U.S. SERVICES PMIs
The divergence seen last week in the manufacturing PMIs is even more troubling with the services PMIs released yesterday. For the same reasons, I give more credibility to S&P Global’s survey.
August survey data signalled a sharp and quicker decline in business activity across the US service sector, according to the latest PMI™ data. The decrease in output stemmed from weak domestic and foreign client demand, as new orders returned to contraction territory. At the same time, weak inflows of new business led firms to moderate their hiring activity. Employment rose at the softest rate since January as backlogs of work contracted at the fastest pace in over two years. Although the degree of optimism picked up to a three-month high, it was below the series average as concerns regarding the impact of price rises on demand weighed on expectations.
On the price front, rates of input cost and output charge inflation eased to the slowest in a year-and-a-half. Concessions were reportedly made to clients amid decreases in some material costs and efforts to drive sales.
The seasonally adjusted final S&P Global US Services PMI Business Activity Index registered 43.7 in August, down from 47.3 in July and lower than the earlier released ‘flash’ estimate of 44.1. The latest data signalled a steep fall in output across the US service sector, and the fastest fall in activity since May 2020. The further loss of growth momentum among service providers was linked to weak client demand and greater client hesitancy in placing new orders.
Service providers recorded a solid decline in new business in August, with new orders falling for the second time in three months. The rate of contraction was the sharpest for over two years and among the fastest on record. With the exception of the initial pandemic period, the fall was the quickest on record (since October 2009). The impact of high inflation and increased interest rates on client demand reportedly weighed on total sales.
The decrease in total new business coincided with a third successive monthly decline in new export orders midway through the third quarter. The downturn in new business from abroad was linked to strains on client incomes in external markets.
Meanwhile, average cost burdens continued to rise at an historically marked pace during August. The increase in operating expenses was often attributed to higher transportation, wage and material prices, alongside hikes in interest rates. Nonetheless, amid reports of decreasing costs for some items, the rate of input price inflation moderated to the slowest since February 2021.
Subsequently, output charges at service providers increased at a substantial, but softer pace, in August. Firms continued to note the pass-through of higher costs to clients, but some companies stated that concessions were made to customers in an effort to drive new sales. The rate of charge inflation was the softest for a year-and-a-half.
Weak client demand led to a slower rise in employment during August, with the rate of job creation slipping to the softest since January. Pressure on capacity fell for the third successive month as backlogs of work were reduced at a strong rate. The decrease in the level of incomplete business was the steepest since May 2020.
Finally, business expectations regarding the outlook for output at service sector firms picked up to the highest for three months in August. Although optimism was buoyed by hopes of greater client demand and the diversification of business lines, the level of positive sentiment was below the series average amid concerns regarding inflation and interest rate hikes.
The S&P Global US Composite PMI Output Index posted 44.6 in August, down from 47.7 in July, to signal a sharp contraction in business activity across the private sector. Although manufacturers also recorded a decline, the decrease was led by service providers.
In contrast to that seen in July, service sector firms registered a decline in new business in August. As a result, private sector new orders fell at the quickest pace since May 2020, while new export orders also fell at a solid pace.
Inflationary pressures eased further across the private sector, with average cost burdens rising at the slowest pace since January 2021. Output charges also increased at a softer rate as some firms sought to offer concessions to clients in an effort to drive sales.
Despite the degree of confidence rising to a three-month high, weak client demand led to a softer increase in employment in August. Pressure on private sector capacities waned as service providers recorded a strong fall in backlogs of work.
- The ISM: In August, the Services PMI® registered 56.9 percent, 0.2 percentage point higher than July’s reading of 56.7 percent. The Business Activity Index registered 60.9 percent, an increase of 1 percentage point compared to the reading of 59.9 percent in July. The New Orders Index figure of 61.8 percent is 1.9 percentage points higher than the July reading of 59.9 percent. (…) The Prices Index decreased for the fourth consecutive month in August, down 0.8 percentage point to 71.5 percent. (…)
US private sector firms signalled a broad-based decline in output during August, as all seven monitored sectors registered contractions in business activity. It was only the second time on record (since October 2009) that all sectors have seen a decrease in output, the first time having been in May 2020 during the initial wave of COVID-19.
Exports, the Engine of China’s Slowing Economy, Are Sputtering Chinese goods shipments to the rest of the world rose by 7.1% last month, the weakest gain since April, reflecting the impact from rising inflation and slowing growth elsewhere.
(…) The result fell below a median forecast of 12.5% among economists polled by The Wall Street Journal, and decelerated from July’s 18% year-over-year gain.
