Fed Signals Cuts Are Possible but Not Imminent as It Holds Rates Steady The central bank abandons formal guidance that had kept hikes on the table since last raising rates in July.

(…) “It’s a highly consequential decision to start the process” of lowering interest rates “and we want to get that right,” said Fed Chair Jerome Powell at a news conference. “We’ve made a lot of progress on inflation. We just want to make sure that we do get the job done in a sustainable way.” (…)

“I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting” to justify a rate cut, “but that’s to be seen,” he said. (…)

Powell said Wednesday the Fed might be slower to cut rates or drag out the process if inflation proved to be more persistent. It could cut rates sooner and faster if the labor market weakened or there was “very, very persuasive lower inflation,” he said. (…)

“We want to see more good data. It’s not that we’re looking for better data,” Powell said. “Are the last six months flattered by factors that are one-off factors that won’t repeat themselves? We don’t think so. But that’s the question…we have to ask.” (…)

About inflation specifically:

So we have six months of good inflation data. The question really is: That six month of good inflation data, is it sending us a true signal that we are, in fact, on a path—a sustainable path down to 2 percent inflation? That’s the question. And the answer will come from some more data that’s also good data. It doesn’t—it’s not that the six-month data isn’t low enough; it is. It’s just a question of can we take that with confidence that we’re moving sustainably down to 2 percent. (…)

But you can—and you know this—you can look behind those numbers and you can see that a lot of it’s been coming from goods inflation, for example. And goods inflation running significantly negative, it’s a reasonable assumption that over time—because inflation will flatten out, probably approximate zero—that would mean the services sectors would have to contribute more. So, in other words, what we care about is the aggregate number, not so much the composition.

(Wells Fargo)

Mr. Powell acknowledged that monetary policy has been and is “well into restrictive territory, and we’ve been seeing the effects on economic activity and inflation.”

And yet:

So I think, whereas a year ago we were thinking that we needed to see some softening in economic activity, that hasn’t been the case. So I think we look at—we look at stronger growth—we don’t look at it as a problem. I think at this point we want to see strong growth. We want to see a strong labor market. We’re not looking for a weaker labor market.

With strong growth and a strong labor market, “the case is likely that it [inflation] will continue to come down”.

US Labor-Cost Gauge Cools in Sign of Easing Inflation Pressures Employment cost index increases at slowest pace since 2021

A broad gauge of US labor costs cooled by more than forecast in a fresh sign of easing inflation pressures that give Federal Reserve officials room to cut interest rates this year.

The employment cost index, which measures wages and benefits, increased 0.9% in the fourth quarter, the smallest advance since 2021, after rising 1.1% in the prior three-month period, according to Bureau of Labor Statistics figures released Wednesday. (…)

Compared with a year earlier, the ECI was up 4.2%, the smallest annual advance since the end of 2021. Still, that’s well above the typical pace seen in the years before the pandemic. (…)

Wages and salaries for civilian workers also rose 0.9% in the fourth quarter and were up 4.3% from a year earlier for the smallest annual increase since 2021. (…)

(Wells Fargo)

Focusing on the service sector, labor costs growth remains in 4.0% range but is not accelerating.

Yesterday’s release of eurozone inflation data also shows services inflation stuck around 4%:

(Goldman Sachs)

Canada: GDP avoids contraction in the last months of 2023

After having contracted in the third quarter, it appears that GDP has evaded a similar fate in the final three months of the year. Data for November and preliminary figures for December indeed hint at 1.2% annualized expansion in Q4. This below-potential figure nonetheless follows a relatively tepid period for the Canadian economy; November saw the first output expansion since May and thus broke a lethargic streak the length of which had not been seen since the
2008-2009 financial crisis and the 2015-2016 slowdown attributable to the oil supply shock.

Despite the slight economic rebound to end the year, population growth remains stunning. As such, GDP as measured on a per capita basis contracted for a 10th consecutive month on a year-over year basis.

Looking at what drove growth in November, the goods producing sector was the standout. It recovered some lost ground and rose at its fastest pace in 10 months on broad-based gains. Despite a manufacturing PMI in contraction territory, the sector saw healthy growth in November due to the resumption of
activities following shutdowns/maintenance in plants.

Looking on the services side, it was more of a mixed bag. While growth stemmed in part from the transportation segment which rebounded following strikes in the Saint-Lawrence seaway it was also limited by educational services as strikes in Quebec commenced in the month.

Information and cultural services also saw a rebound in the month following 5 months of pullbacks as the SAG-AFTRA strike ended and businesses in the industry spun up productions. Looking ahead, we continue to expect the Canadian economy to contract in the first half of 2024, as it has yet to feel the full effects of past rate hikes and interest rates remain restrictive, particularly in real terms.

Eurozone manufacturing downturn cools in January

The HCOB Eurozone Manufacturing PMI, compiled by S&P Global, rose to 46.6 in January, up markedly from 44.4 in December to its highest level in ten months. While still below the 50.0 no-change mark – as has been the case since July 2022 – and therefore indicative of a further deterioration in manufacturing sector conditions, the headline index signalled a softening of the downturn for the third successive month.

