Note: I am travelling (Pacific time zone) until August 10. Posting will be irregular and possibly limited by time and equipment constraints.

SERVICES PMIs

USA: Activity rises markedly again in July

The seasonally adjusted S&P Global US Services PMI® Business Activity Index posted well above the 50.0 no-change mark again in July, dipping only slightly from 55.3 in June to 55.0. The reading signalled a marked monthly expansion in services activity, extending the current sequence of growth to 18 months.

Where output increased, companies often linked this to higher new orders. New business rose for the third consecutive month and at a solid pace, albeit with the rate of expansion easing slightly from that seen in June. According to respondents, customer referrals had played a role in them being able to secure new business during the month.

New business from abroad increased for the first time in six months, albeit only marginally and to a much lesser extent than total new orders.

Service providers remained optimistic that business activity will rise over the coming year, although confidence eased to an eight-month low. A greater focus on marketing and sales efforts is predicted to bear fruit. Meanwhile, a reduction in interest rates and an improvement in demand following the Presidential Election were also factors supporting confidence.

Positive projections for the coming year, allied with solid new order growth in the latest survey period, encouraged companies to take on additional staff as the second half of the year got underway. Employment increased for the second month running, albeit modestly and to a lesser extent than in June.

The modest increase in employment was not sufficient to fully keep up with new order growth in July, resulting in a second consecutive monthly rise in backlogs of work. The rate of accumulation in outstanding business was only slight, however.

Service providers signalled a further sharp rise in input costs, with the rate of inflation quickening to a four-month high. The latest increase was also sharper than the series average. Respondents indicated that higher wage and transportation costs had been the main factors pushing up input prices.

While a number of companies responded to higher input costs by increasing their selling prices accordingly, there were other reports that competitive pressures led some firms to lower their charges. The rate of output price inflation was solid, but eased for the second month running to the slowest since January.

The S&P Global US Composite PMI Output Index* registered 54.3 in July, down slightly from 54.8 in June but still signaling a solid monthly expansion in private sector business activity in the US at the start of the third quarter of the year. Growth was led by the service sector, while manufacturing output rose only marginally.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, said:

“The PMI surveys bring encouraging news of a welcome combination of solid economic growth and cooler selling price inflation in July.

“Another strong expansion of business activity in the service sector, which over the past two months has enjoyed its best growth spell for over two years, contrasts with the deteriorating picture seen in the manufacturing sector, where output came close to stalling in July.

“While manufacturers are reporting reduced demand for goods, this in part reflects a further switching of spending from consumers towards services such as travel and recreation. However, healthcare and financial services are also reporting buoyant growth, fueling a wide divergence between the manufacturing and service economies.

“Thanks to the relatively larger size of the service sector, the July PMI surveys are indicative of the economy continuing to grow at the start of the third quarter at a rate comparable to GDP rising at a solid annualized 2.2% pace.

“A further cooling of selling price inflation in the service sector meanwhile brings encouraging news for the Fed. Combined with a near-stalling of price increases in the manufacturing sector, the latest survey data point to average prices charged for goods and services rising at a rate which is indicative of consumer price inflation moving closer to the 2% target. However, the surveys saw some upward pressures on costs, especially in the service sector, which policymakers will likely be eager to see soften before being confident of inflation falling sustainably to target.”

The ISM:

Economic activity in the services sector expanded in July, a trend that has been interrupted only three times — though twice in the last four months — since early in the coronavirus pandemic, say the nation’s purchasing and supply executives in the latest Services ISM Report On Business. The Services PMI registered 51.4 percent, indicating sector expansion for the 47th time in 50 months.

“In July, the Services PMI registered 51.4 percent, 2.6 percentage points higher than June’s figure of 48.8 percent. (…)

The Business Activity Index registered 54.5 percent in July, which is 4.9 percentage points higher than the 49.6 percent recorded in June and a return to expansion after one month of contraction.

The New Orders Index expanded to 52.4 percent in July, 5.1 percentage points higher than June’s figure of 47.3 percent; however, the index’s current reading is its fourth-lowest since early in the pandemic. The Employment Index expanded for just the second time in 2024; the reading of 51.1 percent is a 5-percentage point increase compared to the 46.1 percent recorded in June.

“The Supplier Deliveries Index registered 47.6 percent, 4.6 percentage points lower than the 52.2 percent recorded in June. The index returned to contraction territory — indicating faster supplier delivery performance — in July after two months in ‘slower’ territory. (Supplier Deliveries is the only ISM^® Report On Business^® index that is inversed; a reading of above 50 percent indicates slower deliveries, which is typical as the economy improves and customer demand increases.)

