Earnings upgrade cycle is in the price while cost inflation cycle is being ignored

Local market started positive and then faded to flat before late buying pushed it back to positive territory. It was a day when size and sector mattered. Mid Caps were preferred by a margin while Tech sector was on the sell card with Buy Now Pay Later (BNPL) sector getting punished as PayPal and Apple make moves in the sector. BNPL is a classic example of a sector that will continue to attract competition due to the high multiples and low barrier to entry. Utilities and Staples were the best while Tech and Property were the worst. Spark Infrastructure may be following Sydney Airports into privatization by a consortium of super funds. Basically the big global super funds are saying that they prefer to lock in solid single digit returns over what the market has to offer in the next decade. Given their track record, risk management and long term planning, the current market multiples do not match up to that expectations. It may be different this time!

Markets on extreme valuations are walking into US producer price index, US reporting season, US Fed chair’s testimony, China data dump including GDP and Option/Futures expiry week in Australia and US. We are in a unique time when all asset classes are correlated and in bubbles. Risk management has almost become impossible and been outsourced to Central Banks. Central Banks have a very bad track record of managing inflation cycles. What could go wrong?

US inflation was a solid beat again but markets are buying into the Central Bank marketing pitch that it is transient. Some parts are and some parts are not. Supply side issues are real and not transient. We are likely to see some parts fade and other parts speed up through the next few quarters. The world is sitting on asset bubbles in all asset classes including property. NZ are moving to control the risk as they are small and the effects of supply side issues are hitting them early. Everything from commodity prices to workers to currency are adding to the problem with border closed. Australia will start to see it soon enough but RBA is choosing to deny reality till it smacks them across the face. Australia usually oscillates between commodity bubble in the West to property bubble in the East but we are currently sitting on everything bubble. RBA is wiling to risk the economy to save asset bubbles by moving from inflation to job market targets to guide rate cycle. What could go wrong? 

US Producer Price Index (PPI) data tonight will confirm that costs are at all time high and rising faster than US Fed benchmark. It means margin squeeze for markets trading at historical high multiples. It may be different this time!

US reporting season started overnight and financials beat expectations. Even Stevie Wonder can see that Financials will be firing on all cylinders and will be red hot but analyst seems to not be aware of that. If you are wondering if this is unique? Well…it is not different this time. 

US earnings beat in the last 30 years have gone from 40% to 90%. We either have very dumb analysts or the data is being managed more and more every cycle for earnings beat. We are getting to that part of the cycle that we have already priced in 90-100% earnings beat in the US market. What could go wrong? It may be different this time!

China data dump tomorrow will be headed by China GDP growth and it should be strong given the recent data update. As per normal, they will guide to lower numbers to build low expectations. The recent moves by China to curb inflation and boost lending suggest China is feeling the fading global recovery.

The option/futures expiry week has had some seasonal effects due to extreme leverage in the markets. History suggest market outperform into expiry and underperform after. It may be different this time!

NSW mockdown/lockdown has now been extended till the end of July and we may have triggered a cluster into VIC as well. Historical trend suggest the base case will go into mid August. Time will tell.

Let us run through the main data points released in the last 24 hours…

The NFIB Small Business Optimism Index in the United States increased to 102.5 in June of 2021 from 99.6 in May, reaching the highest level in 8 months. Seven of the 10 subindexes improved in June, while three decreased compared with May. A net 28% of businesses plan to create new jobs in the next three months, up one point from May and a record high. "Small businesses optimism is rising as the economy opens up, yet a record number of employers continue to report that there are few or no qualified applicants for open positions. Owners also are struggling to keep their inventory stocks up with strong sales and supply chain problems", Bill Dunkelberg, NFIB chief economist said.

Annual inflation rate in the US accelerated to 5.4% in June of 2021 from 5% in May, hitting a fresh high since August of 2008, and well above forecasts of 4.9%. Biggest price increases were recorded for used cars and trucks (45.2%), gasoline (45.1%), fuel oil (44.5), utility gas service (15.6%) and transportation services (10.4%). Shelter costs were up 2.6% and food 2.4%. Inflation has been on the rise this year amid low base effects from 2020 and as the economic recovery picks up, business restrictions ease and demand surges amid widespread vaccination and federal support. Meanwhile, high commodity prices, supply constraints and higher wages as companies grapple with a labour shortage continue to weigh on the CPI.