All five components of the Manufacturing PMI exerted a positive directional influence in January. Indices for new orders and output (which combined, account for 55% of the PMI) each increased by over two points at the start of the year. Although they were indicative of further month-on-month contractions, the rates of decline were their weakest for nine months in both instances. A slower rate of deterioration was also seen in new orders from external sources, with export sales falling by the weakest margin since last April.

Nevertheless, January survey data showed substantial spare capacity at eurozone factories, as evidenced by yet another sharp monthly drop in backlogs of work. This was despite the rate of depletion cooling for a third month in succession. Further reductions to employment were made, extending the current period of job shedding that began last June, but cuts to workforce numbers were the softest in four months.

Eurozone manufacturers were less aggressive with purchasing reductions during January. After registering some of the steepest contractions in the survey history during the second half of 2023, input buying fell at the weakest pace since last March. Inventory levels declined further in January, although a softer reduction in pre-production stocks contrasted with a quicker decline in holdings of finished goods.

Sustained (albeit slower) inventory drawdowns remained deliberate, anecdotal evidence showed, with the weak prevailing demand environment a key motivator for firms to hold less stock. This was despite renewed supply chain disruption, caused by the rerouting of ships away from the Suez Canal. According to the latest survey data, suppliers’ delivery times lengthened for the first time in a year.

As for prices, January saw sustained declines in input costs and output charges, with rates of decrease accelerating for the first time since last July and last September respectively.

Beijing Pledges More Fiscal Support as Economy Stumbles

(…) Fiscal expenditure in 2024 will be maintained at the necessary intensity and fiscal transfers to local governments will remain at certain levels, officials from the Ministry of Finance said at a press conference on Thursday, signaling more financial support from Beijing to local governments struggling with piling debt.

Authorities will set a reasonable size for government investment, Vice Finance Minister Wang Dongwei said at the briefing, adding that the ministry will increase the amount under the central budget.

China’s Finance Minister Lan Fo’an said earlier this month that Beijing will boost fiscal spending this year to better support domestic demand. (…)

• China’s Central Bank Adds $21 Billion in Cheap Funds for Housing

The People’s Bank of China provided 150 billion yuan ($20.9 billion) worth of low-cost funds for lending to housing and infrastructure projects last month, stepping up support for the economy.

The outstanding amount of the PBOC’s Pledged Supplemental Lending program to policy-oriented banks 3.4 trillion yuan at the end of January, according to a central bank statement Thursday.

The PSL program is seen as an important tool for Beijing to support the economy and mitigate the impact from the worst property downturn on record. The cheap central bank money is for policy banks to lend to projects, which could help alleviate the decline in construction activities.

The PBOC increased the quota of PSL funds by 500 billion yuan for the so-called “major projects,” which include building government-subsidized housing and renovating run-down inner city districts, according to an article published by the central bank last month. It injected a net 350 billion yuan in December, which was the largest since November 2022. (…)

CHINA MANUFACTURING PMI: Manufacturing sector expansion holds steady in January

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI) posted 50.8 in January, unchanged from December, and pointed to a further mild improvement in business conditions. The health of the sector has now strengthened for three successive months, to mark the longest period of continuous improvement for two-and-a-half years.

Chinese manufacturing companies signalled an expansion of output for the third month running in January. The rate of growth was little-changed from December and, though modest, was among the fastest recorded over the past year-and-a-half. Firms often mentioned raising output due to firmer market conditions and higher sales.

Overall new business increased for the sixth successive month, though the rate of growth slipped to the slowest since last October. The softer rise in total sales was despite a renewed improvement in foreign demand. New export orders increased for the first time since last June, albeit marginally.

In line with rising business requirements, manufacturers expanded their purchasing activity in January. Whilst modest, the rate of growth was the best recorded since last August. Inventories of purchased inputs and finished items also increased at the start of the year, though rates of accumulation were only slight in both cases.

Supply chain performance improved for the third time in the past four months, albeit fractionally. Firms often mentioned that suppliers had sufficient capacity to deliver orders in a timely manner.

Capacity pressures at manufacturing firms in China were also relatively muted, as highlighted by a back-to-back decline in unfinished workloads. This led firms to trim their workforce numbers again at the start of the year. However, the rate of job shedding moderated notably from December and was the weakest recorded in five months.

The softer drop in employment coincided with an improvement in business confidence around the 12-month outlook for production. The degree of positive sentiment was the most pronounced in nine months, and supported by forecasts of stronger global demand conditions, planned investment, new product releases and efforts to expand into new markets.

Finally, prices data indicated that inflationary pressures remained muted at the start of 2024. Average inputs costs increased at a marginal pace that was the slowest in five months. At the same time, efforts to attract and secure new business prompted manufacturers to cut their own selling prices slightly in January.

Modest deterioration in Japanese manufacturing conditions in January

At 48.0 in January, the headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI®) rose fractionally from 47.9 in December to signal a further modest deterioration in the health of the sector.

