Fed to Signal It Has Stomach to Keep Rates High for Longer Firmer price pressures could lead longer-term rates to rise as investors continue paring back expectations of cuts

(…) officials are likely to emphasize that they are prepared to hold rates steady, at a level most of them expect will provide meaningful restraint to economic activity, for longer than they previously anticipated.

With no new economic projections at this meeting and minimal changes expected to the Fed’s policy statement, Fed Chair Jerome Powell’s press conference will be the main event on Wednesday. (…)

Powell is likely to repeat a message he delivered two weeks ago, when he said recent data had “clearly not given us greater confidence” that inflation would continue declining to 2% “and instead indicate that it’s likely to take longer than expected to achieve

that.” (…)

The Fed’s rate outlook hinges on its inflation forecast, and the most recent data raises two possibilities. One is that the Fed’s expectation that inflation continues to move lower but in an uneven and “bumpy” fashion is still intact—but with bigger bumps. In such a scenario, a delayed and slower pace of rate cuts is still possible this year.

A second possibility is that inflation, rather than on a “bumpy” path to 2%, is getting stuck at a level closer to 3%. Without evidence that the economy is slowing more notably, that could scrap the case for cuts altogether.

Powell is likely to acknowledge that officials have less conviction about when and how much to reduce interest rates. (…)

At the same time, Fed officials have indicated that they are broadly comfortable with their current stance. This makes a hawkish pivot toward entertaining rate increases unlikely.

“Policy is well-positioned to handle the risks that we face,” Powell said on April 16. If inflation continues to run somewhat stronger, the Fed will simply keep rates at their current level for longer, he said.

As financial-market participants anticipate fewer cuts, longer-dated bond yields will rise. In effect, this achieves the same kind of tightening in financial conditions that Fed officials sought when they raised interest rates last year. Higher yields across the Treasury yield curve should ultimately hit asset values, including stocks, and slow the economy’s momentum. (…)

But a hawkish pivot, suggesting an increase in rates is more likely than a cut, appears unlikely, for now. Any such shift is likely to unfold over a longer period. It would require some combination of a new, nasty supply shock such as a significant increase in commodity prices; signs that wage growth was reaccelerating; and evidence the public was anticipating higher inflation to continue well into the future.

A key measure on wages will be released Tuesday morning by the Labor Department, which will report the employment-cost index for the first quarter. Fed officials consider that measure the most comprehensive measure of pay growth. Signs that wage pressures have continued to ease would likely allay concerns about stickier service-sector inflation. (…)

If and when the FOMC thinks about raising rates further, somebody will likely flash this chart during the meeting. Times have changed, haven’t they?

Source: BofA Global Research

China Manufacturing PMI: Business conditions improve amid fastest rise in new work in 14 months

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI) rose to 51.4 in April, up from 51.1 in March. This indicated a sixth successive monthly improvement in the health of the sector, with growth the most pronounced in 14 months.

Underpinning the latest acceleration in manufacturing sector growth was better demand conditions. Incoming new orders expanded at the fastest pace in over a year, supported by improvements in underlying demand conditions and marketing efforts from manufacturers. Additionally, new orders from abroad expanded at the fastest pace for nearly three-and-a-half years. Global market demand improved at the start of the second quarter, according to panellists.

In turn, Chinese manufacturers raised their production levels at the fastest pace since May 2023, though that still resulted in additional backlog accumulation. Sub-sector data revealed that the investment goods sector recorded the fastest growth across the measures of new orders, output, and backlogs.

Purchasing activity meanwhile rose in line with higher production, further contributing to higher stocks of purchases in April. Anecdotal evidence revealed that some manufacturers also raised their holdings of raw material and semi-finished items for safety stock building. The level of post-production inventories similarly rose in April. Although marginal, this marked the first increase in warehouse goods in three months.

Despite rising new work inflows and capacity pressures, Chinese manufacturers remained cautious with hiring. Employment levels fell for an eighth straight month in April amidst resignations and redundancies due to restructuring efforts.

