Year: 2023

Inflation Eased to 3% in June, Slowest Pace in More Than Two Years Price pressures cooled, but inflation remains strong enough to keep the Fed on course to continue raising interest rates.

(…) Overall consumer prices increased a seasonally adjusted 0.2% in June from the prior month, compared with May’s 0.1% gain. Core consumer prices climbed 0.2%, just slightly above their pace in February 2021 at the start of the inflation surge. A more narrow measure of inflation that excludes goods, housing and energy was essentially flat in June from the prior month, according to Wall Street Journal calculations. (…)

Facts:

• CPI +0.18% MoM for June  (+3.0% YoY) after +0.12% (+4.1%)
• Core CPI +0.16% MoM for June (+4.8% YoY) after +0.44% (+5.3%)
• Core Goods -0.1% MoM (+1.3% YoY) after +0.6% in April and May.
• Core Services +0.3% moM after +0.4% in April and May.
• CPI “Essentials” (food, energy, rent) +0.33% MoM in June (+4.1% YoY) after 0% in May

John Authers: Getting So Much Better, But Not Enough to Stop a Rate Hike

(…) Breaking down year-on-year inflation into its component elements shows that energy now has a negative impact, after fuel costs drove the spike in 2021. That’s not surprising. More impressively, core goods inflation, running hot at the beginning of last year, has dwindled almost to nothing. And core services, the source of the greatest current anxiety, is also ticking down. This is close to exactly what the Fed would have wanted to see:

(…) In short, this looks much less like a “head fake” (as colleague Jonathan Levin puts it) toward lower inflation than then previous alarms of the last two years. (…)

What does the Fed itself think about all of this? On Wednesday, it released its latest Beige Book, filled with impressionistic reports from its research teams across the country. It’s a long and detailed read, but computer techniques are getting ever better at scanning big blocks of text to produce some quantified numbers. This chart of the word counts in each Beige Book  this decade comes from Oxford Economics:

Concern about inflation is abating, as are worries about wages, while talk of recession is (thankfully) limited. The chart does suggest that the Fed’s employees are picking up persistent concerns about the availability of credit. But in general, this analysis is exactly in line with the current perception of the Fed’s stance: That it doesn’t believe it needs to raise rates much more, is genuinely hopeful that a recession can be avoided, and the possibility of a credit incident poses the greatest risk to that outlook.

Meanwhile, the bond market, which only last week saw an epic jolt to bring the two-year yield above 5% for the first time in more than decade, seems implicitly to be betting on a downturn. (…)

Real consumer demand has stalled since January but the recent uptick in real aggregate payrolls suggest stronger demand in H2.

• “Consumer spending continued to stabilize in June. Bank of America aggregated total credit and debit card spending per household declined by 0.2% year-over-year (YoY) , in line with the YoY rate in May.” (@MikeZaccardi)

Credit card use is biased towards goods.

Core CPI monthly growth fell back to its pre-pandemic range, along with core services. But we have seen monthly head fakes before:

• Quarterly:

CPI services is intimately correlated with wages, still rising 4.5-5.0%.

GS: “Today’s report is consistent with our view that Fed tightening is in its final innings. We continue to expect a final 25bp hike at the July FOMC meeting to 5.25%-5.5%, followed by unchanged policy for the remainder of the year.”

Ed Yardeni:

Investors have turned from fearful to fearless in recent months as the economy has proven to be resilient to the Fed’s tightening of monetary policy while inflation has continued to moderate. We can see their fearlessness in the S&P 500 VIX, which is highly correlated with the percentage of bears in the Investors Intelligence weekly survey of stock market sentiment. Both are down to pre-pandemic lows.

Now that everyone is so bullish, we have to conclude that the technicals are looking increasingly dicey from a contrarian perspective. Meanwhile, the fundamentals continue to be bullish as they confirm a disinflationary soft-landing scenario. We would welcome a mini-correction down to the 50-day moving average of the S&P 500. If instead, the index jumps above its bull-market channel, we may have to contend with a melt-up situation. For now, we are sticking with our 4600 yearend target for this year.

Bank of Canada Lifts Interest Rates, Warns Path to Stable Inflation at Risk Central bank raises its main rate to 5%, saying it would take longer than expected to reach 2% inflation

(…) The back-to-back rate rises represent a sharp pivot for Canada’s central bank, which in January declared a pause on further tightening on the belief that a series of aggressive, rapid-fire increases in borrowing costs would damp inflation and employment through the year.

