Year: 2021

U.S. Manufacturing PMI: July PMI ticks up to record high, but supply delays and price pressures also hit new peaks

July PMI data from IHS Markit signalled the most substantial improvement in operating conditions across the U.S. manufacturing sector on record. Overall growth was supported by stronger expansions in output and new orders, with the latter increasing at the second-fastest pace since data collection began in May 2007. Unprecedented supplier shortages and delays continued to exert upward pressure on input costs and stymie firms’ ability to process incoming new work. As a result, cost burdens rose at a record breaking rate and the accumulation of backlogs accelerated.

Nonetheless, output expectations remained upbeat amid hopes of further boosts to client demand over the coming year.

The seasonally adjusted IHS Markit U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) posted 63.4 in July, up from 62.1 in June and slightly higher than the earlier released ‘flash’ estimate of 63.1. The improvement in the health of the manufacturing sector was the strongest in the 14-year series history.

Contributing to the uptick in the headline figure was a sharper expansion in production at the start of the third quarter. The upturn was reportedly linked to stronger client demand and efforts to clear backlogs of work. The rate of growth was the steepest for six months and marked overall.

New business at manufacturing firms rose at a robust rate, that was close to the record pace set in May. Firms stated that greater new order inflows stemmed from stronger client demand from new and existing customers, as some sought to stockpile. At the same time, foreign client demand rose at one of the fastest rates since data collection began in 2007 amid the reopening of key export markets.

July data signalled an unprecedented deterioration in vendor performance, as supplier delays were driven by transportation issues and severe raw material shortages.

Such constraints on component deliveries and greater global demand for inputs reportedly pushed input costs up. The rate of cost inflation was the sharpest on record. Firms were, however, able to continue to raise their selling prices in July as charges also increased at a record-breaking pace. The uptick in output charges was overwhelmingly attributed to efforts to pass-through higher costs where possible.

Supplier price hikes led to greater stockpiling activity at manufacturers, as growth in input buying accelerated to a fresh series high. Efforts to mitigate against future price rises or material shortages resulted in an unprecedented rise in pre-production inventories. In contrast, stocks of finished goods fell at a strong pace as firms sought to sell from their current holdings.

At the same time, stronger new order growth led to the second-fastest accumulation in work-in-hand since 2007. To reduce pressure on capacity, firms expanded their workforce numbers at the steepest pace for three months, but some continued to note difficulties filling vacancies.

Finally, goods producers were markedly upbeat overall regarding the outlook for output over the coming year in July. Optimism was often linked to hopes of stability in future supply chains and further boosts to client demand. Although easing from that seen in June, the degree of confidence was above the long-run series average.

Chris Williamson, Chief Business Economist at IHS Markit:

Despite reporting another surge in production, supported by rising payroll numbers, output continued to lag well behind order book growth to one of the greatest extents in the survey’s 14-year history, leading to a near-record build-up of uncompleted orders.

Capacity is being constrained by yet another unprecedented lengthening of supply chains, with delivery delays reported far more widely in the past two months than at any time prior in the survey’s history. Manufacturers and their customers are consequently striving to maintain adequate inventory levels, often reporting the building of safety stocks where supply permits, to help keep production lines running and satisfy surging sales.

The result is perhaps the strongest sellers’ market that we’ve seen since the survey began in 2007, with suppliers hiking prices for inputs into factories at the steepest rate yet recorded and manufacturers able to raise their selling prices to an unprecedented extent, as both suppliers and producers often encounter little price resistance from customers.

From the ISM Manufacturing PMI (my emphasis):

• “Business levels continue to exhibit strong demand, with no signs of backing down. Purchases continue to have long lead times due to shortages of raw materials and labor force, as well as logistics challenges. Increased costs are being passed to customers.” [Computer & Electronic Products]
• “Supply chains are slowly, very slowly filling up. Like a water hose, starting upstream and slowly flowing downstream. Rumor is a full return to ‘normal’ may be nearer to year’s end, but the situation is progressing. Transportation (equipment and drivers) is the current pinch point, more so than material shortages.” [Chemical Products]
• “Strong sales continue, and inventories are low as the chip shortage is keeping production numbers down — we have idled several of our assembly plants to reduce the strain on the chip supply base.” [Transportation Equipment]
• “Still dealing with price increases from force majeure issues as well as overseas shipping premiums and higher costs of items like fuel. Customer demand still high; pushing plant to max production rates.” [Food, Beverage & Tobacco Products]
• “Strong operations, (with) new programs, orders and launches. Continue to have hiring difficulties and are unable to fill production and salaried jobs (due to) a lack of candidates. Raw materials are still in short supply, with longer lead times.” [Fabricated Metal Products]
• “Incoming bookings continue to be strong, and economy continues to return. Still struggling with inflation and availability (of materials, labor and freight).” [Furniture & Related Products]
• “Sales are above last year by a good percentage, but meeting demand is just not possible due to force majeure situations, logistics, and labor shortages. We don’t anticipate this ending until well into 2022.” [Nonmetallic Mineral Products]
• “Supply chain continues to be extremely challenging in a variety of categories. Having to place orders months ahead of time just to get a place in line.” [Machinery]
• “Very busy with new orders. Material costs continue to rise, and supplies are sometimes delayed. Labor issues are still affecting us the most with finding proper labor. Labor— costs are increasing as we are competing locally for top talent.” [Miscellaneous Manufacturing]
• “Business levels continue to be very strong, but we also continue to struggle finding employees. We can only fill 75 percent of our order requirements due to the labor shortage.” [Primary Metals]

The ISM data reveal that manufacturers’ inventories remain tight and unstable. Manufacturers’ reading of their customers’ inventories (chart) declined 5.8% to 25% in July, “the lowest since the index was established in January 1997.”

