Year: 2023

REACCELERATION?

Goldman Sachs just reduced the odds of a recession over the next 12 months to 25%, from 35%, against a consensus at 65%.

(…) incoming data have strengthened the case for a soft landing. All four steps of the rebalancing process needed to tame inflation are now underway: demand growth is below potential, the jobs-workers gap has shrunk, wage growth has fallen, and inflation has slowed.

While this progress is encouraging, the Fed needs to keep growth below potential for a while longer to further rebalance the labor market. Our baseline forecast implies that additional hikes in March and May will be enough to achieve this. But we see some risk that as the drag from monetary and fiscal policy tightening diminishes, the economy could reaccelerate prematurely.

As a result, we see the risks to our 5-5.25% forecast for the peak fed funds rate as tilted to the upside. If the FOMC eventually decides it needs to take a more hawkish path to keep inflation moving back toward the 2% target, we think the most likely option would be to add on a longer string of 25bp hikes, not to return to 50bp hikes or to add hikes at last cycle’s quarterly pace.

We do not expect the FOMC to cut the funds rate until a growth risk emerges.

We doubt that a decline in inflation alone will be enough to prompt cuts. Cutting shortly after an unsettling inflation surge with a still-tight labor market would risk reputational damage if inflation flared back up.

Data: CME Group; Chart: Axios Visuals

Manhattan median rent rose to the third-highest on record as the vacancy rate slipped for the first time in nine months.

After peaking in July, median rent continued to move sideways at a nominally lower level as new leasing levels expanded in the New Year. The median rent rose 15.4% annually to $4,097, the third-highest on record and 14% higher than pre-pandemic levels. Average
rent and average rent per square foot followed a similar trend.

The market share of landlord concessions declined annually to 16.5%, 23.7% less than pre-pandemic levels. The average landlord concession was 1.8 months of equivalent rent, the highest since September 2021.

The vacancy rate slipped for the first time in nine months to 2.52%, consistent with the decade average of 2.74%.

The credit hype machine is going to break

According to Bloomberg, January was a record month for investment grade (IG) corporate bond ETF flows as the credit hype machine went into overdrive. As a result, the amount investors are being compensated for the additional risk relative to US Treasury bonds (known as credit spreads) has declined rapidly. (…)

Low quality credit simply does not perform well during earnings recessions and the investment grade market’s weight in BBB-rated bonds (the lowest quality IG rating) is near a record high at 50%. Investors appear to be focused solely on the above-mentioned health of the market and seem to have forgotten about downgrade risk (due to an earnings recession), liquidity risk, and most importantly, volatility. Corporate bond investors hate volatility; they want the certainty of earning their coupon and the ultimate payment of principle. A good gauge of this risk is equity option volatility as proxied by the VIX Index*. Should equity volatility spike, credit spreads will likely widen.

Consider the following: an investor today can buy a 2-year Treasury note with virtually no credit risk and little downgrade risk for just 60bps less yield than what is offered by the investment grade market. On that basis, 2-year Treasuries have rarely been cheaper relative to IG bonds and has historically been a great opportunity to reduce credit risk. The IG market appears to be priced for perfection by this measure.

It is clear that one need not own credit to generate income at the moment. Treasury yields are at post financial crisis highs, after all! But don’t forget the potential for total return. The decision of whether to own IG bonds (credit risk and interest rate risk) or Treasuries (just interest rate risk) comes down to how credit spreads are likely to change.

If one owned a 20-year Treasury bond and interest rates across the yield curve fell by 50bps, they should generate a return of nearly 10%. For IG bonds to generate the same return, credit spreads on IG bonds would need to decline to near post crisis lows. This seems like an unlikely outcome given lower Treasury yields tend to cause wider, not tighter, spreads, especially when accompanied by an earnings recession.

On the other hand, if interest rates were to rise, it would not be surprising to see credit spreads widen (perhaps in a disorderly way), creating a losing outcome for IG bonds from both interest rates and credit spreads.

If the credit markets start to price in an earnings recession, the case to own them will be more compelling… but it is clearly not today.

Topdown Charts adds that:

• Tighter lending standards point to upside risk for credit spreads.

Banks are tightening standards across the board:

• Banks Tighten Spigot,Consumer Credit Slows (Moody’s)

(…) The latest Senior Loan Officer Opinion Survey indicates that risks are skewed to the downside for near-term growth in consumer credit. The net percentages of banks tightening lending standards for credit cards and auto loans rose by nearly 9.5 and 15.3 percentage points, respectively, to their highest in more than two years. On net, banks are also implementing stricter standards on all other consumer loans.

(…) the Fed is getting the stricter lending standards of banks that it wants. (…)

As of December, revolving credit is 1% short of where it would have been if its pre-pandemic trend had persisted over the past three years. Moreover, revolving credit makes up only 10.5% of wages and salaries, whereas that share was typically above 11.5% in the couple of years prior to the pandemic.