Slowing exports partly reflect disruptions in factory production due to temporary power shortages as a severe drought and heat wave swept through central China last month, though economists expect the impact of that to be short-lived. Recent flare-ups of Covid-19 cases, however, threaten to disrupt manufacturing in more cities as authorities stepped up restrictions ahead of a Communist Party gathering in October, when Chinese leader Xi Jinping is expected to break with recent precedent and claim a third term. (…)
South Korea’s exports to China have dropped for three consecutive months, and were down 5.4% in August from a year earlier, contributing to a record trade deficit of $9.47 billion. The country’s semiconductor exports contracted in August for the first time since April 2020 due to weak consumer demand among other factors.
China’s weakening export data came as the world’s business activity fell into contraction for the first time in more than two years, pointing to shrinking global demand amid economic fallout from the Ukraine war and interest-rate increases by central banks to battle inflation.
Global economic output contracted in August for the first time since June 2020, according to the purchasing managers index survey compiled by S&P Global. The headline PMI, which measures output for both manufacturing and services sectors, fell to 49.3 last month, down from 50.8 in July and below the 50 mark that separates expansion from contraction.
If lockdown months are excluded, the latest reading was the lowest since June 2009 when the world was ensnared by the global financial crisis, noted S&P Global. (…)
China’s imports weakened further in August, pointing to disappointing demand at home, as consumer confidence remains feeble while the jobless rate among young people rose to a record high.
Inbound shipment to China was flat as it gained 0.3% from a year earlier to $235.5 billion, down from a 2.3% increase in July. The reading was the weakest since April, when port and factory activities came to a halt due to lockdowns in Shanghai and other cities. It undershot the 1.5% forecast among economists polled by the Journal. (…)
As of Tuesday, 49 cities were under lockdown or various degrees of control measures, accounting for about a quarter of China’s gross domestic product and affecting a fifth of China’s total population, economists from Nomura estimated. As a result, they lowered China’s full-year growth forecast to 2.7% from 2.8%. (…)
Samsung Expects Sharp Downturn in Chip Sales to Extend Into Next Year Samsung sees the sharp downturn in chip sales extending into next year, the latest note of pessimism for a semiconductor industry reeling from a dramatic pullback in sales of PCs, smartphones and data servers.
(…) “The second half of this year looks bad, and as of now, next year doesn’t really seem to show a clear momentum for much improvement,” said Kyung Kye-hyun, who heads Samsung’s semiconductors unit and serves as the company’s co-CEO, at a Wednesday media briefing. (…)
Earlier this year, industry executives widely believed that the second half of 2022 would be stronger than the first. But by late spring, it became apparent that demand levels had “drastically changed” and would instead be softening significantly, Mr. Kyung said. (…)
Samsung also runs two chip-making plants in Xi’an, China. The South Korean chip maker expects potential difficulties in bringing new equipment to its China facilities due to U.S. export restrictions. But China, which makes up about 40% of global tech demand, is a market that can’t be overlooked, Mr. Kyung said. (…)
U.S. consumers and businesses are still in good financial shape despite high inflation and concerns about a looming recession, some of the nation’s top bankers told a conference in New York on Tuesday.
Brian Moynihan, chief executive officer of Bank of America Corp (BAC.N), the nation’s second-largest bank, said customers spent 10% more in August from a year earlier, and bank account balances are higher for many than they were pre-pandemic. (…)
J.P. Morgan’s Chase consumer card spending tracker is not as buoyant, to say the least (remember, this is all in nominal $):
Chase’s control retail sales tracker points to a negative August:
- Inflation Now Causing Hardship for Majority in U.S. A majority of Americans, 56%, now say price increases are causing financial hardship for their household, up from 49% in January and 45% in November. The latest reading includes 12% who describe the hardship as severe and 44% as moderate.
(…) Lower-income Americans are more likely than others to be experiencing severe hardship — 26% of those whose annual household income is less than $48,000 say prices are causing severe hardship for their families. That compares with 12% of middle-income Americans and 4% of upper-income Americans.
Lower-income Americans are about as likely now as last fall to say they are experiencing either severe or moderate hardship — 74%, compared with 70% in November.
Middle-income (63%) and upper-income (40%) Americans remain significantly less likely than lower-income Americans to say they are experiencing hardship. However, sharply more middle- and upper-income Americans are struggling now than were last November. The increase has been greater among middle-income Americans — up 17 percentage points — than among upper-income Americans — up 12 points. (…)
The most common action, mentioned by 24% of those experiencing hardship, is to reduce spending, including buying less in general or buying only essential items. Another 17% say they are traveling less or canceling vacations, while the same percentage indicate they are driving less or trying to use less gas.