Additionally, average charges also declined alongside export charges even as input price inflation renewed in April. The rate at which average input costs rose was the fastest since October 2023 with higher metals, oil and other input material costs often mentioned by panellists. However, increased competition and promotional efforts aimed at supporting sales limited Chinese manufacturers’ pricing power. Intense market competition led businesses to slash prices, resulting in output prices declining for the fourth straight month.

Finally, sentiment among Chinese manufacturers remained positive at the start of the second quarter with firms staying hopeful that sales can rise as economic conditions improve. That said, the level of confidence eased from March to a four-month low amidst concerns over rising costs and increased competition.

• China’s Factory Activity Keeps Growing But Loses Some Steam China’s official manufacturing purchasing managers index fell to 50.4 in April from 50.8 in March

(…) Tuesday’s official data also show that production rose in April from March, while total new orders declined over the period and new export orders also fell, though both stayed in expansionary territory. (…)

If you only read the official PMI, you are missing the clear upturn in world manufacturing demand revealed by S&P Global’s survey. This is the WSJ’s headline today: China’s Factory Activity Keeps Growing But Loses Some Steam. S&P Global’s data on new orders and new export orders suggest exactly the opposite. The goods inventory down cycle is over and consumers keep buying goods amid this “very restrictive monetary policy”.

Bloomberg illustrates the different PMI gauges but new orders would better reflect what’s really going on.

Goldman has a longer term chart:

It is also interesting that China’s National Bureau of Statistics specified that “equipment manufacturing and high-tech manufacturing PMIs were 51.3 and 53.0, respectively” and that “they continued to be in the expansion range and were both higher than the overall manufacturing industry”. High-end manufacturing maintained rapid development.”

President Xi Jinping’s call to boost growth through green and IT industries is showing rapid success.

China Hints at Rate Cuts, Property-Market Support Leaders warned of rising uncertainty and signaled a new campaign to revive the country’s flagging economy.

At a Tuesday meeting, the Communist Party’s elite Politburo warned of “significantly rising external uncertainties,” an apparent reference to global geopolitical and economic frictions. It said it would gather the party’s top 370 or so officials for a plenary meeting, or plenum, in July to discuss economic development and reforms.

In a statement issued after Tuesday’s meeting and carried by the state-run Xinhua News Agency, the 24-member Politburo pledged to issue ultra-long-term special treasury bonds and local government special-purpose bonds more quickly and called for them to be put into use as soon as possible to provide a fiscal boost to the economy.

Both types of bonds are usually used to fund government-led infrastructure investment projects. Beijing said in March that it would issue ultra-long-term special treasury bonds equivalent to $138 billion as well as local government special-purpose bonds worth $539 billion.

The Politburo also said the government could use interest rates and bank-reserve requirement ratios to slash financing costs and offer more support to the economy. People’s Bank of China governor Pan Gongsheng signaled in March that the central bank could cut banks’ reserve requirement ratio to release more liquidity into the financial system, though no such easing policies have materialized since then.

On real estate, leaders said the government would study new measures to “digest existing homes” while optimizing incremental housing amid a prolonged property downturn. (…)

Cheaper Teslas? China Says ‘You Ain’t Seen Nothing Yet’ Despite a brutal price year, China’s large automakers are in surprisingly good shape. That means the EV price war will continue.

(…) Despite enormous overcapacity, the largest Chinese automakers still have big cash cushions. And gross margins at BYD, China’s market leader, actually rose last year. That means the global EV price war will continue—and probably get worse. (…)

BYD took the competition up a gear in February when it priced some of its plug-in hybrids at around $11,000, cheaper than equivalent gasoline-powered cars. Tesla responded by slashing prices by nearly $2,000 for its cars in China this month. Its Model 3 now starts at around $32,000 there. [$39k in USA, +22%] (…)

Around half of cars sold in China in the first three weeks of April were new-energy vehicles, which include plug-in hybrids, according to the China Passenger Car Association.