Bank of Canada Gov. Tiff Macklem said the central bank is prepared to raise interest rates further should inflation fail to moderate as forecast. (…)

Macklem added that ahead of Wednesday’s decision, senior officials discussed holding rates steady and waiting for further data. In the end, Macklem said, officials agreed interest rates needed to go higher and “the cost of delaying action was larger than the benefit of waiting.”

The central bank said in a statement explaining the rate decision, and an accompanying economic forecast, that downward pressure on inflation is at risk of stalling. This decision comes as households continue to spend on goods and services at a solid pace buoyed by a strong labor market, population growth fueled by immigration and accumulated savings during the Covid-19 pandemic. Canada recorded the fastest economic growth among the Group of Seven economies in the first quarter, at a 3.1% annual rate, or above the central bank’s forecast for 2.3% expansion. (…)

It envisages inflation cooling from its current 3.4% level to 2% in mid-2025, or six months later than previously expected. The central bank said it expects inflation to hover around 3% for the next 12 months. (…)

“Underlying price pressures appear to be more persistent than anticipated,” the bank said, adding a recent survey of executives suggesting businesses still intend to raise their prices more frequently than normal. (…)

Canada’s unemployment rate has climbed, to 5.4% in June from 5.0% in April. Macklem said the jobless rate “remains historically low,” and that the current pace of annual wage growth, between 4% and 5%, needs to moderate further to help hit the 2% inflation target.

The central bank said it expects economic activity to slow, although recent data covering retail sales and other indicators “suggest more persistent excess demand in the economy.” It forecasts annualized economic growth of 1.5% in the second quarter, or above its earlier 1% estimate, and then growth to average 1% through the second half of this year and first half of 2024, as higher interest rates reduce the amount of after-tax income available to households.

The central bank also expects growth from exports to weaken as higher rates elsewhere in the world, especially the U.S., kick in and weaken global demand. (…)

Xi Jinping Chokes Off Crucial Engine of China’s Economy Foreign direct investment in China fell to $20 billion in the first quarter from $100 billion a year earlier, hurting an already struggling economy.

Desperate for capital and with their economies struggling, China’s cities are wooing Western businesses with previously unavailable goodies. Beijing has labeled 2023 the “Year of Investing in China” and local officials have embarked on promotional tours overseas to drum up interest from investors.

That effort is running headlong into President Xi Jinping’s national-security agenda, with its focus on fending off perceived foreign threats. That has made any Chinese investment a potential minefield for foreign firms.

A Xi-led campaign this year has hit Western management consultants, auditors and other firms with a wave of raids, investigations and detentions. Meanwhile, an expanded anti-espionage law has added to foreign executives’ worry that conducting routine business activities in China, such as market research, could be construed as spying.

The perception that doing business in China has become much riskier is choking the flow of capital into an economy already struggling with weak private investment and consumption, as well as soaring youth unemployment. (…)

The tug of war is leaving financially distressed cities and townships across China in the lurch. Mired in debt and struggling to create jobs after three years of Covid-19 restrictions, many are in dire need of capital. (…)

A trade official in Chengdu, the capital of southwestern Sichuan province, recently embarked on an investment-promotion trip to Europe. He returned empty-handed. “In my 20 years of trying to get investments from Europe, this was the first time we didn’t get to sign even one memorandum of understanding,” the official said.

A senior official in a county of southern Guangdong province, which earlier this year set a goal of attracting nearly $300 billion in investment in the next five years, told a visiting American trade group recently that the county would reward any U.S. corporate “decision maker” investing there 10% of the value of the promised deal, according to people briefed on the matter. (…)

Recent surveys by business groups in China have shown American, German and other European companies pausing expansion or reducing investment in China. (…)

What’s mandarin for “You can’t have your cake and eat it, too”?

• China’s $400 Billion Pension Sends New Warning on Debt Risks

The National Council for Social Security Fund, which oversees about $417 billion according to the latest available figures, has advised asset managers that handle its money to sell some bonds including those from riskier LGFVs and private developers after a review, people familiar with the matter said, asking not to be identified discussing private information. Several of them mentioned that bonds from LGFVs in Tianjin, a debt-saddled northern port city, were singled out.