“Average lead time for production materials in July was 86 days, down two days from the June figure of 88 days, the highest since ISM^® began collecting this data in 1987.”

• Supply chain constraints stymie growth of global manufacturing sector in July

(…) Out of the 29 nations for which July data were available, 22 saw growth during the latest survey month. The eurozone remained a bright spot, with the three highest-ranked countries based on PMI readings (the Netherlands, Germany and Austria) all located in the currency bloc. The US was in fourth place overall. PMI readings for China (50.3) and Japan (53.0) were well below the global average.

Emerging markets tended to underperform compared with developed nations in July, continuing a trend observed over the past eight months. The emerging Asia region was especially weak, containing five out of the seven nations seeing contractions (Thailand, Malaysia, Vietnam, Indonesia and Myanmar). (…)

EARNINGS WATCH

Two variables drive equity markets, earnings growth and changes in earnings multiples. This is about earnings:

According to Refinitiv data, S&P 500 earnings will grow 8.5% in 2022 to reach $221.86 per share on a 10.4% gain in revenues. Non-Financials will grow their earnings 12.0% on a 10.7% rise in revenues.

S&P 500 revenues growth correlates closely with that of total U.S. business sales as Ed Yardeni illustrates:

Real business sales growth rarely exceeds 5.0% which would imply inflation exceeding 5% in 2022 for S&P 500 revenues to rise more than 10%. Revenue estimates thus appear stretched, otherwise J. Powell & Co. will get a nasty surprise.

Meanwhile, unlike the post-2009 period, corporate input costs are rising much faster than consumer prices. So far, this squeeze is offset by the unusual demand created by the huge rescue moneys sent directly to Americans but many corporate officers are already warning about the challenges ahead when demand and revenues normalize.

Last week, the U.S. Bureau of Labor Statistics released the Employment Cost Index for Q2. Noflationists are quick to note that the ECI came in light, rising 0.7% from Q1, below the consensus view of +0.9% and only 2.8% annualized. Some also point out the “sharp slowing in employment costs in the exact part of the economy that the gurus are saying is in the shortest labor supply situation —services!” where the ECI came in +0.7% QoQ, down from 0.9% in Q1.

But a deeper, broader analysis is more concerning:

• Private industry compensation rose 0.8% QoQ in Q2 after +1.0% in Q1. But the total was helped by an awkwardly low +0.3% rise in benefits which masked the +1.0% rise in Wages and Salaries that followed Q1’s +1.1%. Private wages are up 4.2% annualized in the first half.
• Goods-producing industries saw their total comp jump 1.1% in Q2 after +0.7% in Q1. Service-providers’ total comp slowed from +0.9% to +0.7% partly due to a 2.2% decline in Finance and insurance, “correcting” the 4.3% jump in Q1 likely caused by bonuses. That group’s comp is still up 4.2% annualized in the first half.
• During the first half, wages for goods producers rose 3.8% a.r., a sharp acceleration from +2.8% in all of 2020. But they jumped 1.3% QoQ (+5.3% a.r.) in Q2 (1.4% in Construction).
• Private service provider employees saw their wages rise 0.9% in Q2 after 1.3% in Q1, +4.5% annualized in the first half.
• And as to the “exact part of the economy that the gurus are saying is in the shortest labor supply situation”, leisure and hospitality, private wages exploded +2.8% in Q2 after +1.6% in Q1 for a 9.0% annualized rate in the first half after +3.6% in 2020.

This next chart plots the growth in business sales minus wages and salaries against nonfinancial profit margins which tend to fluctuate with businesses’ ability to grow revenues faster than wage costs. The chart ends in Q1 because we don’t have Biz sales for June yet. But if we assume 2022 inflation at 2.5% and real revenues up 3.0%, many corporations might be hard pressed to grow their margins in 2022, let alone maintain them.

All this to say that expectations of 12% growth in S&P 500 non-financial earnings in 2022 look set for disappointments, unless inflation is much higher than 2.5%, in which case many other people will be disappointed.

Pricing power has become a crucial attribute as price makers will grow earnings faster than price takers in coming years. That differentiation will become more obvious when stimulus and reopening demand cools off and revenue growth returns to more normal levels.

Refinitiv will shortly give us its first tally of corporate guidance for Q3 and the rest of 2021. Rosenberg Research makes its own tally of what comes out of conf. calls. Half way in the reporting season, 34% have guided down for Q3 earnings and 24% have guided down for the upcoming fiscal year. This compares with 39% negative guidance for all of Q2 and 43% for Q1.

So far, so good, but as costs keep rising while revenues slow down from their current strong pace, guidance could get much less enthusiastic.