“The Prices Index registered 57 percent in July, a 0.7-percentage point increase from June’s reading of 56.3 percent. The Inventories Index contracted for the second consecutive month in July, registering 49.8 percent, an increase of 6.9 percentage points from June’s figure of 42.9 percent. The Inventory Sentiment Index (63.2 percent, down 0.9 percentage point from June’s reading of 64.1 percent) expanded for the 15th consecutive month. The Backlog of Orders Index returned to expansion territory for the fifth time in 2024, registering 50.6 percent in July, a 6.6-percentage point increase compared to the June reading of 44 percent.

“Ten industries reported growth in July. The Services PMI^® has expanded in 17 of the last 19 months dating back to January 2023, and the July reading is only 0.9 percentage point lower than the average of 52.3 percent over that period of time. Also, the PMI^® has not recorded back-to-back months in contraction since April and May 2020, another indication of sustained growth for the sector.”

Miller continues, “The increase in the composite index in July is a result of an average increase of 5 percentage points for the Business Activity, New Orders, and Employment indexes, offset by the 4.6-point drop in the Supplier Deliveries Index. The last time Supplier Deliveries was in contraction (faster) territory while the other three indexes registered expansion was in November 2023. Survey respondents again reported that increased costs are impacting their businesses, with generally positive commentary on business activity being flat or expanding gradually. Comments continued to express a wait-and-see attitude regarding the upcoming presidential election, with one respondent expressing concern over potential increases in tariffs. Many panelists noted a return to more stable supply chain performance, albeit with higher costs.”

Wells Fargo agrees with me that consumer spending is not about to take the economy in recession (baring an explosion in oil prices, see below):

(…) Renewed attention on the labor market notwithstanding, we think that an under-appreciated factor amid all the worry about the health of the economy is that households just keep finding ways to sustain spending. The labor market may be losing momentum, but in the latest personal income and spending report we learned that real services outlays grew 0.2% in June, the fastest pace in four months. While most of the spending on services goes toward non-discretionary categories such as healthcare and housing, consumers are still spending in other categories too. Real services spending less healthcare and housing rose more than broad services, up 0.24%.

Recall that S&P Global’s own Services PMI surveys never weakened like the ISM’s. On July 1, S&P wrote: “Total new business expanded for the second month running, and at a solid pace that was the fastest for a year.” That solid pace continued in July.

Corrections, particularly from all-time highs, happen from time to time. The S&P 500 is still just 8.5% below its record high of 5,667 on July 16. On that date, the S&P 500 exceeded its 200-day moving average by 15%, an overbought level that has often been followed by selloffs. [Yesterday], that spread was down to 3.5%. (Ed Yardeni)

THE YEN CARRY TRADE

The yen carry trade involves borrowing money in a low-interest-rate currency (yen) and invest that money in higher-yielding assets, or fast rising equities, denominated in another currency. The risk is if the yen appreciates significantly against the dollar.

That strategy has been helped by the significant depreciation of the yen in recent years. The yen was 103 per 1 USD in January 2021; it reached a 34-year low on June 27, 2024, at 160.49 Yen per 1 USD.

The yen has been appreciating since, closing at 150.76 per 1 USD on  August 1.

A major relative monetary policy shift (Fed vs. BoJ) is now underway as the BoJ shifted policy last week. Not only did the BoJ raise interest rates to levels unseen in 15 years, Governor Ueda said in the press conference that ‘neutral is some way off’ (i.e. more hikes coming).
BoJ hiking while Fed loosening.

That relative policy switch is happening against elevated yen short positioning. The jump in the yen has forced traders to rush to unwind their shorts.

Bye bye the ‘risk-on’ trade, hello risk off!

BTW, some of these hedge (!) funds used the carry trade to get long techs.

FYI, pay attention!

• Wall Street Journal: Iran has rejected requests from the United States and Arab countries to “show restraint” after the killing of Hamas leader Ismail Haniyeh. Tehran says it doesn’t care whether its strike on Israel leads to a major war or not.

• An underground bunker in the Jerusalem mountains has been prepared for Netanyahu and other Israeli officials in the event of an Iranian attack, The Times of Israel reports, citing the Walla news site. This bunker, also known as the National Control Center, was built almost 20 years ago. It has not yet been used during the current war with Hamas and the massive shelling by Iran in April.

• Sergei Shoigu (Secretary of the Security Council of the Russian Federation) arrived on a visit to Iran, where he will meet with the president, the secretary of the Supreme National Security Council and the head of the General Staff, the Russian Security Council reports.

• “Retaliation against Israel for the assassination of Haniyeh will be through a new scenario that will be implemented suddenly” says an advisor to the Commander of the Iranian Revolutionary Guard — Al Jazeera

FYI, pay attention!