The recent Sino-Ocean Group Holding Ltd.’s debt rout raised the pension fund’s concerns as one of its biggest asset managers holds a large position in the state-backed developer’s debt, the people said. That triggered the request for a health check of their exposure to riskier LGFVs and builders, if relevant bond prices are below 95% of face value, the people added.

The move underscores the difficult balancing act facing Chinese authorities as they try to defuse risks in the credit markets without destabilizing the financial system. While offloading weaker bonds may help the state pension protect the value of its investments, it risks heightening market concerns about the health of LGFVs and developers at a time when Beijing is trying to restore confidence in the world’s second-largest economy. (…)

CPI for all items rises 0.2% in June; shelter up

The U.S. labor market continues to cool, but only at a gradual pace

According to one of the Federal Reserve’s key indicators, the ratio of job openings to unemployment, the labor market has begun to show signs of easing. LinkedIn’s measure of labor market tightness, which has a slightly different definition than government data (includes all job seekers, not just the unemployed), indicates more slack than government data implies. In June, there was 1 job opening for every 2 active applicants on the platform, marking a significant slowdown compared to the previous peak of 1 job opening per applicant observed in the last months of 2022.

June 2023 witnessed a 2% decline in hiring across all industries in the U.S. compared to the previous month of May 2023. Furthermore, national hiring in June 2023 experienced a significant 20.9% drop compared to the same period in the previous year, June 2022. However, there are signs that the decline in hiring is starting to stabilize.

The most impacted industry in terms of hiring continues to be the Technology, Information, and Media sector, which saw a staggering 42% decrease in hiring compared to the same period last year. Retail and Wholesale sectors also faced substantial challenges, with YoY hiring rates dropping by 32% each. Real Estate and Equipment Rental Services experienced a 27% decline in hiring, closely followed by Professional Services at 24%. Other industries also faced significant declines, such as Manufacturing and Transportation, Logistics, Supply Chain, and Storage, which both saw a 22% reduction in hiring. Financial Services and Accommodation and Food Services also experienced notable declines at 21% and 19%, respectively.

The short tenure rate, or STR, which measures the fraction of positions that end after being held for less than a year, has decreased across industries over the past year.

Short tenures started a growth spell in August 2021 that peaked in March 2022 when the STR was up 10.25% year-over-year. However, due to the current slowdown in the labor market, workers are now staying in their positions for longer durations compared to the previous year, resulting in a year-over-year decrease of -5.46% in STR as of June 2023. This suggests that workers’ confidence in the labor market is waning and their expectation to land jobs elsewhere is declining. After all, there are less jobs available for every active job seeker today compared to the trend of the last two years.

Some industries are seeing a more prevalent decline in quick quitting than others, as shown in the chart below above. The STR in the technology, information, and media industry, for example, declined 12.6% year-over-year in June, meaning workers are leaving their jobs at a much slower rate this year compared to last year. (…)

The Accountant Shortage Is Showing Up in Financial Statements Advance Auto Parts and others have cited a lack of skilled accounting personnel for material weaknesses in their financial-reporting controls, a key predictor of restatements

(…) The company said it wasn’t able to attract and retain enough qualified people to fulfill internal-control responsibilities. (…)

The disclosures come as fewer people are pursuing degrees in accounting and entering the field, resulting in more positions open and for longer periods of time. What’s more, academics say, the shortage will likely be compounded as more accountants retire without a robust pipeline of replacements. (…)

Nearly 600 U.S.-listed companies of a total 7,359 reported material weaknesses related to personnel, typically in accounting or information technology, this year through June, down 5.2% from the prior-year period, but up 40.6% from the 2019 period, according to a review of filings by research firm Bedrock AI.

Of these companies, 21% were based outside the U.S., a jurisdiction whose reporting requirements can be knotty for companies with complex operations and corporate structures. (…)

The number of foreign U.S.-listed companies reporting personnel-related material weaknesses this year through June grew 5% to 125, compared with the prior-year period, Bedrock said. That is nearly triple that of the 2019 period. The 125 companies included 16 with at least a $1 billion market capitalization, up from 15 in the prior-year period and six in the 2019 period. (…)

“Higher salaries are coming for in-house accountants whether management likes it or not,” he said.