Moreover, price cuts last year were partly offset by plunging costs of raw materials such as lithium and nickel. Deeper cuts this year could be more painful with more stable commodity prices.

Yet the price war will likely still drag on for a while. Goldman Sachs estimates that BYD makes around 8,100 yuan, the equivalent of $1,118, per car, compared with 2,600 yuan for the whole EV industry in China. That means BYD has room to cut prices 7% while still being profitable.

And further cost savings and better economies of scale may give the company even more leeway. BYD is vertically integrated, making its own batteries and even chips, which allows it plenty of ways to shave costs. BYD actually improved its gross margin to 20% last year, from 17% a year earlier. (…)

Goldman says the top 13 listed Chinese automobile manufacturers, which represented 69% of the total passenger-car market, had 315 billion yuan of net cash at the end of 2023. Some of those are also state-owned.

Many Chinese EV makers will target exports, which command a price premium, to soothe the pain at home, especially since capacity has risen so fast over the past couple of years. Automobile manufacturing utilization rates fell below 65% in the first quarter, compared with 76% in the previous quarter.

Cheaper EVs are good news for consumers, and the green transition. But they are terrible news for most Western carmakers, especially those that are lagging behind.

How the TikTok Law Could Intensify the US-China Tech Spat The law is almost certain to lead to a Supreme Court case and retaliation against US interests in China.

(…) A ban of the immensely popular app has for years seemed like a long shot to overcome the effective lobbying and congressional dysfunction that have stifled nearly every other attempt to impose stricter regulations on tech companies. Then, improbably, the forces that govern the process of legislating in Washington suddenly aligned, and the provision was approved as part of an emergency bill authorizing tens of billions of dollars in aid to Ukraine, Israel and Taiwan. On April 24, President Joe Biden signed it.

This set up an inevitable legal challenge, probably on First Amendment grounds. “Make no mistake, this is a ban, a ban on you and your voice,” Shou Chew, the Singapore-based chief executive officer of TikTok, said in a video on the app the day the bill was signed. “Politicians may say otherwise, but don’t get confused. Many who signed the bill say the TikTok ban is the ultimate goal.” It also raised the chances that China will retaliate against a US company or industry. This spat over an app best known for silly dancing videos could be a pivotal moment in an escalating rivalry between the world’s two superpowers.

TikTok has about 170 million users in the US, and they spend significantly more time on it than people do on Instagram or Snapchat, according to app monitoring firm SensorTower. A Chinese company operating a giant consumer internet service in the West had always suggested an uncomfortable double standard. US-owned apps such as Facebook, Google, Instagram, Signal and WhatsApp aren’t allowed in China. (…)

In a flurry of classified briefings between that bill’s introduction in March and its inclusion in the foreign aid package, senior officials from the FBI and other federal agencies warned that the app is subject to Chinese national security laws that require turning over data and algorithms to the government in Beijing. They raised the possibility that the app could influence American politics. (…)

The proliferation of pro-Hamas videos on the app after the Oct. 7 attacks on Israel also swayed some lawmakers, as did a series of alerts TikTok sent in March, urging its adult users to contact their representatives to express opposition to the bill. The alerts triggered plenty of angry phone calls to Capitol Hill offices, but the maneuver may have backfired on TikTok by proving that the app could in fact manipulate the behavior of Americans, according to Representative Mike Gallagher, the Wisconsin Republican who until recently chaired the House China committee.

