Month: August 2018

Guest post: Japan just showed us exactly how screwed the country really is

It’s been a busy week for the Bank of Japan…

The market believed Japan’s central bank would back off its massive bond-buying program and negative interest-rate policy with yesterday’s policy decision (it didn’t), so investors were dumping bonds in advance of the meeting. That sent yields on 10-year Japanese government bonds (JGBs) soaring from 0.03% to 0.11% in just under two weeks.

So the BOJ stepped in, for the third time in one week, saying it would buy unlimited government bonds to keep yields down. That’s the strategy behind Japan’s latest form of quantitative easing called “yield-curve control.” Essentially, it’s stepping in to buy bonds any time yields rise above 0.1%.

So, when yields hit 0.11%, an 18-month high, the bank bought another $14.4 billion in bonds.

But this is just the latest iteration of Japan’s aggressive and unprecedented QE. Since 2012, Japan has been hell bent on keeping its interest rates near zero.

The BOJ printed yen to buy basically all of the $9.5 trillion of JGBs outstanding. When it ran out of bonds, BOJ started buying stocks. Now it’s a top 10 shareholder in 40% of Japanese listed companies. And today, it’s vowed to spend unlimited money to keep yields below 0.1%.

Never mind what the planned exit strategy is (which will no doubt be catastrophic), let’s take a quick look at Japan’s debt situation – which is growing by the day.

Japan, the world’s third-largest economy, has total debt of more than ONE QUADRILLION YEN. And government debt currently sits at a whopping 224% of GDP, making it more leveraged than even Greece, whose debt-to-GDP is around 180%.

Japan spent 24.1% of TOTAL REVENUE (appx. 23.5 trillion yen) last year on servicing its debt – that includes interest and paying down principal. Those figures are right off the government’s website. And that percentage has no doubt gone higher this year.

Think about that…

Japan’s debt service eats up one-quarter of the entire budget with interest rates around 0.1%.

They cannot afford higher interest rates by even a fraction of a percent.

If interest rates in Japan went to just, say, 1%, debt service would literally exceed all of government tax revenue.

For the longest time, Japan has experienced deflation. So ultra-low rates have been palatable… if the purchasing power of your money increases every year, you’re probably willing to buy an investment that only returns 0.05% – you’re still maintaining purchasing power.

But Japan is currently seeing inflation of around 1% a year, and the BOJ’s target is 2% – given their complete commitment to the program, I’d say they achieve it eventually.

If inflation is running at 2% a year, who wants to own something paying out less than 0.1%? No rational person would take that trade because you’re guaranteed to lose money.

So you sell those bonds. Then interest rates rise (which Japan absolutely cannot afford). So the BOJ intervenes. That stokes inflation.

I think you see the cycle here…

Now the BOJ has waged war against rising interest rates three times in the past week. That’s a HUGE deal. Remember, the government already owns the majority of JGBs and TONS of Japanese equities.

But it continues to prop up the market by conjuring money out of thin air.

This is the third-largest economy in the world… and it is a complete disaster in the making.

The BOJ’s latest actions give you a sense of how close to the end we may be.

But what is the end game if Japan goes bust?

In June, I wrote about the mini-meltdown we experienced after the President of Italy opposed the nomination of a finance minister named Paolo Savona.

If that sounds boring and worthless, that’s because it is.

Still, the market freaked out because a tiny, economically inconsequential country had a small blip in its electoral process.

What do you think would happen if the world’s third-largest economy collapsed under the weight of its own debt?

Imagine the chaos and panic that would ensue.

The Japanese government is fighting for its life right now (with absolutely ZERO concern for its other financial obligations). And it’s continuing to add unlimited debt into the future.

This won’t end well.

And it’s time to start loading up on the safest assets you can find.

Source

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Cheesecake Factory Tumbles Most Since 1999 After Surge In Labor Costs

With investor fears growing about the negative impact of tariffs and the strong dollar, one concern that had fallen between the cracks in recent weeks has been the rise of labor costs. Today, shareholders of Cheesecake Factory got a swift and painful reminder just how acute the impact of wage inflation is on the corporate bottom line when they dumped shares of the restaurant chain the most in more than 19 years after the company posted Q2 earnings that missed analysts’ estimates and lowered its full-year profit forecast.