Core consumer prices in the United States increased 4.5% in June of 2021 over the same month in the previous year, the largest 12-month increase since the period ending November 1991 and well above market expectations of 4%. The energy index rose 24.5% over the last 12-months, and the food index increased 2.4%.

The US posted a budget deficit of USD 174 billion in June 2021, compared with a deficit of USD 864 billion in the same period last year and market expectations of a USD 194.0 billion gap. Receipts jumped 87% year-on-year to USD 449 billion due to an earlier tax deadline this year. In addition, taxes withheld from wages increased by 33% and corporate taxes rose to USD 79 billion from USD 11 billion last year, helped by the continued labor market recovery. Meanwhile, outlays dropped 44% from a year earlier to USD 623 billion, largely due to the outsized impact on the deficit a year earlier from the implementation of the Paycheck Protection Program. Fiscal year-to-date deficit narrowed to USD 2.238 trillion from USD 2.744 trillion for the first nine months of the prior fiscal year.

US crude oil inventories dropped by 4.079 million barrels in the July 9th week, an eight consecutive period of decline and compared with market consensus of a 4.333 million fall, data from the API's Weekly Statistical Bulletin showed.

Export Prices in South Korea increased to 107.12 points in June from 106.39 points in May of 2021.

Import Prices in South Korea increased to 115.43 points in June from 112.81 points in May of 2021.

The Reuters Tankan sentiment index for manufacturers in Japan rose to 25 in July 2021 from 22 in the previous month, its highest since November 2018, as export-reliant firms benefited from a recovery of global demand. Confidence improved mostly among car, chemical and metal products makers, the textiles and paper sector remained pessimistic. Meanwhile, the service index fell to -3 from a flat reading the prior month, following the imposition of a fresh state of emergency for Tokyo due to a resurgence in COVID-19 cases.

The unemployment rate in South Korea edged down to 3.7% in June of 2021 from 3.8% in the previous month and compared with 4.2% in the same month of the prior year. The number of unemployed declined by 24 thousand to 1.049 million, while the number of employed rose by 18 thousand to 27.331 million. Meanwhile, the labor force participation rate was unchanged at 63.0.

The Westpac-Melbourne Institute Index of Consumer Sentiment for Australia rose by 1.5% to 108.8 in July 2021, as concerns over the virus outbreak and associated restrictions in New South Wales were not spilling over to the rest of the country. The family finances vs a year ago rose the most by 4.6% to 93.7, followed by the family finances for the next 12 months (2.5% to 109.9), economic conditions in the next 12 months (0.8% to 109.5), and time to buy a major household item (3.5% to 120.6). In contrast, the economic conditions in the next five years fell 3.1% to 110.5). "Confidence has held up overall despite a sharp fall in NSW as other states – notably Victoria and Western Australia – recorded strong bounce-backs from COVID-related disruptions in June," said Westpac chief economist Bill Evans. The survey was conducted over the week of July 5–9, when Sydney was locked down but restrictions were tightened further on July 9.

Industrial production in Japan declined by 6.5% month-over-month in May 2021, compared with the preliminary reading of 5.9% drop and after a final 2.9% gain a month earlier. This was the first fall in industrial output since February, amid a renewed restrictions in some parts of the country following a surge in local coronavirus infections. Industries that mainly contributed to the decrease were motor vehicles (-19.4% vs -1% vs April), production machinery (-6.0% vs 7.7%), and electrical machinery, and information and communication electronics equipment (-4.6% vs 10.4%). On a yearly basis, industrial output surged 21.1% in May, the third straight month of growth, after a 15.8% rise in April.

Comments on US market last close…

US market moved negative as inflation data beat expectations again. Even the core beat and the usual spin that it’s transitory and major component was used car. Even if you removed used car component, core inflation above US Fed range but they are not going to move till market panics. Inflation is transitory but that may be 9-12 months. Financials started the reporting season with massive beats. Everyone knew they killed on the macro except the analysts covering the stocks... no conflict of interest there. RUSSELL -1.88%, NASDAQ -0.38%, S&P -0.35% and DOW -0.31%. VIX above 17. Yields and USD higher while Copper lower. Oil and Gold were up against the trend. Tech was the only positive sector while Retail, Property and Banks were the worst.

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