  BTW, Starwood CEO Barry Stenlicht on CNBC (h/t Luke Gromen & David Hay): “Volcker did not have a $32 trillion debt…So what Powell faces, if he keeps going up, you have the Weimar Republic–he has to keep printing US dollars to pay interest on the deficit, and you wind up printing and printing…”

In 1981, gross federal debt was 32% of GDP. It is now 122%. The Fed has obliged…

The CBO on February 8: “Net outlays for interest on the public debt increased by $58 billion (or 41 percent) [in the first four months of F2023], mainly because interest rates are significantly higher than they were in the first four months of fiscal year 2022.

FYI, from the U.S. Treasury on Jan. 30th:

During the January – March 2023 quarter, Treasury expects to borrow $932 billion in privately-held net marketable debt, assuming an end-of-March cash balance of $500 billion.  The borrowing estimate is $353 billion higher than announced in October 2022, primarily due to the lower beginning-of-quarter cash balance ($253 billion), and projections of lower receipts and higher outlays ($93 billion).

During the April – June 2023 quarter, Treasury expects to borrow $278 billion in privately-held net marketable debt, assuming an end-of-June cash balance of $550 billion.

So, next 6 months, the gross federal debt will rise by $1.2 trillion or almost 4%. This, along with rising interest rates, will boost interest expense even more. The CBO will release new projections on Feb. 15.

BTW # 2, courtesy of Evergreen/Gavekal’s David Hay:

Greed might be driving the market into another Thelma & Louise-like cruise off a cliff. As you can see above, it’s extremely rare to have BBB-rated corporate debt yield essentially the same as 90-day T-bills. This is because the former has both credit and interest-rate risk, unlike short-term treasuries. Regardless, it is a reflection of extreme risk tolerance that, in the past, has consistently led to an unhappy outcome, sometimes of disastrous proportions.

Chart: Hartnett

EARNINGS WATCH

From Refinitiv/IBES:

Through Feb. 10, 344 companies in the S&P 500 Index have reported earnings for Q4 2022. Of these companies, 69.2% reported earnings above analyst expectations and 27.0% 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, 76% of companies beat the estimates and 21% missed estimates.

In aggregate, companies are reporting earnings that are 1.6% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.1% and the average surprise factor over the prior four quarters of 5.3%.

Of these companies, 66.6% reported revenue above analyst expectations and 33.4% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 73% of companies beat the estimates and 27% missed estimates.

In aggregate, companies are reporting revenues that are 1.2% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 2.5%.

The estimated earnings growth rate for the S&P 500 for 22Q4 is -2.8% [-2.2% on Jan.6]. If the energy sector is excluded, the growth rate declines to -7.1% [-6.7%].

The estimated revenue growth rate for the S&P 500 for 22Q4 is 5.0% [4.1%]. If the energy sector is excluded, the growth rate declines to 4.1% [3.3%].

The estimated earnings growth rate for the S&P 500 for 23Q1 is -3.7% [-2.5% last week, +1.0% on Jan. 6]. If the energy sector is excluded, the growth rate declines to -5.6% [-4.3% last week, -1.1% on Jan. 6].

Negative guidance is widespread this quarter…

…leading to continued downward revisions:

 

The above numbers simply count the number of positive and negative revisions.

But sell-side analysts are a slow moving herd when forecasting the magnitude of the potential decline. Ex-Energy, the last 3 quarters have seen accelerating negative earnings growth and Q1’23 should keep the sequence alive. Bad breath is spreading with 7 of the 10 ex-E sectors averaging -12.3% in Q4’22 and -12.5% in Q1’23. These are recessionary contractions, highly unusual in a non-recessionary environment.

Earnings growth is expected to resume in Q2’23, even though 61% of economists see the U.S. in recession then.

Corporate insiders are not so optimistic, voting with their feet:

(Barron’s via Isabel.net)

INK Research:

Although investors are taking a shine again to the US broad market, pushing it higher on expectations that the Federal Reserve is near the end of its rate hike cycle, insiders are not attending the party. American insider sentiment as tracked by the INK US Indicator fell a couple of points to 38% from 40% a week ago. At 40%, there are four stocks with key insider buying for every 10 with key insider selling.

Industrials have reported very strong earnings in recent quarters, +40.5% expected in Q4’22 and +18.5% in Q1’23, but INK’s reading of insiders activity in that sector is the third lowest at 26% after Consumer Cyclicals (25%) and Technology (14%).