• For Fast Food, Supersized Sales Outrun Heavier Costs Second-quarter earnings show fast-food companies can still attract customers despite higher labor and food costs

(…) McDonald’s MCD -1.08% reported that comparable sales in the U.S. rose nearly 15% from the 2019 quarter. KFC parent Yum Brands YUM 0.76% said the chain grew comparable sales by 19% over that same period.

Even restaurants that supposedly benefit from lockdown conditions are thriving in the reopening. Domino’s Pizza said second-quarter sales grew 3.5% from a year earlier in the U.S., when most restaurants were shut due to public-health orders. (…)

McDonald’s said last week that its U.S. menu prices rose 6% from a year earlier in the second quarter, which did little to dent customer demand. The average second-quarter check size grew due to larger order sizes as well as higher prices, the company said.

And operators have options as labor costs increase. Digital ordering kiosks can reduce a store’s labor needs while also making it easier to offer extra promotions to a customer. (…)

TECHNICALS WATCH

The strongest equity market has some of the weakest breadth on record MS Mike Wilson: “The mid-cycle transition de-rating is advanced but unfinished. Falling earnings revision breadth this fall will likely complete that process.”

Apartment Rents Increase as Workers Return to Cities

(…) Median rent has risen more than 10% over the past year, according to homesearch website Apartment List, reflecting how soaring housing prices are forcing many would-be home buyers out of the for-sale market. (…)

But in nearly every major metro area, rents are now much higher than they were a year ago. New York and San Francisco rents have begun to recover without having to lure tenants with free rent or other incentives so often anymore. (…)

Camden Property Trust, a Houston-based landlord, reported new lease rents at its properties jumped 19% this July. (…)

Goldman Sachs Is Giving Entry-Level Bankers a Nearly 30% Raise The Wall Street firm is increasing base pay for its entry-level employees—first-year analysts—to $110,000, a nearly 30% increase from the previous starting salary.

Fed’s Waller Says September Taper Call May Be Warranted

Federal Reserve Governor Christopher Waller said that if the next two monthly U.S. employment reports show continued gains, he could back an announcement soon on scaling back the central bank’s bond purchases. (…)

“If the jobs reports come in as I think they’re going to in the next two reports, then in my view with tapering we should go early and go fast, in order to make sure we’re in position to raise rates in 2022 if we have to. I’m not saying we would.” (…)

Tapering could begin as soon as October and be completed in around five or six months if the labor market was sufficiently strong, Waller said. That timeline was similar to Bullard’s view, outlined Friday, to begin the taper in the fall and complete it by the end of the first quarter of 2022. (…)

“My concern is this anecdotal evidence I am hearing from business contacts who are saying they are able to pass prices through, they fully intend to,” he said. “They have got pricing power for the first time in a decade. Those are the sorts of issues that make you concerned that this may not be transitory.” (…)

“The delta variant is not going to sidetrack the U.S. economy in any way,” Waller said.

• A hawkish Bullard sees more volatile economic “regime” emerging in U.S.

The coronavirus pandemic may have pushed the United States into a volatile era of stronger growth and better productivity, but higher interest rates and faster inflation as well, St. Louis Federal Reserve president James Bullard said, elaborating on why he thinks the U.S. central bank should end its crisis-era policies.

Bullard, who five years ago said he viewed the United States as mired in an epoch of low growth, low productivity and low inflation, said he is beginning to think a new “regime” may have arrived where the Fed will have to cope with faster change and more frequent shocks.

(…) the risk is higher inflation that could upend the Fed’s current expectation that price pressures will ease on their own and allow for continued loose monetary policy. (…)

China Takes Aim at Auto Chip Dealers Top market regulator probes those it suspects are driving up prices

(…) Chinese authorities have vowed to establish semiconductor supply chains that rely less on imports and have said they are engaging with auto manufacturers and chip makers to match supply and demand. (…)

Taiwan Semiconductor Manufacturing Co. , the world’s largest contract chip maker, said it expects the auto-chip shortage will begin easing this quarter, as it allocated more capacity to producing parts needed for new cars. The company has also noted that it is seeing more clients stock up on inventory to cushion their supplies. (…)

However, analysts and company executives expect the broader supply crunch to extend into next year. Intel Corp. Chief Executive Pat Gelsinger said last month that the shortage could stretch into 2023. (…)

• Stellantis chief financial officer Richard Palmer said on Tuesday the world’s fourth largest carmaker did not expect chip supply to improve before the fourth quarter, with a total projected production loss of around 1.4 million vehicles in 2021. “The rebound of global car markets continues to be hampered by acute supply limitations across the entire value chain,” Infineon CEO Reinhard Ploss told analysts. “All in all, it will take time to get back to a supply-demand equilibrium.” “In our view, this will take until well into 2022, Ploss added. (Reuters)

Tencent Sinks After China Denounces Online Gaming Shares in Tencent and rivals plummeted after a state-owned newspaper criticized online gaming as “opium for the mind,” fueling concerns that the companies’ games could be swept up into a broader regulatory crackdown.

China Shuns Ericsson, Nokia as the West Curbs Huawei The U.S. and many of its allies have restricted the use of 5G cellular equipment made by China’s Huawei. Now Beijing is doing the same to Huawei’s Western rivals.