While Cheesecake reported same-store sales that matched estimates, the company blamed rising labor, group medical insurance and legal costs for hurting the bottom line.

CAKE reported adjusted EPS of 65, far below the consensus estimate of 80 cents; the company also slashed guidance and now sees full-year earnings of $2.40 to $2.48 a share, down from a previous outlook of $2.62 to $2.74. Cheesecake Factory also cited $4.6 million in higher group medical insurance costs year-over-year and $4.5 million in increased legal expenses which they didn’t detail except to say there are a number of current litigations.

But the biggest factor was the sudden surge in labor costs: on the conference call, CFO Matthew Clark said that increases in the minimum wage pushed labor costs up to almost 36% of revenue.

As Bloomberg notes, Cheesecake Factory isn’t alone in its struggle as restaurants nationwide compete for workers in a tight labor market even as minimum wages have been rising across numerous states and cities.

Commenting on the result, Wells Fargo analyst Jon Tower said that “we have limited confidence in a positive top-line or cash flow surprise on the horizon.”

The shares tumbled as much as 14 percent to $48.03 in New York, the biggest intraday decline since January 1999. The stock had been up 16 percent this year through Tuesday’s close.

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Ferrari Crashes After New CEO Throws Marchionne Under The Bus

Ferrari stock prices are collapsing after the new CEO said that former CEO Marchionne’s 2022 targets for the company were “aspirational” which has seemingly been interpreted by investors as ‘make-believe’.

  • *FERRARI CEO CAMILLERI SPEAKS ON CALL WITH ANALYSTS

  • *FERRARI CEO: 2022 TARGET SET BY MARCHIONNE WAS `ASPIRATIONAL’

  • *FERRARI CEO: 2022 TARGETS BRING RISK, OPPORTUNITIES

RACE is now down 11%…

 

 

 

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What Goldman Expects Will Happen In A “Severe” Trade War

In recent months, a cottage industry has emerged on Wall Street trying to quantify the impact from escalating trade war with China, with reports coming out fast and furious with predictions, some dire, others innocuous trying to capture what a worst case scenario would look like, and today was no exception.

In a report from Goldman’s David Kostin, the equity strategist departs from the traditional angle of looking at the hit to the overall economy and GDP, and takes a slightly different angle in evaluating trade war impact, which he analyzes in terms of foreign revenue exposur of US companies – and to infer how the bank’s three tariff scenarios would impact S&P earnings.

According to Goldman calculations, S&P 500 companies in aggregate derived 30% of revenues from international sources, compared with 29% in 2016. At a sector level, Information Technology and Materials have the highest international exposure, representing 60% and 49% of total sector sales, respectively. On the other hand, the most domestic-facing sectors were Telecom Services and Utilities, which both generated 96% of revenues in the US.

When analyzing the impact of trade war on US corporations via the revenue channel, Kostin notes that the relative performance of the most domestic- and foreign-facing stocks is driven by a combination of three factors:

  • First, ongoing trade tensions pose the most risk to companies with high exposure to trade between the affected countries, notably China and the US. As a whole, tariffs will weigh on S&P 500 earnings in two ways: lower export revenues and lower margins resulting from higher input costs. The risk of lower export revenues to be minor: only two percent of S&P 500 sales are from China. The impact of a 10% tariff on Chinese imports would be more substantial, lowering our 2019 S&P 500 EPS estimate by three percent. While we estimate the impact to be limited on the index level, companies with a large portion of sales to China are more exposed.
  • Second, relative GDP growth is another important driver of the performance of our geographic baskets. As US GDP growth rises relative to global, domestic-facing stocks outperform stocks with the highest international sales exposure. Higher global ex-US GDP growth often implies better growth prospects for companies with significant exposure to non-US regions, which in turn drives equity performance.
  • Third, foreign exchange rates are also a key factor of our baskets, with a strong dollar benefiting domestic-facing stocks relative to firms with a high proportion of non-US sales. A strong US dollar represents a potential headwind to firms with the highest foreign sales exposure, as their goods and services become more expensive relative to goods and services within the foreign country

Predictably, Kostin notes that stocks exposed to trade between the US and China have underperformed, although he observes that “the market appears less concerned about trade tensions with Europe.”