With no organized resistance from US tech companies, which could benefit from the elimination of a robust competitor, the TikTok provision was a last-minute addition to the foreign aid bill, the culmination of what one aide describes as the “thunder run,” a military term for sending a line of tanks into enemy lines with no warning. Combining the bills effectively forced the hand of skeptical senators, many of whom felt they couldn’t risk jeopardizing much-needed aid to Ukraine. (…)

ByteDance figures Beijing officials would oppose the sale of TikTok’s prized source code and recommendation algorithms, according to two people familiar with its thinking, who asked not to be named talking about politically sensitive matters. Executives are instead mapping out legal strategies and betting they can get an injunction to avoid an immediate shutdown, according to one of the people. (…)

The still hypothetical legal dispute, TikTok v. US, would almost certainly head to the Supreme Court, which would have to weigh the government’s security concerns against the free speech and “expressive interests” of both its users and the app’s corporate owner. The government would have some precedent on its side: The US has long restricted foreign ownership of media companies, radio stations and telephone networks. “If the question is ‘will this thing hold up in court?’ I think it’s more likely than not that it will,” says Alan Rozenshtein, a law professor at the University of Minnesota and former adviser to the Justice Department on cybersecurity and foreign intelligence.

It’s all but certain that China will retaliate against the US, say China watchers. The country could restrict US access to critical minerals or other key components of the tech supply chain. It also could go after companies such as Apple, Microsoft or Tesla, which have significant manufacturing facilities in the country and sell to Chinese companies and consumers. Apple Inc.’s dependence on China, where it gets one-fifth of its sales, makes it particularly vulnerable, though its contributions to the Chinese economy could protect it from reprisal. (…)

BTW, FYI:

• TikTok, Tesla Show US-China Battle Over Data Is Just Beginning Data fight threatens to reshape US-China trade relations

(…) New technology is creating new risks. Modern devices are becoming ever smarter, gaining unprecedented abilities to generate and transmit data. Cars collect information on drivers and passengers, while medical devices can parse and process personal healthcare intelligence. Washing machines, port cranes and even clothes connect to some sort of remote server. The AI era only promises to magnify those capabilities. (…)

Meanwhile, there is also a crucial war for talent:

The Global AI Talent Tracker 2.0

(…) what’s certain is that a large chunk of the tech world’s capital and talent will be deployed toward bringing AI applications to the real world. If anything, the competition among countries in this arena will be fiercer than ever—and much of that competition will be over the indispensable input of an AI ecosystem: talent.

Talent also happens to be one of the most clearly quantifiable inputs, which is why we are assessing the global balance and flow of top AI researchers and scientists.

Key Takeaways of 2023 Update

1. The United States remains the top destination for top-tier AI talent to work. Within US institutions, researchers of American and Chinese origin (based on undergraduate degrees) comprise 75% of the top-tier AI talent, up from 58% in 2019. Moreover, the United States remains far and away the leading destination for the world’s most elite AI talent (top ~2%) and remains home to 60% of top AI institutions.

2. Beyond the United States and China, the United Kingdom and South Korea, along with continental Europe, have slightly raised their game as destinations for top AI researchers to work. When it comes to AI researcher origin (based on undergraduate degrees), India and Canada have seen relative declines.

3. Meanwhile, China has expanded its domestic AI talent pool over the last few years to meet the demands of its own growing AI industry. Because China produces a sizable portion of the world’s top AI researchers—rising from 29% in 2019 to 47% in 2022—it is no surprise that more Chinese talent are working in domestic industry.

4. A similar dynamic appears to be taking place in India. While India remains a significant exporter of top-tier AI researchers, its ability to retain talent is growing. In 2019, nearly all Indian AI researchers (based on undergraduate degrees) opted to pursue opportunities abroad. But in 2022, one-fifth of Indian AI researchers ended up staying to work in India.

5. These developments in China and India seem to reflect a broader pattern over the last few years: top-tier AI researchers appear to exhibit less mobility overall. Just 42% of top-tier AI researchers in 2022 are foreign nationals currently working in a different country, down 13 percentage points from 2019—meaning more top-tier talent are staying put in their home countries.

