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

MANUFACTURING PMIs

USA: New orders decrease for first time in three months

The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI®) fell to 49.6 in July from 51.6 in June, below the 50.0 no-change mark for the first time in seven months and signaling a slight deterioration in the health of the manufacturing sector.

Central to the worsening of overall business conditions was a first reduction in new orders for three months. New business decreased solidly, and at the fastest pace in 2024 so far. Firms reported a general slowdown in market demand, with clients often reluctant to commit to new projects at the current time. New export orders also decreased, albeit to a lesser extent than total new business. A number of respondents highlighted demand weakness in Canada.

Manufacturing production continued to rise in July, although the drop in new orders meant that the rate of expansion eased to a marginal pace that was the slowest in the current six-month sequence of growth.

Continued increases in production at a time of falling new orders meant that firms were able to work through outstanding business again in July. The rate of depletion in backlogs of work was solid and the fastest in three months. Rises in output also contributed to an increase in stocks of finished goods as some firms looked to build inventories in anticipation of future demand improvements. That said, the drop in sales was also a factor behind rising stock levels.

In act, the accumulation of post-production inventories was the strongest since November 2022 and among the fastest since the series began in May 2007.

Confidence in the future path of production also supported job creation in July, while some firms hired staff to replace previously departed workers. Employment increased for the seventh month running, but at the softest pace since January.

The positive outlook was evident in data on business sentiment, which showed optimism regaining some ground at the start of the third quarter. Hopes that the current soft patch in demand will prove temporary, with new business improving following the Presidential Election, supported confidence in the outlook for production.

Input costs increased markedly in July amid reports of higher prices for energy, freight, labor and raw materials. That said, the rate of inflation eased to a four-month low.

Meanwhile, manufacturers increased their own selling prices at only a marginal pace, with the rate of inflation easing to a one-year low as firms restricted price rises in an attempt to secure sales in a competitive market.

Purchasing activity decreased for the second month running, with firms reluctant to purchase additional inputs given falling new orders and rising prices. The modest drop in purchasing fed through to a further reduction in stocks of inputs, the fifth in as many months.

Reduced demand for inputs led some suppliers to speed up deliveries, but this was cancelled out by shortages of staff and materials, plus shipping delays. Supplier performance was therefore broadly unchanged in July.

• The ISM:

The Manufacturing PMI^® registered 46.8 percent in July, down 1.7 percentage points from the 48.5 percent recorded in June. The New Orders Index remained in contraction territory, registering 47.4 percent, 1.9 percentage points lower than the 49.3 percent recorded in June. The July reading of the Production Index (45.9 percent) is 2.6 percentage points lower than June’s figure of 48.5 percent.

The Prices Index registered 52.9 percent, up 0.8 percentage point compared to the reading of 52.1 percent in June. The Backlog of Orders Index registered 41.7 percent, equaling its June reading. The Employment Index registered 43.4 percent, down 5.9 percentage points from June’s figure of 49.3 percent. (…)

The New Export Orders Index reading of 49 percent is 0.2 percentage point higher than the 48.8 percent registered in June. The Imports Index remained in contraction territory in July, registering 48.6 percent, 0.1 percentage point higher than the 48.5 percent reported in June.”

U.S. manufacturing activity entered deeper into contraction. Demand was weak again, output declined, and inputs stayed generally accommodative. Demand slowing was reflected by the (1) New Orders Index dropping further into contraction, (2) New Export Orders Index continuing in contraction, (3) Backlog of Orders Index remaining in strong contraction territory, and (4) Customers’ Inventories Index moving lower to the higher end of ‘too low’.

Output (measured by the Production and Employment indexes) declined compared to June, with a combined 8.5-percentage point downward impact on the Manufacturing PMI calculation. Panelists’ companies reduced production levels month over month as head-count reductions continued in July. Inputs — defined as supplier deliveries, inventories, prices and imports — generally continued to accommodate future demand growth.

Demand remains subdued, as companies show an unwillingness to invest in capital and inventory due to current federal monetary policy and other conditions. Production execution was down compared to June, likely adding to revenue declines, putting additional pressure on profitability. Suppliers continue to have capacity, with lead times improving and shortages not as severe.