In particular, US and Chinese stocks most affected by the cross-border conflict have trailed their respective market indices by 6 pp and 8 pp since trade discussions became more involved in March. However, a basket of European stocks with the highest US sales exposure outperformed the STOXX 600 (8% vs. 3%) over the same period.

Going back to the above point how tariffs, both implemented and proposed, will impact S&P 500 earnings, Kostin lays out two ways: (1) lower export revenues and (2) lower margins due to higher input costs.

We estimate the impact of the first to be minimal, using GS Economics’ demand-side estimates for a multilateral trade war in which every country imposes a 5% tariff on every other country. Using the resulting decrease of 20 bp and 10 bp for US and World GDP would reduce our 2019 S&P 500 EPS forecast by 1% to $169.

While none of that is surprising, Goldman finds that even a worst case scenario – a 10% tariff on all imports from China – which Kostin calls a serious escalation from current talks, would result in a potential 3% revision to our top-down 2019 S&P 500 EPS estimate of $170.

we laid out a scenario analysis assessing the potential impact of escalating tariff rates on S&P 500 EPS. Using our estimate that S&P 500 firms import 30% of COGS (double the 15% for all US industry), and assuming (a) no supplier substitution, (b) no pass-through of costs, (c) no change in economic activity, and (d) no benefit to domestic producers, a 10% tariff on all imports from China would lower our 2019 EPS estimate by 3% to $165.

And, extending the “severe” scenario’s 10% tariff to all US imports would see Goldman cut its EPS estimate by 15% to $145.

Trade war escalation (or de-escalation) notwithstanding, looking ahead Kostin writes that the bank’s economists expect three new dynamics to emerge in the relationship between trade negotiations and currencies. In mid-July, President Trump commented that a strong US dollar puts the US at a disadvantage internationally. As a result,

  1. the correlation between trade tensions and FX will change, meaning an increase in trade friction may no longer lead to USD gains;
  2. other reserve currencies (e.g., EUR, JPY) should find support; and
  3. the CNY will be more stable, as further depreciation of the currency could be viewed by the US as retaliation against the tariffs.

So far, however, none of these have materialized and the offshore Yuan today tumbled to a fresh one year low as Beijing clearly is encouraging devaluation of the currency. One reason for this may be the disproportionately adverse response for Chinese stocks that have US exposure, compared to Japanese or European stocks, which leaves China with just non-traditional responses to Trump’s tariffs.

While there is more in the full report, perhaps the most interesting part is Goldman’s trade recommendations on how to trade the trade war, specifically depending whether it escalates further, or if a truce finally emerges:

1. If trade tensions escalate, favor stocks with high domestic revenues

If trade tensions continue to rise and new tariffs are proposed and implemented, stocks with the highest domestic sales exposure should outperform. A stronger US dollar and above-trend US economic growth would support this basket, which carries a similar P/E to the S&P 500 (17.1x vs. 17.6x). However, analysts expect a prospective Sharpe ratio of just 0.4, below the S&P 500 median of 0.5.

2. If trade tensions ease, firms with Greater China exposure should outperform

We highlight stocks with over 10% revenue or asset exposure to Greater China. These firms are heavily concentrated in Info Tech, specifically Semiconductors and Semiconductor Equipment. Investors are pricing the US-China dispute, but appear less concerned about an escalation of trade tensions between the US and Europe.

We also highlight S&P 500 stocks with over ten percent sales exposure to Greater China that are at risk from continued escalation of the trade war. Top-line growth for these firms will likely come under pressure if China imposes retaliatory tariffs. Such tariffs would drive up the price paid by consumers in Greater China. It appears that Taiwan will not be directly subject to the Section 301 tariffs. However, firms with high exposure to Taiwan may still be affected by tariffs through the supply chain. Even excluding Taiwan, all of the stocks in Exhibit 12 have over 10% revenue exposure to Greater China

Finally, Goldman also highlight S&P 500 firms with more than 10% asset exposure to China despite limited revenue exposure because these firms may need to make costly alterations to their supply chains. In fact, the management teams of Amphenol (APH), Whirlpool (WHR), and others expressed in their 2Q 2018 earnings calls the need to adapt, via localization or efficiency gains. Twenty-two S&P 500 firms report at least 10% of reported assets in Greater China.