Other common strategies for dealing with higher prices are buying cheaper goods or generic brands of products (12%), eating out less (10%), buying fewer groceries or growing their own food (10%), staying home (8%), and cutting down on entertainment expenses (8%). (…)
Defaults on so-called leveraged loans hit $6 billion in August, the highest monthly total since October 2020, when pandemic shutdowns hobbled the U.S. economy, according to Fitch Ratings. The figure represents a fraction of the sprawling loan market, which doubled over the past decade to about $1.5 trillion. But more defaults are coming, analysts say. (…)
“Borrowers are particularly vulnerable to the double whammy of weaker earnings and rising interest rates,” Morgan Stanley strategist Srikanth Sankaran said. That will trigger a wave of credit-rating downgrades and push average loan prices—currently 95 cents on the dollar—below 85 cents, a level breached only during the 2008 financial crisis and the depth of the Covid-19 pandemic, he said. (…)
The percentage of loans in default will likely rise to roughly 3.25% in mid- 2023 from about 1% now, but it could go significantly higher, said Jeff Darfus, a credit analyst at the bank.
Data from a recent Fed survey of loan officers at top banks showed tightening lending standards that a Barclays’s model predicted could cause roughly 4.5% of the loans to be in default a year from now, he said. (…)
Ironically, investors began piling into loans last year in anticipation of the Fed’s increases because their floating interest rates made them more attractive than bonds, which pay fixed rates. (…)
Companies with single-B ratings—one of the lowest rungs in the junk-debt category—now account for about one-quarter of leveraged loans outstanding, compared with 11% in 2010, said Frank Ossino, manager of a leveraged-loan fund at Newfleet Asset Management.
The trend is accelerating. Around twice as many loans received credit-rating downgrades as upgrades in the past three months, the highest multiple since October 2020, according to research by Bank of America. (…)
- Meanwhile, leveraged loan downgrades outpaced upgrades by a ratio of 1.89:1 last month according to LCD. That ratio held at less than 0.5 for the bulk of 2021 and remained below one as recently as this spring. (ADG)
Developed economies are taking a hit from the dollar’s appreciation to multi-decade highs in ways that were once more familiar to their emerging market peers.
Fueled by the Federal Reserve’s most aggressive tightening cycle in more than a generation, the stronger greenback is pushing rival currencies lower, driving up the cost of imported goods, constricting financial conditions and feeding inflation in other economies.
That’s ratcheting up pressure on other central banks to raise interest rates just as an energy crisis and spiraling consumer prices hobble Europe’s economies, and increases in borrowing costs cool housing markets in Australia, Canada and New Zealand. Yet their ability to influence the dollar’s strength is limited, meaning there’s little prospect for near-term relief. (…)
The Fed’s trade-weighted dollar index versus advanced economies has soared 10% this year to the strongest since 2002, while the emerging-markets measure is up a more modest 3.7% and remains well below its peak from the 2020 pandemic. (…)
Courtesy of ZeroHedge (ZH emphasis):
(…) At the risk of stating the obvious, 2022 has been a challenging year for stock investors of all stripes. The Russell 3000 is down approximately 18% (total return) year to date (YTD): and while Russell 3000 Growth has underperformed significantly (-24%), it’s been no picnic for value investors either (-11%). Clearly, the relative value trade of value over growth has worked well this year, but we note it’s mostly been due to Energy’s outperformance combined with defensive cohorts, rather than cyclicals like Financials. In fact, only 2 sectors, Energy and Utilities, are up in absolute terms this year while just 24% of all stocks in the Russell 3000 are in positive territory. To put that into context, in 2008, 48% of Russell 3000 stocks were up on the year as we entered the month of September. Suffice it to say, this year has been historically bad for stocks in terms of both price and breadth, but that is not a sufficient reason to be bullish. We think that poor breadth is indicative of more challenges to come on the growth side of the equation, which we address in our note today. While some have recently argued the breadth thrust off the June lows is a sign of better times ahead, we firmly disagree as our top down earnings work does not support such a conclusion. Meanwhile, that breadth thrust is losing altitude quickly and looks vulnerable to taking out the 50-day moving average, something it did not do off the March 2020 lows. Let the debate begin. (…)
His more pessimistic view on the S&P 500 index, meanwhile, is based on analysis that indicates all of the 30% de-rating in the forward S&P 500 P/E that occurred from December to June was due to higher rates: “we know this because the equity risk premium (ERP) was flat during this period. Meanwhile, forward NTM EPS estimates for the S&P 500 have come down by only ~1.5% and P/Es are now ~8% higher. With rates now ~30bp below the June highs, the ERP has fallen once again, to just ~285bp. This makes little sense, particularly given the significant slowdown in earnings we think is still to come.”