INSIDERS ACTIVITY: INDUSTRIALS

Here’s the inside on Industrials’ strong earnings growth:

The Airlines industry reported a profit of $2.4 billion in Q4 2022 compared to a loss of -$1.2 billion in Q4 2021. Boeing, American Airlines Group, United Airlines Holdings, and Delta Air Lines are the largest contributors to earnings growth for the sector. If these four companies were excluded, the blended earnings growth rate for the Industrials sector would fall to 8.4% from 36.8%. (Factset)

Canada: Impressive January job gains start 2023 strongly

The labour market is entering 2023 with strength, registering its biggest gain in 11 months and ten times what was expected by the consensus. Not only is the overall number spectacular, but so are the details, with the increase in employment heavily concentrated in private and full-time jobs. Indeed, after a mid-2022 slump, full-time and private employment rose respectively for the fifth and fourth consecutive month in January, both reaching record levels.

At the sectoral level, for the fourth consecutive month, no less than 10 sectors over 16 recorded an increase during the month, demonstrating the widespread nature of the recent surge. However, thanks to a substantial increase in the participation rate and a record population growth (since 1976), the unemployment rate has remained unchanged just above the record 4.9% reached this summer.

But we do not think that the labor market is as overheated as it was then. The average hourly wage for permanent employees has risen by only 2.5% over the past three months, compared to an annual rate of 8.9% between May and August. This moderation is supported by the fact that fewer small and medium-sized firms are reporting that labor shortages are limiting their production capacity.

The same can be said for large employers, as the Bank of Canada’s January survey of businesses showed that firms still see significant labour shortages but are no longer willing to offer wage increases as large as they were six months ago. An easing of the bidding for employees that was generating wage pressures is good news for the central bank.

Despite the surprisingly strong January print, we continue to believe that moderation is in the cards, especially since the same BoC survey shows a darkening economic outlook. A decline in sales volume is expected by as many as 30% of survey respondents, a record high outside of a recession.

Keep in mind that Labour Force Survey data can be very volatile, and we recommend waiting for releases in the coming months to confirm the sustainability of this strength. We continue to expect a hiring freeze over the next few months amidst an extremely tight monetary policy environment.

The participation rate ticked up 0.3pp from an upwardly revised 65.4% in December, suggesting that improved labor supply contributed to strong job gains in January.

Wage growth of permanent employees was -0.1% MoM in January. On a three-month annualized basis, wage growth was +2.5% vs. +4.7% in December. It peaked at +8.9% in August. Go figure!

Similar situation in the USA: wage growth is slowing amid strong labor demand:

Russia to Cut Oil Output, Sending Prices Higher Russia said it plans to cut production by around 500,000 barrels a day, or about 5%, next month, sending crude prices higher in a move that Moscow said was in response to Western oil sanctions.

(…) Some analysts, though, said the move reflected Russia’s challenges in selling its oil amid the Western sanctions. (…) An additional EU ban on Russian refined products and a G-7 price cap on those products came into force Sunday. (…)

In January, Russian oil production stood at 10.9 million barrels a day, just slightly under the 11 million barrels a day recorded in February 2022, according to Viktor Katona, lead crude analyst at Kpler, a commodities-data firm. (…)

China’s Consumer Inflation Picks Up as Recovery Gathers Pace

The consumer price index rose 2.1% from a year earlier, the National Bureau of Statistics said Friday, up from 1.8% in December and matching the median estimate in a Bloomberg survey. Core inflation, which doesn’t include volatile food and energy prices, rose to 1% — the highest since June — a sign of stronger demand in the economy. (…)

Services prices rose 1%, slightly faster than December’s 0.6% increase. (…)

Producer deflation deepened in January, with prices falling 0.8% from a year earlier, largely because of softer commodity costs. Economists surveyed by Bloomberg had expected a 0.5% decline. (…)

Chinese property brokers despair as homebuyers sit on sidelines “It will take a long time for confidence to be restored,” said the executive at the Wuhu developer

U.S. Jobless Claims Climbed Last Week but Remain Historically Low

Initial jobless claims, a proxy for layoffs, increased by 13,000 to a seasonally adjusted 196,000 last week, the Labor Department said Thursday. In 2019, when the labor market was also tight, claims averaged about 220,000 a week.

The four-week moving average of weekly claims, which smooths out volatility, fell slightly to 189,250. (…)

Mass Layoffs or Hiring Boom? What’s Actually Happening in the Jobs Market Restaurants, hotels and hospitals are finally staffing up, more than making up for losses in tech and other sectors. “Knock on wood, things are running like they were before the pandemic,” said one restaurant executive.

(…) Employers in healthcare, education, leisure and hospitality and other services such as dry cleaning and automotive repair account for about 36% of all private-sector payrolls. Together, those service industries added 1.19 million jobs over the past six months, accounting for 63% of all private-sector job gains during that time, up from 47% in the preceding year and a half.

