; today it’s more than $21 trillion. At some point, their theory goes, additional debt is going to be the fiscal straw that breaks the camel’s back. The problem with this theory is that, in spite of record high debt, the net interest on that debt – the cost to government to satisfy interest payment obligations – was only 1.4% of GDP last year, hovering near the lowest levels in the past 50 years…Today, the average interest rate on the publicly-held debt is roughly 2%…One reason net interest remains so low relative to GDP, is that the government itself owns about $6 trillion of the debt and this doesn’t even include the debt owned by the Federal Reserve. So, the “net debt,” also known as the “publicly-held debt,” is roughly $15 trillion.”
The Laffer Curve (theorized by economist Arthur Laffer in 1974 and popularized by Reaganomics) demonstrates a theoretical relationship between taxation rates and the subsequent levels of government revenue. Simply put, “people respond to incentives, especially changes in tax rates”. Scott Grannis, the Calafia Beach Pundit, finds that “when there is talk of a future reduction in tax rates, it is reasonable to expect tax revenues to decline in anticipation, then subsequently rise once the rates have been cut”. Over the past two years (2016-2017), business investment was restrained in anticipation of a Trump led tax cut for business. Going forward in 2018 and going into 2019, business investment should be stronger, resulting in more jobs, more income, more profits, and more tax revenue.
Scott Grannis: “Indeed, there was zero growth in federal revenues beginning in February 2016 through the end of last year. Further, as I predicted back then, ‘if the tax code is reformed, and marginal tax rates on incomes, capital gains, and corporate profits are reduced, [the] Treasury will see an almost immediate surge in revenue’. And it’s happening…[April’s] Treasury report showed that April tax receipts, not only set an all-time record, but were fully 12% higher than last April’s receipts. People and corporations had been postponing income and accelerating deductions for 22 months leading up to last December’s landmark tax reform, and now they are beginning to realize that income and stop postponing deductions…The one thing to worry about is the spending side. Spending discipline unfortunately is lacking in today’s Congress, and the unchecked growth of entitlements promises to wreak havoc with federal finances in the coming years.” Exactly what Goldman’s Jan Hatzius was referring to above.
“The Kansas City Fed researchers found that an abnormally high share of employees still in the same jobs haven’t received a pay raise in the past 12 months despite a 3.9% unemployment rate that is the lowest in decades. Economists call this phenomenon ‘wage rigidity’… [and for] the most recent 12-month period ended in April, hourly U.S. wages increased at a 2.6% rate. Normally when the unemployment rate is as low as it is now, wages tend to rise at 3.5% to 4.5 per year”, according to Jeffry Bartash of MarketWatch.
Equifax said that the “severe” delinquency rate on private label credit cards is up 4.65%, or 0.57% higher than in March of 2017 and now at the highest level since 2011. Outstanding balances were at $81.7 billion, up 0.8% from a year ago.
The American Trucking Association reports that there is currently a shortage of 50,000 truck drivers across the country. Companies are frustrated as the driver shortage is affecting their businesses and the cost of convenience shipping is beginning to bite consumers. When Amazon recently hiked its Prime Membership fee to $119 from $99 per year, the company said one of the reasons for the price jump was increased shipping costs.
Modern-day pirates are terrorizing the Caribbean and Latin America according to a report from Oceans Beyond Piracy. Seventy-one pirate attacks were logged in the region in 2017, up 163% increase from 2016. Of the 71 attacks, 59% involved robberies aboard private yachts.
Boeing says that the third version of the 777 will come with partially retractable wings. The upcoming 777X will have a wingspan of 235 feet and the folding wing will allow the pilots to reduce the wingspan down to 212 feet. The wing change will only work on the ground and it will allow pilots easier navigation on the tarmac of crowded airports.
Singapore Airlines reports it will soon offer the world’s longest non-stop flight route later this year without economy class seating. The airline will start its once daily flight in both directions between Singapore’s Changi Airport and Newark Liberty Airport. The Airbus A350-900 ULR will cover more than 10,000 miles and spend just shy of 19 hours aloft.
Delta Air Lines will re-instate its non-stop service from either Atlanta or JFK to Mumbai, India starting in 2019. Delta was more or less forced to terminate the service back in 2009 after Qatar Airways, Emirates and Etihad Airways with their government subsidies, made it impossible to compete on the route. Recent agreements with Qatar and the U.A.E. have made the route possible again.
According to Sports Business Daily, Nike and Fanatics are closing in on a deal for the on-field apparel rights for Major League Baseball. The deal will start in 2020 and upends Under Armour’s attempt to extend their existing contract.
KKR will acquire BMC Software from Bain Capital and Golden Gate Capital for $6.9 billion. The financing for the acquisition is being provided by Credit Suisse, Goldman Sachs Bank, Jeffries Finance, Macquarie and Mizuho Bank.
Kroger is buying Home Chef, an online meal kit company for $200 million but the deal could grow to over $700 million over the next five years if Home Chef meets certain milestones.
Fifth Third Bancorp of Cincinnati has announced that it will acquire Chicago’s MB Financial for $4.75 billion. MB Financial has about $20 billion in assets and the combined bank will have a Chicago deposit market share of 6.5%, putting it forth in that market.
Best Buy reports 1st quarter earnings of $0.82 per share on revenue of $9.11 billion, an increase of 6.8% year over year.
Salesforce.com reports 1st quarter earnings of $0.52 per share on revenue of $3.01 billion, an increase of 25.9% year over year.
Hewlett Packard reports fiscal 2nd quarter earnings of $0.48 per share on revenue of $14.0 billion, an increase of 13.1% year over year.
Costco reports fiscal 3rd quarter earnings of $1.70 per share on revenue of $31.62 billion, an increase of 12.1% year over year.
Ulta Beauty reports 1st quarter earnings of $2.63 per share on revenue of $1.54 billion, an increase of 17.6% year over year.
Next week: Earnings from: Thor Industries and Vail Resorts. Economic reports: U.S. Manufacturing New Orders for May and ISM Non-Manufacturing Index for May.
WTI crude oil: $66.90 per barrel. 10-year U.S. Treasury note: 2.89%. Gold: $1,297 per ounce. 30-year mortgage: 4.875%.
Sources: CNBC, Real Money Pro, 361 Capital, First Trust Economics, Seeking Alpha, MarketWatch, The Calafia Beach Pundit, The Wall Street Journal, Bloomberg, Reuters, Estimize.com.
A spicy meatball:
Is Gold an investment?
Journey of the RB Eden:
Disclosure: This publication shall not constitute an offer to sell or the solicitation of any offer to buy or sell any securities of the companies mentioned. This publication is solely a compilation of recent news releases from the sources cited above.
Ken Beach, President and Managing Partner of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.