Portion of top-tier AI researchers (top ~20%) working abroad vs. staying home

  

Spending Surges in Spite of Inflation Consumers Rely on Income and Still Dip Into Savings to Fuel Spending

(…) Even as the path lower for inflation continues to be disrupted, paychecks outpaced price gains with personal income rising 0.5% in March. Real disposable personal income rose 0.2% last month. (…)

Nominal spending rose 0.8% for each of the past two months—a feat not surpassed since November 2021. On an inflation adjusted basis, real spending started the year on a dour note falling 0.3%, but since then it has risen 0.5% in back-to-back months.

We learned in yesterday’s GDP report that goods spending contracted in the first quarter, but the weakness was mostly in durables, and we now know that weakness was concentrated in January. Real durables rose 0.9% in March after 1.4% in February. (…)

Upward revisions to January and February data reveal that much of the upside surprise in the annualized rate was due to more inflation in January and not a significant pickup late in the quarter. The monthly changes of core PCE in January and February were revised up to reveal a monthly pattern of 0.50%, 0.27% and 0.32% from January-March.

Still, core inflation picked up in March and that caused the annual rate to hold steady at 2.8%, but the composition of price gains is increasingly important in getting down to 2%.

The “super core” measure of inflation, which focuses on services and strips housing from the estimates, rose at an annualized rate of 5.5% over the past three months. A quick glance at the nearby chart will fan hawkish views that the Fed is nowhere near ready to ease policy as the rate rivals its 2020-23 highs of around 6%.

But here the concern over a fresh acceleration in inflation may be a bit overblown. Super core inflation was firm in March—it rose 0.4%, but the 0.7% gain in January was a major source of the jump in the annualized rate. If we simply match the monthly change in April, the three-month annualized rate will slip back to 4%—still above the roughly 2% pace of this component pre-pandemic but not quite as menacing as the recent three-month pace.

The question for the rates outlook is clouded by whether higher financing costs begin to bite and slow economic activity. There is evidence that financing costs are taking a toll on manufacturing and housing, but it has been difficult to spot the damage of financing costs to consumer outlays. Yet when we look at personal interest expense as a share of disposable income over the past 30 years, we find that peaks in the fed funds rate are associated with peaks in interest costs. At 2.6% in March, personal interest costs comprise about as large a share of income as they have at any point since the start of the financial crisis. How long can spending defy gravity?

You don’t get far in this business betting against the consumer, but earlier in this cycle we saw households dipping into savings to sustain spending when real income growth was flat or down. It is perhaps a symptom of the YOLO mentality of today’s consumer that now consumers are reaching into savings even when real income growth is strong. The personal saving rate slid to 3.2% in March, the lowest since October 2022. Households continue to pull out all the stops to keep spending.

Strong economic growth and a sturdy consumer is not necessarily a problem for the Fed unless it causes sticky inflation, or worst case an acceleration. Price growth was firm in March. That suggests easing isn’t around the corner, and it puts more emphasis on how inflation evolves into Q2 to determine the eventual start of Fed easing.

Other important details:

• Wages and Salaries, which rose at a 4.1% annualized rate in Q4’23, jumped 7.4% a.r. in Q1’24, including +8.5% a.r. in February and March.
• Rental income rose 1.6% MoM after +1.7 in each of January and February. Somebody’s income is somebody else’s expense. Many thought that it was only start-of-the year adjustments…
• Growth in real disposable income is anemic, normally bad for spending. But the huge effect from housing and equities is more than compensating. In nominal terms, DPI rose 4.5% a.r. in Q1’24 from +3.7% in Q4’23. Americans are not bothered, yet, by rising inflation. (see The Wealth Defect )

ING:

Remember that the top 20% of US households by income spend the same amount of money as the bottom 60% of households by income. The top 20% are doing very well with good, high-paying jobs, tending to own their own home (largely with low long-term mortgage rates) and can make 4% in money market funds while feeling the benefits of higher stock and home prices. The bottom 60% are feeling more stress with far less wealth exposure. They are more likely to rent and are more likely to have exhausted pandemic-era-accrued savings. The key question for the spending and growth in general is how long that top 20% can keep offsetting intensifying stresses faced by the bottom 60%.