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.

The five manufacturing industries reporting growth in July are: Printing & Related Support Activities; Petroleum & Coal Products; Miscellaneous Manufacturing; Furniture & Related Products; and Nonmetallic Mineral Products. The 11 industries reporting contraction in July — in the following order — are: Primary Metals; Plastics & Rubber Products; Machinery; Electrical Equipment, Appliances & Components; Transportation Equipment; Fabricated Metal Products; Food, Beverage & Tobacco Products; Wood Products; Paper Products; Chemical Products; and Computer & Electronic Products.

Eurozone factory output contracts at strongest rate in 2024 so far

The HCOB Eurozone Manufacturing PMI, a measure of the overall health of eurozone factories and compiled by S&P Global, matched that seen in June, recording 45.8 once again in July. Subsequently, this represented a further marked deterioration in the health of the euro area’s goods-producing economy.

Albeit unchanged on the month, most of the eight monitored eurozone nations saw Manufacturing PMI figures decrease when compared to June. Germany and France, the currency bloc’s two largest economies, saw their respective index values drop to three- and six-month lows, respectively. Greece and Spain, which have been the two strongest performers in 2024 so far, also lost growth momentum. Italy and Ireland were the only two countries covered by the survey to see their Manufacturing PMI increase.

For the eurozone as a whole, July survey data indicated a slight acceleration in the factory order downturn that has been ongoing since May 2022. Overall, the pace of contraction was the quickest in three months. Cross-border sales activity also weighed on demand for eurozone goods at the start of the third quarter, as evidenced by another solid reduction in new orders from export markets*.

To compensate for lower workloads, eurozone manufacturers leaned more heavily on their backlogs as a means to support production. Outstanding business volumes were depleted at a sharp and quicker rate in July. In fact, the pace of depletion was the fastest since February. Nevertheless, production levels suffered the most marked contraction in the year-to-date.

Net factory employment fell at the start of the third quarter, with workforce numbers decreasing at the fastest pace since last December. This stretched the current sequence of job shedding to 14 months. Lower staffing capacity coincided with a drop in business confidence, the first time since October last year this has been the case. Overall, expectations for output in the coming year slipped to a four-month low.

Eurozone manufacturers trimmed their purchasing activity in July, albeit to a slightly softer extent than in June. Still, the rate of decline was sharp. In turn, pre-production inventories were reduced for the eighteenth month in a row. The latest survey data signalled a further improvement in supplier performance, but the extent to which delivery times shortened was the weakest in six months.

Lastly, HCOB PMI data revealed another monthly increase in eurozone manufacturers’ operating costs. The rate of input price inflation quickened to a one-and-a-half-year high, but remained below the long-run trend. Charges for goods leaving the factory gate were broadly unchanged since June, indicating that firms refrained from passing on higher cost burdens to their clients.

CHINA: Operating conditions deteriorate amid a renewed fall in new orders

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI®) fell to 49.8 in July, down from 51.8 in June. Easing below the 50.0 neutral mark, the latest data signalled that conditions in the manufacturing sector deteriorated for the first time in nine
months, albeit only marginally.

Manufacturing output expansion was the slowest in the nine-month sequence during July, attributed to the first fall in new orders for a year. According to panellists, subdued demand conditions and reductions in client budgets underpinned the latest fall in new work. Export orders meanwhile continued to rise, but the rate of growth slowed from June to a modest pace.

Sub-sector data revealed that reductions in new orders mainly unfolded in the investment and intermediate goods segments while the consumer goods sector expanded slightly in July. (…)

Employment levels remained relatively stable, falling only fractionally in July. While some firms added headcounts to cope with ongoing workloads, others opted to reduce staffing levels, anticipating lower production needs as new orders fell.

Turning to prices, average selling prices declined for the first time since May. Chinese manufacturers indicated reducing selling prices to support sales amid Increased competition. This was partially supported by input cost inflation easing to the lowest in the current four-month sequence.