Is China Mired in a ‘Balance Sheet Recession’? Warning signs are adding up that China might face a slow, post-2008 style U.S. recovery—absent a much bigger fiscal push

(…) The value of contracted sales for China’s top 100 property developers fell 28% from a year earlier in June, compared with 7% growth in May, according to industry tracker CRIC. A higher base from last June—when Shanghai emerged from its Covid-19 lockdown—probably contributed to that decline. But sales were lackluster by any reasonable measure: They only reached around a third of June 2020 and 2021 levels, according to Nomura.

China probably won’t slip back into a formal recession. But, like the U.S. after the 2008 financial crisis, it may be facing a scenario where households and companies refuse new borrowing due to existing heavy debts—and a lack of confidence about the future. Instead, they use new income to pay down existing obligations. That in turn makes it difficult for policy makers to goose the economy with lower interest rates, because the pass-through to actual new investment and consumption is marginal.

That is certainly playing out in the real-estate market. Households, which levered up rapidly over the past decade, are worried about the economy and the fact that housing prices no longer seem destined to keep going up—to say nothing of the small problem that many buyers who bought the rights to future apartments from developers have yet to actually receive their homes. Investors have become less willing to put savings into new apartments.

That spells troubles for developers too. Bond defaults have picked up. The default rate of Chinese property junk bonds is around 16% so far in 2023, according to Goldman Sachs. The bank raised its full-year default rate forecast to 28% earlier this month, after lowering it in February—a sign of how quickly and dramatically the mood has darkened again in financial markets. (…)

More stimulus of some kind is almost certainly in the pipeline this year. But repairing the confidence of home buyers looks increasingly like a long-term battle—one that poor demographics and heavy household debts will make difficult indeed.

• China’s Hidden-Debt Problem Laid Bare in Zunyi City’s Half-Finished Roads, Empty Flats A city in one of China’s poorest provinces is awash in half-built roads and apartment blocks, symbolic of the mounting debt crisis facing municipalities around the country after years of stimulus-fueled growth.

(…) The Fengxin Expressway, still partially closed after construction stalled four years ago, is one of the many unfinished infrastructure projects in Zunyi, a city of 6.6 million people in mountainous Guizhou province. In addition to highways, housing projects and tourist attractions also stand incomplete, symbolic of the stark debt crisis that many local governments in China are facing after years of credit-fueled stimulus to juice growth. (…)

Now, the provincial government is struggling to pay its debts, small businesses are not getting paid for construction projects and displaced residents are demanding overdue compensation and new housing be delivered. (…)

At the heart of China’s debt crisis are so-called local-government financing vehicles, which were created to fund infrastructure by skirting limits on municipal authorities selling bonds in the market. However, LGFVs rarely generate enough returns to cover their obligations, meaning most rely on methods including refinancing and injections of municipal funds to stay solvent, which are now drying up. Rolling over debt is also getting harder as investors are more cautious.

Money owed by LGFVs is known as “hidden debt” because it doesn’t appear on governments’ balance sheets. The issue has grown into a major risk for the Chinese economy and is also a big concern for investors who have bought bonds sold by such firms. (…)

While there is no official figure, the International Monetary Fund estimated in February that there was 66 trillion yuan of such debt outstanding in China at the end of 2022, up from 40 trillion yuan in 2019. (…)

Kicking the can down the road seems to be the main way LGFVs are trying to delay a full-blown credit crisis. China’s biggest state banks are meanwhile offering the vehicles loans with ultra-long maturities and temporary interest relief to prevent a credit crunch in the market. (…)

•   Xi Calls for More Economic Opening, Trade as Recovery Falters China’s attempts to encourage foreign investors have ramped up in recent weeks as it’s become clear that the economy’s recovery following the end of Beijing’s Covid Zero policies is starting to flag.
• Mexico is now the top U.S. trade partner (Axios)

Mexico supplanted China this year as the United States’ top trading partner, Emily writes.

The milestone reflects a real shift in the dynamics of the global economy — away from prioritizing low prices and greater efficiency (via super fragile supply chains) to something more nuanced. (…)

The auto industry accounts for nearly a quarter of the total manufacturing trade activity between the U.S. and Mexico.

• China exports more to the U.S. than the U.S. sends to China, but trade with Mexico is more balanced between imports and exports.
• For example, in some industries, products are started in U.S. plants, and finished in Mexican factories before coming back into the U.S. “We complement each other,” Torres tells Axios.