China quietly sets new ‘buy Chinese’ targets for state companies, U.S. sources say]

China’s government quietly issued new procurement guidelines in May that require up to 100 per cent local content on hundreds of items including X-ray machines and magnetic resonance imaging equipment, erecting fresh barriers for foreign suppliers, three U.S.-based sources told Reuters. (…)

The former official said that when China joined the World Trade Organization, it agreed not to issue such internal documents. The document also violated the spirit of the January, 2020, Phase 1 trade deal with the United States, the former official said. “They need to reduce barriers, not create new ones.”

Sent to Chinese hospitals, companies and other state-owned buyers, the document sets local content requirements of 25 per cent to 100 per cent for 315 items. They include medical equipment, ground-based radar equipment, testing machinery, optical instruments; items used for animal husbandry; seismic instruments, and marine, geological and geophysical equipment, the former official said. (…)

U.S. trade experts said China’s local content rules differed from planned increases in U.S. “Buy American” thresholds because they were not publicly released, and affect far greater volumes of medical equipment and other goods since China’s state-owned enterprises include hospitals and other entities. (…)

Also transitory? Florida breaks record for new coronavirus cases as surge of infections rips through state

Florida reported 21,683 new coronavirus cases on Friday, the state’s highest one-day total since the start of the pandemic, according to data released Saturday by the Centers for Disease Control and Prevention.

The data shows the severity of the surge in Florida, the epicenter of the U.S. outbreak and now responsible for 1 in 5 new infections nationally. The previous peak in Florida had been on Jan. 7, when the state reported 19,334 cases, according to the CDC — before the widespread availability of coronavirus vaccinations. Florida has reported an average of 15,818 new cases a day over the past seven days, according to data compiled by The Washington Post.

The Florida Department of Health reported that coronavirus cases in the state had jumped 50 percent in the past week. In that time, the state has reported 409 deaths. (…)

About 49 percent of Florida’s population has been fully vaccinated as of Sunday.

State health officials have indicated that hospitals are struggling to keep up with the number of covid-19 patients. The Florida Hospital Association said Friday that covid hospitalizations are approaching last year’s peak. (…)

“There is no higher risk area in the United States than we’re seeing here,” Aileen Marty, an infectious-disease expert at Florida International University, told CBS Miami. “The numbers that we’re seeing are unbelievable, just unbelievably frightening.” (…)

More than 2,000 intensive care unit beds in Florida are occupied by covid patients.

At Jackson Memorial Hospital in Miami, all of the beds at its covid-only intensive care unit are filled with unvaccinated patients. “It just went boom,” Akinkunmi said. (…)

Lakshmi noted that 83 percent of the [Tampa General] hospital’s covid patients are unvaccinated.

“It feels like we are getting hit by a train, the pace is so fast and uncontrolled,” she said. “I just don’t have any words anymore. This is awful, just awful, and it is going to be awful.” (…)

But DeSantis has maintained that the increase is a “seasonal wave” caused by more people being indoors and air-conditioning systems circulating the virus. (…)

A coronavirus variant discovered in Colombia is also showing up in South Florida. Carlos Migoya, CEO of Jackson Health System, recently told WPLG that the B.1.621 variant has accounted for infections in some coronavirus patients, trailing behind the delta and gamma variants. B.1.621 has yet to receive a Greek-letter designation, as more prominent variants have. (…)

JULY MANUFACTURING PMIs

Eurozone: Manufacturing growth remains strong despite slight loss of momentum

Manufacturers in the euro area recorded another resilient outturn in July as the headline PMI® signalled a sharp improvement in the health of the goods-producing sector. At 62.8, the final reading of the PMI was slightly firmer than July’s flash figure of 62.6, but down slightly from 63.4 in June and the lowest since March. Nevertheless, the sector has now recorded successive months of expansion since July 2020, with the latest reading only slightly below June’s survey record high. The sub-sector splits of the data showed sharp expansions across consumer, intermediate and investment goods makers once again in July, with the latter boasting the fastest upturn of the three. However, a higher PMI reading at consumer goods producers contrasted with lower prints from the other two sectors.

With the exception of Germany, there was a broad decrease across the national Manufacturing PMIs in July. That said, in countries where rates of improvement slowed, expansions were still historically sharp. In Germany, the rate of growth hit a three-month high that was the third-highest on record, behind March and April. Elsewhere, the Netherlands and Greece retained their positions as the fastest and slowest growing countries within the euro area respectively.

The decline seen in headline PMI reflected a similar trend in the survey’s output index, which signalled the softest increase in eurozone production since February. That said, the overall rate of expansion was still notable. The Netherlands, Germany and Austria registered particularly sharp rates of growth.

Higher output volumes were underpinned by a continued improvement in demand for euro area goods. As has been the case over the past few months, the rate of growth in new business was steep and held close to March’s survey record. Meanwhile, new export orders expanded at a sharp rate, albeit one that was the weakest in five months.

Operating capacities were tested in July, as evidenced by a considerable increase in backlogs of work across euro area goods producers. Firms responded by hiring additional staff at a rate unseen in 24 years of data collection. Job creation was especially marked in Germany and Austria.

Furthermore, purchasing activity was expanded as part of efforts to meet growing production requirements. That said, manufacturers continued to face substantial supply-side challenges, with input lead times lengthening to one of the greatest degrees ever recorded by the survey.