Renewed contraction in Japan’s manufacturing sector

The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI®) fell from the neutral 50.0 mark in June to 49.1 in July to signal a deterioration in the health of the sector for the first time since April. The reduction was modest, yet the strongest seen for four months.

There was a sustained contraction in new orders at the start of the third quarter of 2024. The pace of decline quickened from June, and was the sharpest for four months. According to panellists, demand from both domestic and international markets was subdued.

Also contributing to the sub-50.0 PMI reading was a renewed contraction in output levels in July. The downturn reportedly reflected production adjustments in response to weaker demand, though was only fractional overall. Muted customer demand allowed firms to work through existing orders, as signalled by a stronger fall in backlogs of work. Moreover, the rate of depletion was the fastest since March and sharp overall.

Firms often indicated they kept on top of capacity requirements to complete outstanding business, as indicated by a fifth consecutive increase in employment levels.

On the prices front, input cost pressures intensified in the latest survey period. Average cost burdens rose at a marked rate that was the strongest since April 2023. Higher operating expenses were often attributed to increased labour, logistics, oil and raw material
prices. Output price inflation meanwhile remained steep but eased to a four-month low as firms attempted to remain competitive. (…)

Powell means September, whatever he doesn’t say

(…) Powell did this by saying that “the sense of the committee is closer to cuts but we’re not there yet,” by freely conceding that “downside risks to the labor market are real,” while adding that employment is “not a source of material inflationary pressure,” by calling policy “restrictive, not extremely restrictive but restrictive,” and by cheerfully describing the latest inflation data as “so much better” than 12 months ago. A cut will happen at the next meeting if inflation moves down “in line with expectations,” which is a way of saying that we should expect a cut. (…)

The greatest risk confronting the Fed now would be an unpleasant surprise Friday from the payrolls data for July. Powell made clear that unemployment was now as much of a concern as inflation, but also said that the jobs market was merely “normalizing” rather than moving steadily toward a recession. (…)

Business Confidence for Small and Large Firms

Since the Fed started raising rates, business confidence has diverged for small and large companies.

The source of the divergence is likely higher costs of capital for small companies that have higher leverage and lower coverage ratios, and lack access to broadly syndicated loan markets and private credit.

In other words, the transmission mechanism of tighter monetary policy mainly works through smaller companies that are harder hit by Fed hikes and don’t benefit from tighter credit spreads and higher stock prices.

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

US Labor Costs Rise Less Than Forecast as Inflation Eases Employment cost index increased 0.9% in second quarter

The employment cost index, which measures wages and benefits, increased 0.9% in the April-to-June period, after rising by the most in a year at the start of 2024, according to Bureau of Labor Statistics figures out Wednesday. The median estimate in a Bloomberg survey of economists called for a 1% rise. (…)

The second-quarter slowdown in employment cost growth was broad across private industries and included declines in construction, wholesale trade and information, according to Wednesday’s report. Compared with a year earlier, the ECI climbed 4.1%, the smallest annual advance since 2021.

Though there are a number of other earnings metrics published more frequently — including average hourly earnings figures from the monthly jobs report — economists tend to favor the ECI because it’s not distorted by shifts in the composition of employment among occupations or industries. It’s also the Fed’s preferred wage measure.

Wages and salaries for civilian workers increased 0.9%, the smallest advance in three years. They were up 4.2% from a year ago, also the least since 2021.

Adjusted for inflation, private-industry compensation grew 0.9%, while wages increased 1.1% — both accelerations from the start of the year. The strength of the jobs market, including positive real earnings growth, has been key to sustaining household demand. (…)

Wages for service workers in the private sector rose 1% from the prior quarter, unadjusted for inflation. Since compensation is a major cost for employers in this sector, Fed officials monitor it closely through a subset of inflation known as core services excluding housing.

Worker pay in goods-producing industries climbed 0.2%, the smallest advance since 2009. That included construction, where wages declined by the most on record.

Wells Fargo:

(…) With the ECI the Fed’s preferred barometer of labor costs growth, today’s data mark an important step toward the FOMC gaining “greater confidence” that inflation is cooling sufficiently to begin reducing the fed funds rate.