By comparison, the tech-heavy information sector, which shed jobs for two straight months, makes up 2% of all private-sector jobs. (…)

The sectors driving job growth include hotels, hospitals and restaurants, which laid off workers amid pandemic shutdowns and social distancing in 2020. After demand surged during reopenings, they started hiring again. But they struggled to land enough new employees and retain existing ones. (…)

Now, with the effects of the pandemic diminishing, many executives and business owners in services industries say they are finding it easier to recruit and fill jobs. (…)

In January alone, restaurants and bars added a seasonally adjusted 99,000 jobs. The healthcare industry grew by 58,000, and retailers added 30,000 jobs as fewer holiday-season workers were let go than in past years. (…)

Business owners, executives and economists say there are several reasons more workers are searching for jobs: bigger paychecks and benefits, diminishing fear of getting sick, and financial worries amid high inflation. The result is that employers, including small-business owners, are finding it easier to fill jobs.

With Covid-19 cases down, fewer workers are concerned about getting or spreading Covid than in the previous two winters when the virus surged. That might be boosting searches for jobs that require close personal contact, such as restaurant server, cafeteria worker and hairdresser. Job seekers also are less likely to be sick with or caring for someone sick with Covid, according to the U.S. Census Bureau.

Hiring in the healthcare services sector, including by hospitals, outpatient centers and nursing homes, has provided a boost to overall jobs numbers because the sector accounts for 16% of all private-sector payrolls.

Healthcare payrolls have grown at a robust pace in recent months as more candidates step forward to meet demand. Job applications for healthcare positions on recruiting platform iCIMS rose 7% from January 2022 through December, while they declined in industries such as manufacturing, finance and technology. (…)

More women are flowing back into the labor force, which could help service-sector employers fill positions that traditionally have been held by women. Labor-force participation for women in their prime working years of 25 to 54 returned to prepandemic levels in January. (…)

“We’re definitely seeing a renaissance in terms of people…coming back to the [restaurant] industry.” (…)

Just when Mr. Powell said “Shortage of workers feels more structural than cyclical.”

• “The rate of e-commerce growth in our core markets has decelerated. Inflationary pressures have affected discretionary consumer spending and post-COVID spending patterns are still evolving,” [Paypal] acting finance chief Gabrielle Rabinovitch said in a call with analysts.

Treasury Yield-Curve Inversion Reaches Deepest Level Since 1980s

The yield on the shorter-dated Treasury at one point exceeded the longer-dated note’s by as much as 86 basis points. The two-year rate was 4.10% on Feb. 2, before stronger-than-expected January employment data sparked a reassessment of how much higher the Fed’s policy rate might need to go to stifle inflation. (…)

Overnight index swaps have pushed pricing for a peak in the federal funds rate to about 5.1% in July, suggesting a target range of 5% to 5.25%. But trades in interest-rate options this week hedging the risk of a 6% rate have rattled the policy-sensitive two-year note. (…)

(NDR via CMGWealth)

U.S. Poised to Further Tighten Technology Exports to China After Balloon Incident China risks losing even more access to Western technology, as Washington and its allies consider punishing Beijing with stiffer restrictions on products it needs to advance its military and economic might.

There’s more:

• The Chairman of the House Armed Services Committee is vowing to expel all Chinese goods and materials from the United States’s defense supply chains. Chairman Mike Rogers (R-Ala.) said that he would lead the effort to expunge China-sourced goods during a Feb. 8 hearing of the committee on the subject of defense-industrial base security. “The greatest concern I have with the defense industrial base is our continued reliance on China as the source of raw materials,” Rogers said. “I won’t stop until we’ve completely rid the defense supply chain of Chinese goods and materials.” (via ZeroHedge)

Government’s Borrowing Costs Rise During Debt-Ceiling Clash An era of ultracheap debt is over in Washington as higher borrowing costs widen the U.S. deficit and fuel a partisan clash over raising the debt ceiling and how much borrowing could be too much.

The Treasury’s spending on interest on the debt is up 41% to $198 billion in the first four months of this fiscal year compared with $140 billion in the same period last year, according to a Congressional Budget Office estimate of spending through January.

Paying more for interest on the debt has been among the government’s largest spending increases so far this year, the CBO said. (…)

In projections last year, the CBO said that spending on net interest on the debt as a percentage of U.S. gross domestic product would roughly double from 1.6% in 2022 to 3.3% in 2032. Those estimates, which the nonpartisan agency will update next week, assumed that the Fed would raise the federal-funds rate to 1.9% by the end of 2022 and reach 2.6% by the end of 2023. (…)

TECHNICALS WATCH

• Nothing to fear but fear itself

@LanceRoberts

• S&P 500 Large Cap Index – 13/34–Week EMA Trend

• To give you a sense of how extreme the optimism has become.  Here is a daily tracking (orange line) of the Daily Trading Sentiment number. The dotted line across the top shows prior extreme highs. (Steve Blumenthal)