The combination of scarce input availability and growing order books led firms to utilise their inventories in July. Stocks of purchases were depleted in line with rising output, while warehoused goods were also used to complete sales.

Widespread shortages of materials and poor transport availability pushed up manufacturing input prices in July at a survey-record rate. Indeed, national level data showed rates of cost inflation accelerating to fresh highs across a slew of countries including Austria, Germany and the Netherlands.

A record increase in input costs was accompanied by a record rise in selling charges as firms sought to pass the cost burden on to their clients. Overall, output charges across the eurozone have risen for ten consecutive months.

Lastly, euro area manufacturers retained their optimistic outlook for the next 12 months as the global economic recovery continues and business adjust to fewer pandemic-related restrictions. Overall, output expectations remained in firm positive territory, although the level of confidence slipped to a seven-month low.

Chris Williamson, Chief Business Economist at IHS Markit:

(…) the July survey also brought further signs that manufacturers and their suppliers are struggling to raise production fast enough to meet demand, driving prices ever higher. (…) the July survey showed inflows of new orders outstripping production to an extent unprecedented in the survey’s 24-year history. (…)

Safety stock building also remains widespread amid ongoing speculation about future supply difficulties. Mounting concerns about how the Delta variant poses further threats to supply chains and staff availability have helped push future growth expectations to the lowest so far this year. (…)

China: Operating conditions improve only slightly in July

Manufacturers in China signalled a softer improvement in operating conditions at the start of the third quarter. Output expanded at the slowest rate for 16 months, while overall new work fell slightly for the first time since May 2020. The COVID-19 pandemic meanwhile continued to dampen export sales, which rose only slightly in July. Relatively subdued demand conditions resulted in broadly unchanged employment across the sector. At the same time, inflationary pressures eased, with both input costs and output charges increasing at softer rates.

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI™) slipped from 51.3 in June to 50.3 in July, to point to a softer improvement in the health of the sector that was only slight. Notably, it signalled the slowest improvement for 15 months.

A key factor weighing on the headline reading was a renewed fall in total new business during July. Though only marginal, it marked the first decline in sales for 14 months. Some companies noted that higher factory gate prices had dampened customer demand. At the same time, new export orders rose only slightly as the pandemic continued to hinder sales overseas.

Concurrently, the rate of output growth softened for the third month in a row. The latest increase was the slowest seen for 16 months and only marginal. Where production had increased, it was generally linked to improved capacity and firmer market conditions.

In line with the trend for output, purchasing activity rose again in July, albeit only slightly. Notably, it was the softest increase in input buying for four months. Stocks of purchased items meanwhile declined slightly during the latest survey period. Panel members indicated that some firms increased their usage of current inventories due to rising raw material prices. Meanwhile, the delivery of goods to clients led to a further reduction in stocks of finished goods.

Supply chain delays persisted in July, with average delivery times for inputs increasing solidly. Anecdotal evidence indicated that material shortages and transport delays due to the pandemic had driven the latest increase in lead times.

Capacity pressures eased at the start of the third quarter, with backlogs of work rising at the softest pace for five months. Employment levels meanwhile were little-changed in July, after a slight uptick in payroll numbers in June.

The latest survey data also saw inflationary pressures soften. Input prices rose at the weakest rate since November 2020, albeit still sharply overall. Higher expenses were frequently linked to increased prices for a range of raw materials and greater transport fees. The rate of output charge inflation likewise slowed in July, with selling prices rising only slightly overall.

Chinese manufacturers were generally optimistic that output would increase over the next year. However, the level of confidence slipped to a three-month low amid concerns over how long it would take to get the global pandemic under control and ongoing supply chain disruption.

Japan: Stronger expansion in manufacturing in July

Japanese manufacturers signalled a quicker improvement in operating conditions in July, as respondents registered faster expansions in production and new order volumes. At the same time, businesses continued to report significant supply chain disruption had dampened demand somewhat, with manufacturers commenting that raw material shortages and delays in receiving inputs had contributed to the sharpest rise in cost burdens for nearly 13 years. As a result, firms in the Japanese manufacturing sector signalled softer optimism regarding the year-ahead outlook for output.

The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI) rose from 52.4 in June to 53.0 in July. This signalled the joint-strongest improvement in the health of the sector since April, reflecting a sustained recovery from the impact of the COVID-19 pandemic.

The improvement in operating conditions stemmed from a sixth successive rise in production volumes in July, and at a quicker pace than the previous survey period. Firms often attributed this to improved orders in key manufacturing industries in Japan, notably automotive and semiconductors. The rate of production growth was modest overall, however, constrained by reports of difficulties in sourcing and receiving raw materials.

Japanese manufacturers signalled a further expansion in new order inflows in the latest survey period. This extended the current sequence of growth to seven months, with the rise in July was the sharpest registered for three months. Businesses reported that client demand had continued to recover as sales were boosted by strong demand in key manufacturing sectors. That said, new export orders increased at a softer pace, with anecdotal evidence suggesting that external demand was concentrated in key Asian economies including Taiwan and Mainland China.

Additional pressure on capacity led to Japanese manufacturers expanding employment levels for the fourth month running. The rate of job creation remained only marginal, however, little-changed compared with the second quarter trend . Backlogs of work also continued to increase, providing further evidence of pressure on existing capacity during July.