While still noticeably above last cycle’s peak of 2.9%, employment cost growth slowed to 4.1% year-over-year in Q2, the smallest gain in two and a half years. Moreover, having increased at an annualized rate of 3.7% in the three months ending in June, the second quarter’s figures show employment cost growth closely approaching a pace consistent with the FOMC’s 2% inflation objective once accounting for productivity growth (productivity gains allow businesses to raise compensation faster than prices). (…)

But importantly, the Employment Cost Index is considered the gold standard among Fed officials as it controls for compositional shifts in the economy’s jobs and is a more encompassing measure than average hourly earnings. The ECI accounts for the cost of employer provided benefits—which are just over 30% of total compensation costs—in addition to wage & salaries. It also includes labor cost growth for public sector workers in addition to private sector workers. As a result, the ECI’s moderation in Q2 marks an important step for the FOMC obtaining “greater confidence” that inflation is subsiding back toward 2%. (…)

  

Private sector compensation cost growth advanced 0.9% over the quarter after a 1.1% rise in Q1, with wages & salaries and benefit cost growth moderating. The slowdown came despite another hefty increase to private sector union workers (+1.6%) to help catch up to the compensation gains with non-union workers since the start of 2020. Public sector employment costs also eased over the quarter but are still running ahead of private industry gains over the past year after having initially lagged this cycle. (…)

As demonstrated in yesterday’s JOLTS report, employee retention has greatly improved, while waning demand for workers and growing pool of unemployed workers are lessening the extent to which employers need to raise compensation to retain existing or attract new workers. (…)

Ed Yardeni:

(…) [yesterday’s] employment indicators suggest that the labor market is in good shape. To some economists, it seems to be weakening. To us, it seems to have normalized. In July’s Consumer Confidence Index survey, the percentage of respondents agreeing that “jobs are plentiful” did fall to 34.1% from 42.8% in February, while the percentage saying “jobs are hard to get” edged up to 16.0% (chart). That means that 49.9% believe that jobs are available, which is slightly above the historical norm of 48.1%.

The jobs plentiful series closely tracks the JOLTS series on job openings and quits, both of which came out today but through June. Again, some economists look at these series and see weakening, while we see normalizing (chart). Take your pick.

China Home Sales Slump Drags On Despite Latest Rescue Effort New-home sales value slid 19.7% in July, faster than in June

The value of new-home sales from the 100 biggest real estate companies slumped 19.7% from a year earlier to 279.07 billion yuan ($38.6 billion), faster than the 17% decline in June, according to preliminary data from China Real Estate Information Corp. Transactions dropped 36.4% from June, after showing a notable increase in April and May. (…)

Bloomberg Economics estimates that the central bank’s $42 billion relending program can only help local governments purchase 0.8% of China’s 60 billion unsold homes.

S&P Global Ratings expects residential sales to drop 15% this year, more than the 5% decline it projected earlier. Fitch Ratings cut its annual sales estimate to a decrease of 15%-20%, worse than an earlier estimate of a 5%-10% drop. (…)

China PMIs Signal Continued Softness in Manufacturing, Slowdown in Services The manufacturing purchasing managers index dropped slightly to 49.4 in July, from 49.5 in June

Declines were seen in some key subindexes. The production subindex fell to 50.1 in July from 50.6 in June, while that for total new orders dropped to 49.3, compared with June’s 49.5. New export orders improved somewhat, rising to 48.5 in July from 48.3 in June.

China’s nonmanufacturing PMI, which covers both service and construction activity, also fell last month but remained in growth territory. The headline reading declined to 50.2 in July from 50.5 in June, the statistics bureau said.

The subindex that tracks service activity fell to 50.0 in July from 50.2 in June, while the construction subindex fell to 51.2 from 52.3.

Service activity in retail, capital market services and the property market all contracted in July, the data showed, reflecting subdued domestic consumption amid a protracted real-estate downturn. (…)

Canada Economy on Track to Grow 2.2% in Second Quarter

Gross domestic product is on track to grow at an annualized pace of 2.2%, according to Statistics Canada’s estimate Wednesday. That’s stronger than the Bank of Canada’s and economists’ forecasts of 1.5%, and is an acceleration from 1.7% between January and March.