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Legalizing All Drugs Would Boost Local, State, Federal Budgets

Federal, state, and local governments could save billions of dollars by doing nothing—that is, by ending drug prohibition and no longer spending money fighting the war on drugs.

So says a new study from Jeffrey Miron, a Harvard economist and the director of economic studies at the Cato Institute. Drug prohibition is enormously expensive, and Miron finds that full legalization could leave over $106 billion in the government’s coffers. State and local governments spend $29.37 billion on prohibition efforts, and the federal government spends another $18.47 billion. Meanwhile, Miron calculates that a legal drug trade could bring in additional tax revenues of $58.81 billion.

If anything, that understates the potential economic gains. There’s more to the economy than government budgets, after all. About 789,800 Americans are currently locked up for drug-related offenses. Putting those people back into the workforce would surely catalyze economic growth.

The tide has already turned on pot prohibition. A Pew poll this year showed that 61 percent of America now supports the legalization of marijuana, up from 16 percent just three decades ago. But the “majority of budgetary gains,” writes Miron, “would likely come from legalizing heroin and cocaine.” The war on drugs involves much more than marijuana, and we can’t stop with cannabis. Drug prohibition doesn’t just lead to unquantifiable amounts of injustice—it’s simply too expensive to continue.

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Marco Rubio Pitches Paid Family Leave Tradeoff

Sen. Marco Rubio (R-Fla.) says he will unveil a bill this week that will let workers finance parental leave by delaying retirement.

“Falling rates of marriage and childbirth, coupled with the loss of stable, good-paying employment in a rapidly shifting global economy are making young families socially and financially insecure,” Rubio and Rep. Ann Wagner (R-Mo.) write in a USA Today op-ed published today. (Wagner will be introducing similar legislation in the House.) “Today, having a child can be an income shock matched only by college tuition or a down payment on a home,” the lawmakers add.

Rubio’s legislation, dubbed the Economic Security for New Parents Act, doesn’t force employers to pay for their workers’ time off. Rather, it allows mothers and fathers to pay their expenses while on leave using their future Social Security benefits. “Parents taking the option would receive monthly payments that will help cover costs like rent, groceries and new baby supplies during a time of significant income constraints,” the lawmakers write. In return, parents must put off retirement for three to six months.

Rubio and Wagner say the tradeoff is more than fair. “The financial constraints workers face in the first few weeks after having a child and those after turning 65 years old are not equal,” they write. “Our proposal would be a consistent application of Social Security’s original principle—to provide assistance to dependents in our care—to the challenges of today.”

It’s a clever idea, but it has problems. Social Security is already going bankrupt, so it’s not like there’s lots of extra cash lying around for people who haven’t hit retirement age. And as Reason‘s Shikha Dalmia notes,

Just because employers don’t have to fund the program doesn’t mean there would be no cost to them. The scheme will incentivize more workers to take off and for longer periods of time. This will be especially disruptive for small businesses and start-ups that operate on a shoestring budget and can’t spread the responsibilities of the absent workers across a large workforce. They will inevitably shy away from hiring young women of childbearing age. This will diminish these women’s job options.

Many employers can afford to let workers take the time off, of course—and as the Cato Institute’s Vanessa Brown Calder points out, a lot of them already offer paid family leave. “In a national study, 63 percent of working mothers said their employer provided paid maternity leave benefits,” Calder writes. Lawmakers should let the market work this out instead of introducing new incentives that could leave small businesses and job-seeking women worse off.

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Governor Calls For Calm After New Ebola Outbreak Confirmed In Eastern Congo

One day after a Denver man was promptly quarantined after returning to the US from eastern Congo, where he was working with sick people, and became suddenly ill Sunday (he was subsequently cleared), a new Ebola virus outbreak has been confirmed in eastern Democratic Republic of Congo, Governor Julien Paluku said on Wednesday, just one week after the country declared an end to a separate outbreak that killed 33 people in the northwest.