But the wealth effect (or defect!) is reaching wider this time around as Axios reports:

Average household wealth for those under 40 in the U.S. is up 49% from its pre-pandemic level, Axios’ Emily Peck writes from a new analysis by the left-leaning Center for American Progress.

• Why it matters: Young households haven’t seen wealth growth like this since the Fed started tracking the data in 1989.

Stunning stat: Millennials — currently ages 27-43 — saw their wealth double over this period, according to the analysis.

Zoom in: Americans under 40 have seen big asset gains while reducing some liabilities:

1. Average housing wealth rose $22,000 — as homeownership rose and home prices soared.
2. Liquid assets climbed courtesy of leftover savings from pandemic relief and higher wages.
3. Financial assets, mostly stocks and mutual funds, increased by an average of $31,000.
4. Nonhousing debt fell by $5,000. With more money in their pockets, people could pay off credit cards (the student loan moratorium helped), or not take that debt on at all.

Data: Center for American Progress analysis of Fed data. Chart: Axios Visuals

A few month ago, Jay Powell suggested that splurging on goods would end from a “lack of storage space” but Americans are resourceful, taking advantage of the 3.5% durable goods deflation between September 2022 and December 2023 (they rose 0.5% since).

Consumption of services is only back to trend but it has perked up lately, potentially making services inflation a bigger headache for the FOMC going forward. PCE-services inflation was +5.7% a.r. in Q1’24, much faster than the +3.3% trend of Q4’23.

Maybe, the warnings from the April flash PMI will ease pressures:

• Employment decreased solidly and to the largest extent since mid-2020. In fact, excluding the opening wave of the COVID-19 pandemic, the decline in services staffing levels in April was the most pronounced since the end of 2009. In contrast, manufacturing employment continued to increase modestly.
• Output prices increased at a solid but slower rate during April, the pace of inflation cooling again having accelerated to a ten-month high in March. Prices charged inflation was in line with the series long-run average, though still elevated by pre-pandemic standards. Slower charge inflation was seen across both the manufacturing and services sectors.

There was also this other warning:

Input prices continued to rise sharply in April, although the pace of inflation eased from the six-month high seen in March. This was in spite of the fastest increase in manufacturing input costs for a year amid rising raw material prices. Service providers often noted higher staff and shipping costs, though reported the second-lowest overall cost increase for three-and-a-half years.

Rising costs and strong demand is a combo for higher prices. That’s what small business people are planning for.

Steve Blumenthal writes that

Month-over-month inflation has been rising on average 0.4% for the past three months and 0.3% for the past six months. If inflation continues to rise at this pace for the rest of the year, then year-over-year core CPI inflation will increase from currently 3.8% to 4% to 4.5%, see chart below.

Even if month-over-month increases in core CPI comes in at the historical average of 0.2% for the rest of the year, then year-over-year inflation will still end the year at 3%. To get inflation back to the Fed’s 2% inflation target, core CPI for the rest of the year will have to come in at an unprecedented 0.1% month over month.

If you wish to put odds on the black line above (2% target), know that +0.10% or lower average MoM core CPI over 9 consecutive months has only happened 2% of the times since 1966. Less than 0.21%, only 37% of the times. Which means that the odds of 3%+ inflation by the end of 2024 are 63% on that basis.

EARNINGS WATCH

From LSEG IBES:

229 companies in the S&P 500 Index have reported earnings for Q1 2024. Of these companies, 77.7% reported earnings above analyst expectations and 16.2% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 79% of companies beat the estimates and 17% missed estimates.

In aggregate, companies are reporting earnings that are 9.5% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 7.0%.

Of these companies, 59.4% reported revenue above analyst expectations and 40.6% 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, 65% of companies beat the estimates and 35% missed estimates.