Input cost inflation strengthened further in July. The pace of inflation was robust overall and the strongest since September 2008. Manufacturers widely linked a rise in average input prices with higher raw material costs. Concurrently, average prices charged for Japanese manufactured goods rose at the quickest pace since November 2018 as firms sought to pass through increased input costs to customers.

Supply chain disruption continued to hinder manufacturing activity during July with average lead times lengthening to the most marked extent since April 2020 and the second-greatest in over a decade. Delays in receiving shipments led manufacturers to increase purchasing activity for the fifth month in a row in a bid to build safety stocks of inputs. That said, stocks of purchases increased at the softest pace in the current three-month sequence of expansion as firms drew down existing holdings to fulfil orders.

Looking forward, business confidence regarding output over the year ahead remained positive with sentiment underpinned by hopes that an accelerating vaccine rollout would trigger a broad-based recovery in manufacturing, as well as ease pressure on supply chains.

• China’s Key Factory Gauge Slips as Economic Recovery Eases

The official manufacturing purchasing managers’ index fell to 50.4 from 50.9 in June, the National Bureau of Statistics said Saturday, below the 50.8 median estimate in a Bloomberg survey of economists. The non-manufacturing gauge, which measures activity in the construction and services sectors, eased to 53.3, in line with forecasts. (…)

Manufacturing was hindered in July as some factories usually embark on equipment maintenance, the statistics bureau said. Extreme weather conditions — high temperatures and flooding in some areas — also affected production, it said.

• New orders sub-index fell to 50.9 from 51.5
• New export orders index dropped to 47.7 from 48.1
• Sub-index for manufacturing jobs rose slightly to 49.6; non-manufacturing employment increased to 48.2
• Construction subindex declined to 57.5

Price pressures on manufacturers rebounded in the month, with both input and output prices gaining. (…)

Fed’s Brainard Says Labor Market Hasn’t Satisfied Goals for Reducing Bond Purchases Fed governor Lael Brainard says the labor market is, however, on track to reach a key threshold around the end of the year.

(…) In her remarks, she said the Fed would be in a better position to assess the job market’s progress in October, when spending, school and work patterns “should settle into a post-pandemic normal.” (…)

If the pace of job growth during the second quarter continues for the rest of the year, about two-thirds of job losses as of December 2020 and nearly half of the gap relative to the pre-pandemic trend would be closed by year’s end, she said. A more notable acceleration in job growth could reach those levels somewhat sooner, she said. (…)

Ms. Brainard said she expects forces that have fueled rapid price gains in recent months to dissipate by this time next year, though she said she was watching for evidence that inflation pressures could broaden or that recent high inflation readings would push longer-term inflation expectations to uncomfortably high levels. “Currently, I do not see such signs,” she said.

Ms. Brainard said she sees risks of both stronger- and weaker-than-expected growth and spending resulting, respectively, from high levels of household savings and from risks associated with the Delta variant of the Covid-19 virus. Fears related to the more contagious variant risk dampening a rebound in services and complicate the return to in-person school and work in some areas, she said. (…)

• Polaris Considers More Price Increases After increases across its portfolio by an average of 2.5% in May, sports-vehicle maker weighs boosting prices further amid supply shortages, higher logistics costs

(…) The company’s cost of sales grew 32.8% to $1.57 billion for the quarter ended June 30 compared with the prior-year period. Polaris declined to provide an estimate of its extra costs due to inflation, but stated that the increases are significant. (…)

Polaris’s sales grew 40% to $2.12 billion for the period ended June 30, compared with the prior-year period.

North American retail sales fell 28% in the past quarter largely due to low product availability. Sales in the U.S. and Canada make up about 85% of total revenue. (…) Polaris expects inventories of its recreational sports vehicles to normalize in late 2022 or early 2023. (…)

• Half full or half empty? Heineken doubles profit, warns on costs Rising commodity costs, including for barley, sugar and aluminium for cans, would start affecting Heineken in the second half of 2021 and would have a “material effect” in 2022, when hedging contracts were no longer mitigating the increases.

• “We are seeing inflationary pressures primarily in the U.S., much more mark there than in our global footprint outside the U.S. represent 60% of our business” – Yum! Brands (YUM) CEO David Gibbs

• “I would lastly just say, the pricing that we’ve taken this year, roughly around 6% or so I think in the U.S., that is about in line, maybe a little bit ahead of where the overall inflation is when you add in the labor inflation with food inflation.” – McDonald’s (MCD) CEO Chris Kempczinski

• Food service employees now earn an average of $17.23 per hour, a rise of a full $1 per hour, or 6.2%, just in the four months between January and May. That is up 7.7% from pre-pandemic levels.

Data: BLS. Chart: Axios Visuals

• “The other thing is wage pressure has become evident, we’ve talked about this a bit…It’s very competitive labor market out there. And certainly the biggest contributor to inflationary pressures that we’re seeing in business.” – Amazon.com (AMZN) CFO Brian Olsavsky

How the Fed Is Hedging Its Inflation Bet Though few have noticed, the central bank is already slowing the growth of the money supply.

By Phil Gramm and Thomas R. Saving

(…) In monetary policy, as in all else, actions speak louder than words. The Fed has expanded its reverse-repo borrowing to an unprecedented $1.26 trillion at the end of June from $272 billion in April, pulling almost a trillion dollars of liquidity out of the financial system. Reverse-repo borrowing has reduced bank reserves, even as the Fed has continued to buy Treasurys and mortgage-backed securities.