According to Reuters, the latest outbreak was found in the province of North Kivu, near the Congo’s border with Uganda.

Ebola virus confirmed in North Kivu,” Paluku wrote on Twitter. “I call for calm and prudence.”

While authorities did not say how many cases had been detected, Congo’s health ministry said on Monday that it had found 25 cases of fever near the town of Beni and that samples had been sent to the capital Kinshasa for testing. Congolese and international health officials deployed an experimental vaccine during the last outbreak, which helped contain its spread after it reached a large river port city..

This is the central African country’s 10th outbreak of Ebola since 1976, when the virus was discovered near the eponymous river in the north.

In responding to this year’s outbreak in Congo, the world seemed to be better prepared – especially in comparison with the previous outbreak in West Africa. “One of the many painful lessons from the devastating West African Ebola epidemic of 2014 was that the world expected much more from the World Health Organization than it was then able to deliver,” WHO spokesman Tarik Jašarević said.

During that outbreak, 28,616 cases of Ebola virus disease and 11,310 deaths were reported in Guinea, Liberia and Sierra Leone. An additional 36 cases and 15 deaths occurred when the outbreak spread outside those three countries, according to the CDC.

“Since then, we have dedicated ourselves to ensuring that the world is better prepared, not only for Ebola but for the many high threat pathogens, including pandemic influenza, that can cross the species barrier, from animals to humans, at any moment,” Jašarević said.

As of now, WHO and other global health organizations are ensuring the end of the Ebola response in Congo and maintaining an increased vigilance to identify lessons learned and good practices in responding to such outbreaks moving forward, Jašarević said.

“Already, we can say we have contributed to improving surveillance systems, and for next time, will have in place protocols for vaccines and therapeutics,” he said. “Another legacy is capacity building, such as training vaccinators who will now not only be able to respond domestically but can also help neighboring countries, too.”

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Finally… A Major Victory For Common Sense

Authored by Simon Black via SovereignMan.com,

In a major victory for common sense, a group of cosmetologists defeated an insanely stupid regulation passed down by the state of Louisiana.

Louisiana, just like the other 49 states in the Land of the Free, governs licensing requirements for dozens… hundreds of professions… ranging from athletic trainers to tour guides to barbers and cosmetologists.

And most of the time the licensing requirements are just plain idiotic.

In Louisiana, for example, the State Board of Cosmetology had formerly required an unbelievable 750 hours of training (which costs thousands of dollars) simply to be able to thread eyebrows.

(If you’re like me and totally unfamiliar with eyebrow threading, check out this video. You’ll probably agree that 750 hours of training is totally ridiculous.)

And so, in conjunction with the Institute for Justice, several Louisiana-based cosmetologists filed a lawsuit against the Board.

The Board backed down… passing a new regulation exempting eyebrow threaders from such pointless licensing requirements.

One down. 2,214 to go.

That’s right. According to the Institute of Justice’s study License to Work, there are over two thousand licensing requirements across the Land of the Free… and that’s just for low income jobs like manicurists or floor sanders. We’re not even talking about doctors and dentists here.

Another study from the Brookings Institute shows that nearly 30% of US workers require some sort of state license. That’s up from just 5% in the 1950s.

Many of the licenses truly defy any logic whatsoever.

The State of Michigan, for example, sees fit to require 467 days of education and training to receive a barber’s license, but only 26 days to be a licensed Emergency Medical Technician.

The State of California requires aspiring tree trimmers to have 1,460 days of education and training. But pre-school teachers only require 365 days.

The District of Columbia requires 2,190 days of education and training to be an Interior Designer, but ZERO days to be a school bus driver.

The State of Iowa requires 1,460 days for athletic trainers, but just 370 for dental assistants.

What exactly are these people trying to tell us about their priorities? Trees and furniture are more important than children? Hair is more important than health? Abs are more important than teeth?

It’s all quite bizarre.

But there is one occupation I noticed that is conspicuously absent from this list.