The estimated revenue growth rate for the S&P 500 for 24Q1 is 3.8%. If the energy sector is excluded, the growth rate improves to 4.4%.

In aggregate, companies are reporting revenues that are 1.3% 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 1.5%. The estimated earnings growth rate for the S&P 500 for 24Q1 is 5.6%. If the energy sector is excluded, the growth rate improves to 8.5%.

The estimated earnings growth rate for the S&P 500 for 24Q2 is 10.9%. If the energy sector is excluded, the growth rate declines to 10.4%.

Trailing EPS are now $224.30. Full year 2024: $242.32e. Forward EPS: $252.55e.

Revisions up and up!

  

• Earnings Growth — Mag 7 and the Rest: OK, in the short-term, Mag 7 have indeed been on a dream run when it comes to earnings growth. But here’s an interesting development… later this year the rest of the market is expected to start outperforming Mag 7 on earnings growth. Trees never grow to the sky, night never lasts forever. Stay alert for narrative changes! (Callum Thomas)

Source:  NewEdge Wealth Weekly Note

RBA’s Richard Bernstein hits the same nail showing that the Mag-7 are no longer exceptional growers …

… yet sell at exceptional multiples:

SMALL VS LARGE

Callum Thomas: “While the cycles vary in magnitude and duration, there does appear to be a distinct tendency for small vs large relative performance to undergo cycles, and on a number of fronts the current one seems overdue for a turn.”

Source:  @ISABELNET_SA

Source:  Daily Chartbook

That’s because the economy is strengthening and broadening.

A few great charts from Ed Yardeni:

• Small caps’ revenues are flat:

• Small caps’ profits are down:

• Small caps’ margins are down:

• Small caps are cheap, but for good reasons:

• But S&P 600 forward EPS are seen up 12.4%, same as S&P 500 EPS. Note however that while S&P 500 trailing earnings met expectations, S&P 600 earnings are 7% below forecast one year ago.

Remember that about 40% of the companies in the Russell 2000 are losing money. None in the S&P 600 index.

Why the large cap advantages?

• Smaller banks are more exposed to the commercial real estate bust. CRE loans make up just 6% of large bank balance sheets, versus 30% for small banks per Gavekal.
• Smaller banks are more vulnerable to deposit flight as short term interest rates stay higher for longer and to depositors’ angst about unrealized bond losses as longer rates rise.
• Financials represent 18% of the S&P 600 Index vs 13% for the S&P 500.
• Non-financial small-cap companies tend to borrow more at the short end of the curve, relying on short-term or variable interest-rate bank loans. Larger companies make broader use of the fixed-rate bond market.
• Large companies in need of financing have no trouble issuing bonds while small businesses, which generally have less liquid balance sheets, suffer from reduced credit availability.

As this RBA chart shows, small caps used to do well when long rates were rising, symptom of a strengthening economy. The pandemic seems to have impacted smaller companies more than usual. Is this the new normal?

Musk Wins China’s Backing for Tesla’s Driver-Assistance Service Beijing gives tentative approval for carmaker’s tech in its second-biggest market

After his flurry of meetings with top officials in Beijing, China’s government signaled its blessing for Tesla to roll out its advanced driver-assistance service in the carmaker’s second-biggest market. (…)

Chinese officials told Tesla that Beijing has tentatively approved the company’s plan to launch its “Full Self-Driving,” or FSD, software feature in the country, people familiar with the matter said Monday.

The U.S. electric-vehicle maker will deploy its autonomous driving services based on mapping and navigation functions provided by Chinese technology giant Baidu, the people said.