• “I’m for electric cars. I have to be because, you know, Elon endorsed me very strongly,” Trump told the crowd. “So, I have no choice.”
• “Christians, get out and vote, just this time. “You won’t have to do it anymore. Four more years, you know what, it will be fixed, it will be fine, you won’t have to vote anymore, my beautiful Christians.” (Donald Trump)
  

Note: I am travelling (Pacific time zone) until August 10. Posting will be irregular and possibly limited by time and equipment constraints.

July Employment: That Was Sahm Jobs Reports

The ongoing deterioration in the jobs market was on full display in the July Employment report. Nonfarm payrolls expanded by just 114K, well below consensus expectations for a 175K gain and close to the smallest monthly gain this cycle. Revisions were minimal relative to the last two months’ downward adjustment of 111K, but were once again negative with the net change the prior two months lowered by 29K. Over the past three months, payrolls have expanded at an average monthly pace of 170K, down from 267K in the first quarter and 251K in 2023.

(…) the jump in the unemployment rate to 4.3% from 4.1% in June cannot be explained away by the hurricane. The increase in unemployment from 3.5% this time last year is more concerning because the unemployment rate tends to vacillate little throughout the business cycle. Rising unemployment can set off a negative feedback loop between income, spending and hiring.

This dynamic has put a spotlight on the “Sahm Rule,” which highlights the historical pattern that the unemployment rate has never risen 0.5 points above its prior 12-month low (when measured on a three-month average basis) without the economy being in a recession.

July’s unemployment rate reading has pushed the Sahm Rule indicator to 0.53, above its 0.5 point threshold. As we discussed in a recent report, the increase in unemployment has been driven more by entrants into the labor force than at the start of prior recessions. In July, new and re-entrants accounted for 22 bps of the rise in the Sahm Rule indicator over the past year, more than its contribution in the first month of each of the past seven recessions.

Source: U.S. Department of Labor and Wells Fargo Economics

This increase in unemployment for the “right” reasons suggests that the crossing of the 0.5 point threshold may not be the sure-fire sign of recession that it has been in the past. That said, unemployment due to a permanent job loss or completion of temporary work has also risen significantly over the past year, including another increase in July. This increase for the “wrong” reasons underscores that even if the threshold for a recession might be somewhat higher this cycle, there has nevertheless been a clear deterioration in labor market conditions.

Source: U.S. Department of Labor and Wells Fargo Economics

Source: U.S. Department of Labor and Wells Fargo Economics

The looser labor market is having the intended effect of reducing inflation pressures. Average hourly earnings increased 0.2% in July, bringing the year-over-year change down to a three-year low of 3.6%. The moderation adds to other evidence released this week that labor costs are no longer a threat to inflation, including the Employment Cost Index, the Fed’s preferred gauge of compensation costs, slipping to an annualized rate of 3.7% in Q2 and unit labor costs now running comfortably below 2%.

The July jobs report offers the latest indication that the exceptional jobs market that followed the unique circumstances of the pandemic looks to have come to an end. Demand for new workers continues to fade, as evidenced by the downward trend in job openings, small business hiring plans and temporary help employment. Workers have taken notice, with perceptions of job availability and the share of employees quitting their jobs falling to cycle lows.

The weakening trend in hiring, unemployment and job switching over the past year puts conditions on par with the late 2010s. While the labor market remains in decent shape in an absolute sense, further softening would be hard to attribute to “normalization” and instead would be consistent without outright weakness in our view.

We expect the FOMC to begin dialing back the current level of policy restriction soon. Although inflation has not yet returned to the Fed’s 2% target, the cooler jobs market points to inflation pressures continuing to recede. Our forecast remains for the FOMC to reduce the fed funds rate beginning in September by 25 bps at every other meeting through 2025, although growing risks to the employment side of the Fed’s mandate suggest a 50 bps cut in September could also be on the table as more and/or a faster pace of rate cuts look increasingly warranted.

Suddenly, bad news is actually treated as bad news by the markets. Nasdaq officially entered a correction, down 10.8% from its July 11 record high.

Right after Wednesday’s FOMC when Powell said that “downside risks to the labor market are real”, we got a series of data that seemingly proved his foresight:

• Thursday, initial unemployment claims increased by 14,000 to 249,000 in the week ended July 27 (+28% since January) while continuing claims rose by 33,000 to 1.88 million in the week ended July 20 (+8.6%).
• The same day, the widely followed ISM Manufacturing PMI declined to 46.8 in July from  48.5 with generally weak details, particularly the following observations:

Eighty-six percent of manufacturing gross domestic product (GDP) contracted in July, up from 62 percent in June. More concerning: The share of sector GDP registering a composite PMI calculation at or below 45 percent (a good barometer of overall manufacturing weakness) was 53 percent in July, 39 percentage points higher than the 14 percent reported in June. Notably, all six of the largest manufacturing industries — Machinery; Transportation Equipment; Fabricated Metal Products; Food, Beverage & Tobacco Products; Chemical Products; and Computer & Electronic Products — contracted in July.