The data point to Canada’s economy expanding 1.3% in the first half of the year, the fastest six-month period of growth since August 2022. Still, preliminary data suggest June output grew 0.1%, suggesting weakening momentum following a 0.2% expansion in May and 0.3% in April. (…)

Taken together with Canada’s rapid population growth due to strong immigration, Wednesday’s report shows an economy that’s still in excess supply and growing below its potential, which will continue to help cool price pressures as the Bank of Canada further reduces the restrictiveness of monetary policy.

While quarterly growth has picked up, data showed weakness in household spending as high interest rates weigh on consumers.

Retail trade was the largest detractor to growth in May, contracting 0.9% and more than offsetting the increase in the previous month. Wholesale trade also fell.

Manufacturing led the growth in May, with over half of the increase stemming from petroleum and coal products. That subsector rose 7.3%, its largest increase since June 2021.

The crude oil and other pipeline transportation industry rose 1.5%, reflecting in part the opening of the expanded Trans Mountain pipeline carrying Alberta crude to the British Columbia coast for shipment. (…)

In June, factories along with wholesalers saw declines in output, according to Statistics Canada’s early estimate. (…)

Three Big Differences Between the AI and Dot-Com Bubbles It’s looking a bit like summer 2000.

(…) Deluard draws a parallel between the present AI bubble (might as well call it what it is) and the bursting of the late 1990s dot-com bubble. He notes that the same thing happened in the summer of 2000. The US economy slowed, and money rotated from the similarly expensive tech leaders that were leading the market back then, and into the value laggards.

As some of you will recall, the 2000s cycle saw a shallow but eye-catching recession to accompany the bear market, plus big interest-rate cuts from the Federal Reserve.

However, Deluard argues, there are three major differences between now and then — ones that mean we may not see the recession, the cuts or even the same scale of bear market.

His first point is that the recession and rate cuts were largely driven by the September 11th, 2001, terrorist attacks on New York, “which we all hope were a one-time catastrophe”, as Deluard puts it. Without the terrorist attacks, there would probably have been a soft landing, and the rate cuts from the Federal Reserve would never have been as deep.

His second point is that fiscal policy is far more stimulative today than during the tech bubble. The idea of a developed economy government ever running a surplus seems unthinkable today, but that’s exactly what the US was doing back then. Today’s government spending forms another cushion against the potential impact of any bursting AI bubble.

His final point is probably the most intriguing, and one that perhaps points to deeper structural issues with our markets. This is about the rise of passive investing and how that might stifle the scale of any correction.

Passive investing has lots of advantages and I am by no means opposed to it. It’s cheap, it’s low maintenance, and it’s a very accessible way for “normal” people to invest their money without having to get deep into the weeds of financial admin. If anything has made investment more accessible — “democratised” it, if you must — it’s the rise of passive.

But you can have too much of a good thing. To put it simply, passive investing means a big dollop of money gets directed into stocks every month, without any discernment beyond “what’s biggest?” That’s a world in which active money — which is making judgements about value — has less power.

The exact levels and precise mechanisms are heavily disputed here, mainly because these days everyone has skin in the game on one side or the other. But it strikes me as common sense that if the majority of capital flows are being allocated on a passive, market-cap-weighted basis, that’s going to favour momentum investing — the big get bigger.

The risk, argues Deluard, is not so much that the great rotation stops altogether, but that “shorting” the momentum-driven side — i.e. betting that the Big Tech stocks will continue to fall — is just very dangerous.

The good news is that we’re all retail investors here (or at least hanging out in that camp for the purposes of this newsletter) and so actively shorting stuff or “pairs trading” indices is not the sort of thing most of us do.

From that point of view, investing in the boring value stocks that haven’t gone up is a reasonable way to bet on a rotation continuing, and one that’s nowhere near as likely to leave you nursing painful actual losses (as opposed to relative underperformance) as a short bet might. (…)

FYI:

Source: @TheTerminal, Bloomberg Finance L.P.