The partnership clears an important regulatory hurdle for Tesla to offer its driver-assistance system there. Working with a Chinese company helps ease regulators’ concerns over any data-security risks, the people said. Bloomberg earlier reported the deal with Baidu, which in addition to its core search-engine business has expanded into autonomous driving and artificial intelligence. (…)

The approval follows a meeting on Sunday between Musk and top Chinese officials including Premier Li Qiang, who was previously the Communist Party chief in Shanghai when Tesla was setting up its production facilities there. (…)

Chinese officials haven’t responded to Musk’s request for approval to transfer data that Tesla’s cars collect in China to the U.S. to train its driver-assistance features, people familiar with the matter said. Data from China, where Tesla has 1.7 million drivers, would help Tesla improve its algorithms.

It is a potentially thorny issue given Beijing regards protecting such data as a matter of national security. Tesla would have to go through China’s stringent approval process for data cross-border transfer, the people said.  

The China Association of Automobile Manufacturers said Sunday that Tesla’s Model 3 and Model Y had passed its tests and were compliant with China’s data-security requirements. The government-backed industry group checked how vehicles process facial-recognition data they collect using cameras outside the cars, as well as real-time data of drivers and passengers.

That clearance may pave the way for local authorities to loosen restrictions on where Tesla’s cars can go in China, the people said. Tesla’s EVs are banned from entering sensitive locations of the Chinese military and government and, in some cases, airports and train stations over concerns that data its cars collected could pose national-security risks.

Tesla has said that all data generated by its cars sold in China is stored locally in a data center it built in 2021.

On Monday, Musk also met with Robin Zeng, chairman of Tesla’s key battery supplier Contemporary Amperex Technology, in Beijing, a person familiar with the matter said. In an interview last month, Zeng said CATL was in talks with Tesla and other automakers to license its battery technology in the U.S.

So, China would let Tesla completely loose within China without making sure the U.S. would allow entry of Chinese cars in the U.S.? Such one-sided deal ain’t Chinese, is it? Why the “tentative” approval?

Last February:

Biden Is Looking Beyond Tariffs to Keep Chinese ‘Smart Cars’ Out of the US US considers restrictions to address data security concerns

(…) The measures would apply to electric vehicles and parts originating from China, no matter where they’re finally assembled, to prevent Chinese makers from moving cars and components into American markets through third countries like Mexico, the people said. The measures could also apply to other countries about which the US has data concerns, one of the people said. Tariffs alone, they added, won’t fully address this issue.

US officials are particularly concerned about the troves of data collected by so-called smart cars — which include EVs and other types of connected and autonomous vehicles — said the people, who were granted anonymity to discuss confidential conversations. Many of today’s cars, both gas and electric, are equipped with modems connecting them to the internet, making them potential targets for hacking.

The administration may try to address data security concerns using existing Commerce Department authorities to regulate some information and communications technology transactions, some of the people said, but no decision has been made as officials conduct a sweeping policy study.

A separate executive order intended to ensure data privacy in general is expected to be released as soon as next week, and officials are also weighing adjustments to a 27.5% tariff on Chinese EVs originally imposed by President Donald Trump. (…)

Commerce Secretary Gina Raimondo worries that data could wind up in Beijing’s hands, she said last week, pointing to China’s ban on Tesla Inc. cars near government gatherings and for military use. “You can’t drive a Tesla on certain parts of Chinese roads, they say for national security reasons,” she said at an Atlantic Council event. “Well, think about that. What are the national security concerns?”

Chinese automakers like BYD Co. have stayed out of American markets in part because of high tariffs, but US officials think they may eventually choose to swallow those costs. The retail price of EVs made in China is less than half that of those manufactured in the US, so a flood a Chinese cars could upend President Joe Biden’s efforts to turbocharge domestic EV production. There’s also worry in Congress that Chinese companies like Contemporary Amperex Technology Co., the world’s biggest EV battery maker, may try to take advantage of tax credits in the Inflation Reduction Act, Democrats’ signature climate law. (…)

Trump, who has for years been vocal about Chinese EV firms’ ambitions in Mexico, has pledged to ratchet up tariffs on China if elected president in November, saying this month he may even go beyond a previously floated across-the-board figure of 60%.