(…) Wilson thinks that asset markets may be entering fire and ice part two. In contrast with part one, this time the MS strategist contends that the decline in stocks should come mostly via a higher ERP and lower earnings rather than higher rates.
Meanwhile, the bank’s earnings models are all flashing red for the S&P 500, and Wilson is highly confident that the decline in NTM S&P 500 EPS forecasts is far from over. In short, Wilson writes that “part two will be more icy than fiery, the opposite of 1H22. That’s not to say rates don’t matter – they do – and we expect bonds to perform better than stocks in this icier scenario.” (..)
So what are Wilson’s new S&P ESP forecasts following today’s downward revisions which point to continued and increasingly significant EPS growth downside well into 2023? Here is the answer:
- cut the 2022 base case EPS estimate to $220 from $225 (down 2%),
- 2023 base case estimate cut to $212 from $236 (down 10%),
- 2024 base case estimate cut to $226 from $237 (down 5%).
The ’22/’23/’24 base case estimates are now 3%/13%/14% below consensus, respectively, and more notably, in Morgan Stanley’s base case, 2023 now marks a modest earnings contraction (-3% year-over-year growth), although Morgan Stanley is still terrified to make a recession its base case scenario (that would scare off too many clients).
The logic here is that nominal top line growth slows, but remains positive (mid-single-digit territory), while margins contract materially (1-1.5% margin compression) driven by sticky cost pressures, particularly on the labor side. The bank’s 2023 bear case EPS is modestly lower to $190 from $195 – a case which continues to assume an economic recession (consistent with views published in our mid-year outlook), and implies an 11% year-over-year EPS growth contraction. The ’23 bull case EPS forecast also comes down to $234 from $245. In this scenario, nominal top line is slightly better and margin pressure is less significant. (…)
Wilson’s call for price downside as a result of declining EPS into mid-2023 – the basis of this note, and a high conviction view – is very much a tactical view (next 3 months). To further reinforce this point, the strategist notes that the market multiple typically troughs when EPS is only a third of the way through its decline (i.e., price front-runs EPS declines).
Putting it all together, Wilson’s base case tactical view remains that fair value price for the S&P 500 is ~3,400, and while he expects that price level to be reached before year end, stocks will then work back toward 3,900 by mid next year (actually they will be much higher as the QE needed to monetize all the energy stimmies will long have been in play by then). As previously noted, Wilson thinks tactical fair value in his bear case (an economic recession) is 3,000, which implies an overshoot to the downside of his June ’23 bear case price target in advance of that date. …)
the next several quarters will end up containing some of the most significant downward revisions to forward EPS forecasts seen in the past several cycles. As for valuation, the Morgan Stanley strategist thinks very little of these revisions have actually been discounted, as evidenced by the still depressed ERP component of the S&P 500 P/E ratio. While that view could be challenged as a subjective one, Wilson is confident that his ERP model suggests it is at least 100bps too low today and probably even more since the US is headed toward a recession (our bear case). That said, the strategist certainly appreciates that “this debate is what makes a market and have no illusion markets can trade more richly than they should for long periods of time.” On that note, he thinks the increased size of QT that is expected to begin this month could play a significant role in changing the market’s view of fair value for the ERP.
Speaking of ERP, Callum Thomas offers this:
Despite some reduction in valuations (e.g. PE Ratios have fallen), the issue is that bond yields have gone up as well, so the equity risk premium has not really improved.
For instance, compare and contrast the current levels of the ERP [Equity Risk Premium] vs that seen during the peak of the pandemic panic or the 2008 financial crisis. Current levels are simply not compelling, certainly not compared to those episodes.
The ERP works well as a key input for asset allocation e.g. by giving buy signals when it spikes (n.b. higher = better) because it reflects outright valuations, but also valuations relative to the risk free alternative (i.e. bonds) — and indirectly also reflects sentiment and monetary conditions with regards to changes in bond yields.
Simply put, the higher the ERP, the better compensation you are getting for being in risky assets vs “safe“ assets. So clearly, a lower ERP means less compensation for risk, and hence a riskier setup, all else equal.
The key takeaway is that the current level of the ERP is not particularly attractive for US equities. Even the rest of the world, while boasting a higher ERP vs the USA, still hasn’t moved up to previous major buying opportunity levels at this point. Hence again, we see another indicator saying “not yet“ for global equities.
This divergence raises a series of important economic issues and questions. Among them is the ability of the ECB to raise interest rates without prompting a rise in the yield spreads between the bonds of European peripherals and German Bunds. The last time the ECB’s deposit facility rate was above zero, the euro area was in the throes of a debt crisis. Things may have changed since then, but a significant increase in the policy rate could raise the question of debt sustainability once again.