• S&P Global’s own manufacturing PMI survey also came in weak, down 2 points to 49.6, with the also depressing comments that “new business decreased solidly, and at the fastest pace in 2024 so far. Firms reported a general slowdown in market demand (…)”.
• And Friday’s employment report confirmed that “downside risks to the labor market are real”, spooking investors to the delight of the few remaining hard-landers out there.

That bad?

Ed Yardeni blames

much of the weakness on the weather. Yes, we know, the Bureau of Labor Statistics (BLS) noted that Hurricane Beryl had no impact on the report. Yet, the BLS household employment survey showed that 1.54 million workers were either not working or only part time due to weather, far above the historical average.

Workers on temporary layoff jumped to 14.8% of total unemployment, a two-year high.
Many of these temporary layoffs showed up in the initial unemployment claims in Texas. We expect both series to revert lower in August.

Goldman Sachs estimates that

underlying trend job growth based on payroll and household employment growth remains near 150k—still in line with our estimate of the go-forward breakeven rate now that immigration is slowing. (…) more than 70% of the increase [in the unemployment rate] in July came from temporary layoffs. Whether or not they were related to Hurricane Beryl, temporary layoffs might reverse in coming months and historically have not been a good recession predictor.

Claims, a BLS seasonally adjusted series, are following a summer mini-seasonality, displaying no worsening trends on a YoY basis. Furthermore, “87% of the nsa increase in continuing claims was from Texas, which is dealing with distortions from Hurricane Beryl.”

The 0.2% jump in the unemployment rate to 4.3%, from 3.5% last year, is scaring people and triggering the Sahm Rule. But all of it is caused by labor supply rising faster than demand for workers rather than outright job losses. A surge in immigration is boosting labor availability. Goldman: “Foreign-born workers once again made an outsized contribution to the increase in the unemployment rate in July, and we now estimate that recent immigrants who came to the US in the last three years have contributed 16bp of the 59bp increase in the three-month average unemployment rate since the cycle low.”

Meanwhile, job openings are still 17% above pre-pandemic levels (+14% for private employers) and have actually stabilized since March (per JOLTS data) and increased in July (per Indeed job postings, black).

Private employment growth was a low +97k in July but the 3-month average is +146k, in line with the 2019 average of +154k. In the 6 months prior to the 2008 recession, private employment growth slid from +133k to +29k per month. In 2001, it dropped from +104k to +26k per month. In 1990: from +193k to +21k.

If Ed Yardeni is right and the weather is to blame for July’s poor jobs data, aggregate labor income (employment x hours x wages) should bounce back from its zero July MoM growth in coming months.

On a YoY basis, aggregate payrolls are still rising by nearly 5% while PCE inflation has nicely slowed to the 2.5% range.

In late 2007, inflation was accelerating, quickly eroding real purchasing power…

… dragging down growth in real expenditures from +2.0% into negative territory in 6 months.

Considering current trends in employment, wages and inflation, coupled with a rather wealthy consumer, risk of a significant slowdown in consumer spending is low. Unless the dangerously boiling situation in the Middle-East erupts and boosts oil prices to levels that would choke world economies and the American consumer whose savings rate is currently historically low. WTI prices doubled to $100 in 2007.

Corporate profits are also not suggestive of meaningful budget compressions, particularly given that unit labor costs rose only 0.5% YoY in Q2 and jumped 2.7% YoY, positive for profit margins and inflation.

EARNINGS WATCH

From LSEG IBES:

376 companies in the S&P 500 Index have reported earnings for Q2 2024. Of these companies, 78.7% reported earnings above analyst expectations and 15.7% 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 16% missed estimates.

In aggregate, companies are reporting earnings that are 3.6% 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 7.3%.

Of these companies, 57.4% reported revenue above analyst expectations and 42.6% 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, 62% of
companies beat the estimates and 38% missed estimates.

In aggregate, companies are reporting revenues that are 0.9% 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 1.2%.

The estimated earnings growth rate for the S&P 500 for 24Q2 is 12.9%. If the energy sector is excluded, the growth rate improves to 13.9%.

The estimated revenue growth rate for the S&P 500 for 24Q2 is 5.1%. If the energy sector is excluded, the growth rate declines to 4.9%.

The estimated earnings growth rate for the S&P 500 for 24Q3 is 6.8%. If the energy sector is excluded, the growth rate improves to 8.0%.

Trailing EPS are now $231.90. Full year 2023 EPS: $243.60e. Forward EPS: $259.51e.