And it’s a big one.

Not a single state in the union has a licensing requirement for this profession.

And that’s an incredible irony given that this occupation gets to tell the rest of the occupations how much training they require.

Did you figure it out?

It’s politicians.

Just think about it: Barbers and manicurists require hundreds of hours of training.

But the people who have the power to pass idiotic legislation, waste taxpayer funds, declare war, tell us what we can/cannot put in our own bodies, and regulate every aspect of our lives, don’t even have to be literate.

(And judging by some of the laws they pass, that may very well be the case.)

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WTI Holds Below $68 After Surprise Crude Inventory Build

WTI has extended its losses since last night’s surprise API-reported crude inventory build., and DOE confirmed with a surprise 3.8mm bbl inventory build and while WTI tried to rally (smaller build than API), the jump stalled at $68.00…

 

API

  • Crude +5.59mm  (-3mm exp)

  • Cushing -930k (-500k exp)

  • Gasoline -791k

  • Distillates +2.89mm

DOE

  • Crude  +3.803mm (-3mm exp, -850k whisper)

  • Cushing -1.338mm (-500k exp)

  • Gasoline -2.536mm (-2mm exp)

  • Distillates  -101k (+500k exp)

So another surprise build – not a seasonal norm – but smaller than API-reported…

 

US crude production dipped on the week…

NOTE: As Erik Townsend pointed out, EIA changed the rules June 1st – now they round to the nearest 100k bbl. So the week-to-week production data is now next to worthless. The reason it LOOKED LIKE a ‘surge’ of 100k bbl last week is because that was from prior weeks (reported as zero). Each time is crosses the half-way point, they bump the official number up 100k.

WTI traded below $68 ahead of the DOE data, and kneejerked up to 68 the figure on the print…

“Oil bulls have been left battered and bruised,” said Stephen Brennock, an analyst at PVM Oil Associates Ltd. in London.

“The rebalancing paused abruptly last week” as inventories likely increased, while “downside risks for the global economy and therefore oil demand growth prospects remained alive and well.”

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Jay Austin, Tiny House Innovator, Killed in Attack Claimed by ISIS

Jay Austin, 29, was killed along with his girlfriend and two others while cycling across Tajikistan. ISIS has claimed credit for the attacks. Austin was the eponymous subject of Jay Austin’s Beautiful, Illegal Tiny House, a video I produced for Reason in 2014.

According to the U.S. embassy in Tajikistan, a car slammed into a group of seven cyclists. Assailants exited the car and stabbed and shot the survivors. Three other cyclists were also injured. Euronews published amateur video that purports to show the attack.

Authorities tracked down the car during a search operation. After a chase, one suspect was arrested and four were killed. The U.S. embassy praised the swift response by the Tajik government.

I found Austin a pleasure to interview and I admired his independent ways. When I first met him in 2014, he had been working at the Department of Housing and Urban Development (HUD) for four years. He understood the nuts and bolts of housing policy and harbored a strong sense of disenchantment with the federal bureaucracy, calling public housing “a failed experiment” and HUD “The Death Star.”

Austin resisted HUD’s stodgy, institutional culture. He wore chucks and jeans at the office, in defiance of the standard suit and tie worn by other federal employees. “I’m going to be myself or I’m not going to work here,” he said he told his employer. They kept him on.

A few months after meeting him, Austin began traveling, taking leaves of absence for months at a time. Two years after that, he quit HUD, leaving behind the 145-square-foot tiny house he built and the community of tiny houses he co-founded to become a full-time traveler. He lived frugally, often backpacking alone through remote parts of the globe, and he blogged and Instagrammed his adventures enthusiastically.

“Everyone should try it at some point in their life,” Austin told me while sipping his favorite St. Germain cocktail in the hot tub behind his tiny house on a snowy winter’s day. “A month, a half-year, a week without a structure, without a stable place to call home.”

Austin was keenly aware how his upbringing in foster care shaped his outlook on life. He learned self sufficiency at an early age; by the time he was in middle school, he felt like an adult. “As a ward of the state,” he said, “I was an inherent non-conformist.”

Jay Austin, you are missed.

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