Data: U.S. Census; Chart: Axios Visuals

For the record, YtD in 2023:

• U.S. imports from China total $168.6B. From Mexico: $194.9B. From Canada: $175.5B.
• U.S. exports to China total $62.4B. To Mexico: $133.2B. To Canada: $146.2B.
• U.S. trade balance with China: $-106.4B. With Mexico: $-61.8B. With Canada: $-29.3B.

EARNINGS WATCH

A repeat performance? (Refinitiv)

Heading into the Q1 earnings season, we were expecting an ‘earnings recession’ based on a negative Q4 actual growth rate along with analyst estimates forecasting a negative growth rate for both Q1 and Q2.  However, Q1 marked a resilient (and suspenseful) quarter which threw water on the earnings recession narrative as the growth rate finished at +0.1% from a starting point of -5.1% at the beginning of the quarter.  It was a suspenseful ending to earnings season as many readers waited to see if the Q1 growth rate would turn to positive territory and eventually did at the last minute.  This was a remarkable feat as we have only seen the growth rate start negative and end positive on eight occasions since 2002.

Looking at Q2, the backdrop heading into the quarter looks remarkably similar to Q1 which raises the question – will we see ‘A Repeat Performance’ of last quarter?

Surprisingly, the upbeat Q1 did not translate into upward Q2 growth expectations. Instead, analysts  have set the bar lower heading into earnings season by downgrading Q2 estimates, albeit at a slower pace compared to the prior three quarters.  From a guidance perspective, we have seen 62 negative Q2 EPS pre-announcements compared to 39 positives, resulting in a negative/positive ratio of 1.6, which is below the long-term average of 2.5 and the prior four-quarter average of 2.0.

Over the last three-months, the Q2 EPS estimate has declined from $54.24 to $52.81 per share, resulting in analysts downgrading y/y growth expectations by 2.5 ppt heading into earnings season. Interestingly, the majority of Q2 downgrades finished by the beginning of May and remained unchanged throughout the month of May and June.  Finally, Q2 has seen a slower pace of revisions compared to the prior three quarters where estimates were revised downwards by an average of 6.8 ppt.

(…) ex-energy earnings growth is currently forecasted to be negative for the fifth consecutive quarter, surpassing the three quarters of negative ex-energy growth seen in 2020.

(…) The S&P 500 forward 12-month P/E ratio is 19.2x, which ranks in the 84^th percentile (since 1985) and a 9.2% premium to its 10-year average (17.5x). For reference, the trough forward P/E during the last four recessions were as followed: 10.1x (Oct 1990), 17.3x (Sept 2001), 8.9x (Nov 2008), and 13.0x (March 2020).

Furthermore, the S&P 500 ‘PEG’ ratio is currently 1.99x which ranks in the 98^th percentile (since 1985) and a 42.3% premium to its 10-year average (1.3x).  The PEG ratio is expensive as the forward P/E continues to rise since the October low, while the long-term EPS growth rate expectations have sharply declined 2021. (…)

(…) The ‘Magnificent-7’ group comprising of Apple Inc, Amazon.com Inc, Alphabet Inc, Meta Platforms Inc, Microsoft Corp, NVIDIA Corp, and Tesla Inc has a market cap weight of 27.9% compared to an earnings and revenue weight of 14.0% and 9.3% respectively. The ‘Magnificent-7’ group has an aggregate forward P/E of 33.2x, a 73.0% premium to the overall index. (…)

CIBC Capital Markets has this chart showing that the P/E of the equal-weight S&P 500 index is just below its 25-year median:

BofA data reveals that only 23% of individual equities have outperformed the S&P 500 during Q2, the lowest share on record going back to 1986.

• The top 10 holdings in the S&P 500 now make up over 30% of the index, the highest concentration we’ve seen with data going back to 1980. (@charliebilello)

• Technology’s percentage of S&P 500 at 23-year high (NDR)

• Technology’s relative forward P/E highest since 2004 (NDR)

• Ed Yardeni (my green dashed line):

• IT revenue growth is not materially different than that of S&P 500 companies:

• IT Earnings are growing faster long-term (my dashed lines):

• How high can IT margins go?

• Investors are betting higher:

• Analysts also see continued margins expansion, in spite of slowing revenue growth (my dashed lines):

WSJ investigation finds that AT&T and Verizon knew about toxic lead cables in their networks — and did little. (WSJ) (Remember leaded gasoline…)