Not surprisingly, money supply growth is starting to moderate. The growth of the M2 money stock fell from around 25% in 2020 to around 10% on an annualized basis in the first six months of 2021. It was less than 4% in the last quarter. Remarkably in an economy awash in money, Fed action to reduce liquidity by $1 trillion in three months has thus far gone largely unnoticed, but this stealth action represents a dramatic change in monetary policy. The magnitude of the explosion in reverse-repo borrowing is roughly the equivalent of the impact of selling rather than buying $120 billion of securities to the public a month for more than eight months. (…)

Mr. Powell assures us that the inflation spike is temporary and interest rates won’t rise until 2023. Yet the Fed has raised both the interest rate it pays on reverse-repo borrowing and on reserves. If market interest rates start to rise, the Fed must raise the rate it pays on reserves and reverse-repo borrowing, engage in huge open-market security sales, or raise reserve requirements to stop the money supply from exploding as banks use the overhang of excess reserves to increase lending.

The good news is that the Fed is already using its capacity to borrow in the reverse-repo market to reduce money supply growth. But the excess reserves of the private-banking system are still almost $4 trillion. The bad news is that if the inflation problem doesn’t go away and market interest rates start to rise, the reserve overhang has the potential to cause a money-supply eruption. The use of any of the Fed’s powers to stop the growth in the money supply and inflation will only send interest rates higher.

TECHNICALS WATCH

My favorite technical analysis firm is getting more forceful in its advice for prudence. The deterioration in the main technical indicators continues. Increased volatility, persistent poor breadth and rising selling pressures are masked by still positive price actions in some of the main indices.

Looking at the various indices, the smaller the capitalization, the higher the volatility and the flatter the trend:

  

  

The Russell 2000 stalled in mid-February, the S&P 600 in mid-March, the S&P mid-caps in mid-May with all three displaying increasing weakness in June and July. The Renaissance IPO index had its bear market between mid-February and mid-May (-29%) and is still down 17%. The main SPAC index (SPAK) crashed 36% during the same Feb-May period and remains down 32.8%. ARK’s Innovation ETF also lost 36% at some point and is still down 23%.

Meanwhile, many of the retail crowd’s favorites are hurting big time. AMC lost 41% in the last 2 months, GME 47% in the last 6 weeks. Robinhood is down 7.5% already.

Horan Capital Advisors informs us that

• nearly 40% of the S&P 500 stocks are down greater 10% from their 52-week high and the average decline for stocks from their 52-week highs is 9.1%.
• The mid cap index is down 2.4% from its high yet the average decline for the stocks in the index is 13.5% and nearly 57% of the stocks are down more than 10%.
• The S&P 600 Small Cap Index has seen even broader weakness with almost 70% of the index’s stocks down more than 10% from their 52-week highs. The percentage of stocks down more than 20% is 37.4% with the average decline equaling 31.7%. The small cap index is down 5.15% from its high and the average decline of the stocks in the index from their 52-week high is 18.4%.

That said, CMG Wealth’s Steve Blumenthal’s dashboard is mostly green with Steve concluding that “the weight of trend evidence remains bullish for equities, high grade bonds, and gold,” in stark contrast to Lowry’s Research’s analysis which concludes that the risk/reward picture “has become unfavorable”. To my recollection, this is the most cautious Lowry’s has been in several years. In early July, the warning was that a topping process might be underway. It looks like the then seemingly short term problems are not being resolved and that this could be the topping process.

Steve’s 13/34–Week EMA Trend Chart on the S&P 500 Index remains bullish but the 13W line is uncharacteristically extended, 5.3% above its 34W trend line.

This is happening as we enter the last month of summer heading into the more dangerous September-October period. This topdowncharts.com table highlights September’s bad numbers but also the often painful October.

Topdown’s Callum Thomas yesterday:

And here is the seasonal pattern by itself, as I’ve noted before, seasonality is simply a statistical characterization of the past (past performance does not necessarily = future performance); it is an average (averages can deceive); and there are many exceptions to the seasonal rule. That said, it is an interesting point to note – maybe after such a strong run, the market is due for a bit of a breather.

Ned Davis Research has this intriguing Cycle Composite (mix of seasonality signal, presidential cycle, and decennial cycles) chart:

Source: @dnl8201

Bank of America presents seasonality in its own way:

Also from BofA:

Investors have to come to terms with some contradictory trends:

• large cap equity markets are strong but most equities are not;
• profits are exploding but nobody cares about rising costs that cannot indefinitely be offset by booming revenues;
• the bond market is telling us that the economy may not be as strong as everybody expects;
• the USD seems to say the same;
• the Fed is openly telling us that excess liquidity will soon dry up;
• the China MSCI index is down 26.7% since mid-February, -13.5% in the last 2 months;
• the Delta variant is a rising threat: Fauci predicts worse to come in US Covid resurgence Biden’s chief medical adviser rejects new lockdowns despite rising cases and falling vaccination rates. China is confronting its broadest coronavirus outbreak since the pathogen emerged in late 2019, with cases now in 14 of 32 provinces. Israel’s public health officials are beginning to see signs of more serious disease among the vaccinated elderly.

EARNINGS WATCH

From Refinitiv:

Through Jul. 30, 296 companies in the S&P 500 Index have reported earnings for Q2 2021. Of these companies, 88.5% reported earnings above analyst expectations and 8.4% reported earnings below analyst expectations. In a typical quarter (since 1994), 66% of companies beat estimates and 20% miss estimates. Over the past four quarters, 83% of companies beat the estimates and 14% missed estimates.

In aggregate, companies are reporting earnings that are 16.7% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.9% and the average surprise factor over the prior four quarters of 20.1%.

Of these companies, 86.8% reported revenue above analyst expectations and 13.2% reported revenue below analyst expectations. In a
typical quarter (since 2002), 61% of companies beat estimates and 39% miss estimates. Over the past four quarters, 74% of companies beat the estimates and 26% missed estimates.

In aggregate, companies are reporting revenue that are 4.2% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.1% and the average surprise factor over the prior four quarters of 3.5%.

The estimated earnings growth rate for the S&P 500 for 21Q2 is 89.8%. If the energy sector is excluded, the growth rate declines to 75.0%. The estimated revenue growth rate for the S&P 500 for 21Q2 is 21.8%. If the energy sector is excluded, the growth rate declines to 18.1%.

The estimated earnings growth rate for the S&P 500 for 21Q3 is 29.7%. If the energy sector is excluded, the growth rate declines to 23.4%.

Trailing EPS are now $181.34. Full year 2021e: $200.53 up 1.5% from 197.47 last Friday. 2022e: $221.59, up 2.3% from last Friday.

Heavyweight Companies Enjoy Outsize Rewards as Economy Rebounds Corporate titans during the Covid-19 pandemic have extended their lead over smaller rivals

(…) Evidence since the global financial crisis a decade ago suggests bigger investment, especially in intangible assets, translates into fatter margins and quicker growth, as titans exert more leverage on consumer prices and wages.

Two-thirds of growth in research and development in the year through the third quarter of 2020 came from big, highly productive companies, according to a McKinsey study of 5,500 U.S. and European companies. Moreover, these companies experienced no decline in sales during the same period while other companies lost 11% of their revenues on average.

The International Monetary Fund warned in March that, due to the pandemic, industry concentration could now increase in advanced economies by at least as much as it did in the 15 years through 2015.

Industry concentration, defined as the ratio of sales of the top four firms to the sales of the top 20 firms in the market, has increased by more than 30% since 1980, according to IMF research across industries and countries. After the pandemic, the top four firms will hold 60% of those sales on average, compared with 56% had the pandemic not happened, according to IMF projections. (…)

During the pandemic, larger companies had the financial firepower and digital capabilities to rapidly retool their business models and develop new products, while many smaller competitors languished and focused on survival. (…)

Big businesses also have their pick of the best candidates, while small firms struggle with worker shortages, and can edge out smaller competitors in procuring materials. (…) Bigger competitors have deeper pockets and suppliers don’t want to disappoint their biggest customers (…).

The net profit margins of the S&P 500 companies rose to a record of 12.8% in the first quarter of 2021, up from about 11% before the pandemic, according to FactSet. Smaller listed companies had margins of about 6% both before and after the crisis. (…)

The importance of scale is a particular challenge for Europe because its economy is dominated by smaller companies, especially in the South. Only around 20% of Italians work for businesses with more than 250 staff, compared with almost 60% of Americans. (…)

Interesting WSJ piece but a comparison of revenues and profits of S&P 500 companies with S&P 600 companies does not verify. Some charts from Ed Yardeni:

And yet:

Hmmm…If the apparent equity market topping process is mainly due to smaller caps, it does not seem to reflect the relative fundamentals. Hmmm…

Anti-Ark ETF to Bet Against Cathie Wood’s Flagship Fund

The Short ARKK ETF would seek to track the inverse performance of the $23 billion Ark Innovation ETF (ticker ARKK) — the largest fund in Ark Investment Management’s lineup — through swaps contracts, according to a filing Friday with the U.S. Securities and Exchange Commission. The fund would trade under the ticker SARK and charge a 0.75% operating expense, in line with ARKK’s fee.

If launched, SARK would serve as a bold bet against one of 2020’s most successful managers. ARKK surged roughly 150% last year with Wood at the helm, frequently doubling down on Tesla Inc. and other high-flying technology shares. However, some of the fund’s hottest stocks have since weighed on its performance as the market’s speculative fervor settles — ARKK is underwater by 3.6% in 2021, versus the S&P 500’s 17% gain. (…)

Ray Dalio: Understanding China’s Recent Moves in Its Capital Markets

(…) As for investing, as I see it the American and Chinese systems and markets both have opportunities and risks and are likely to compete with each other and diversify each other. Hence they both should be considered as important parts of one’s portfolio. I urge you to not misinterpret these sorts of moves as reversals of the trends that have existed for the last several decades and let that scare you away.

And FYI via The Market Ear:

US regulators launch crackdown on Chinese listings SEC to require more disclosures about companies’ structure and contacts with Beijing

Japan calls for greater attention to ‘survival of Taiwan’ Defence minister’s remarks follow Tokyo’s decision to link Taipei’s security to its own