Total new work decreased for the eighth month running in the latest survey period, and at a sharp rate overall. Weak domestic and global economic conditions were cited as key headwinds to new order intakes. Lower export sales, especially in Mainland China and the wider Asia-Pacific region, also held back total new orders at the start of the year. (…)

ASEAN manufacturing sector sees renewed improvement in operating conditions at start of 2024

Printing above the neutral 50.0 threshold for the first time in five months, the headline S&P Global ASEAN Manufacturing Purchasing Managers’ Index™ (PMI®) rose from 49.7 in December to 50.3 in January. The latest reading signalled only a slight improvement in the health of the ASEAN manufacturing sector, however.

Output rose for the twenty-eighth month running in January, and at the quickest pace since last August. The upturn was supported by firms working through backlogs, which fell for the seventh successive month, as new orders declined again.

Demand weakness was particularly notable across export markets, and this led overall new orders to decline for the fifth straight month. That said, the rate of contraction was the softest seen over this period and only marginal. Turning to employment, for the second time in three months payroll numbers were left unchanged, thereby reflecting a hesitancy across firms to commit to new hires.

New York Community Bancorp Stock Plunges 38%, Reigniting Fears for Regional Banks NYCB built up capital after acquiring most of the failed Signature Bank in last year’s crisis.

Shares of New York Community Bancorp plummeted 38% Wednesday after the company swung to a fourth-quarter loss and slashed its dividend to shore up capital following its purchase of the assets of the collapsed Signature Bank.

The company swung to a loss of $252 million, or 36 cents a share, at the end of December. That was compared with a profit of $172 million, or 30 cents a share, in the same period a year earlier. Analysts expected earnings of 27 cents a share for the fourth quarter.

Loan losses surged, and the bank set aside millions of dollars more to prepare for future potential losses. (…)

As part of its steps to bolster those capital and liquidity levels, the company cut its quarterly dividend to 5 cents a share, from 17 cents a share. (…)

In the fourth quarter, deposits at NYCB were down 2% from the previous quarter, driven by a $1.8 billion decrease in custodial deposits related to the Signature transaction.

“In the spring, it was deposits running out the door,” said Casey Haire, an analyst at Jefferies. “This is preparing to be a $100 billion bank and credit risk.”

NYCB said more of its property loans have started to sour. The bank also piled into its reserves for potential losses, particularly in the commercial-property space that has come under stress. (…)

Net charge-offs surged to $185 million from $1 million a year earlier, driven by two loans in that space. One was an office loan that had gone bad after an updated valuation in the third quarter. The other was a co-op loan that wasn’t in default but that the bank expects to sell in the first quarter.

“I don’t see systemic issues within their loan portfolio that I’m overly concerned about,” said Mark Fitzgibbon, head of financial services research at Piper Sandler. “It felt like this was a cleanup quarter…the company said we’re going to rip the Band-Aid off all at once.”

• A $560 Billion Real Estate Warning Hits Banks From NY to Tokyo

The US commercial real estate market has been in turmoil since the onset of the Covid-19 pandemic. But New York Community Bancorp and Japan’s Aozora Bank Ltd. delivered a reminder that some lenders are only just beginning to see the pain.

New York Community Bancorp’s decisions to slash its dividend and stockpile reserves sent its stock down a record 38% and dragged the KBW Regional Banking Index to its worst day since the collapse of Silicon Valley Bank last March. Tokyo-based Aozora Bank plunged more than 20% after warning of a loss tied to investments in US commercial property. In Europe, Deutsche Bank AG more than quadrupled its US real estate loss provisions to €123 million ($133 million) in the fourth quarter from a year earlier.

The concern reflects the ongoing slide in commercial property values coupled with the difficulty predicting which specific loans might unravel. Setting that stage is a pandemic-induced shift to remote work and a rapid runup in interest rates, which have made it more expensive for strained borrowers to refinance. Billionaire investor Barry Sternlicht warned this week that the office market is headed for more than $1 trillion in losses. (…)

“Banks’ balance sheets aren’t accounting for the fact that there’s lots of real estate on there that’s not going to pay off at maturity.” (…)

Banks are facing roughly $560 billion in commercial real estate maturities by the end of 2025, according to Trepp, representing more than half of the total property debt coming due over that period. Regional lenders in particular are more exposed to the industry, and stand to be hurt harder than their larger peers because they lack the large credit card portfolios or investment banking businesses that can insulate them.

Commercial real estate loans account for 28.7% of assets at small banks, compared with just 6.5% at bigger lenders, according to a JPMorgan Chase & Co. report published in April. (…)

The Aon Center, the third-tallest office tower in Los Angeles, recently sold for $147.8 million, about 45% less than its previous purchase price in 2014. (…)

New York Community Bancorp said its increase in charge-offs were related to a co-op building and an office property. (…)

New York Community Bancorp, which acquired part of Signature Bank last year, said Wednesday that 8.3% of its apartment loans were considered criticized, meaning they have an elevated risk of default.

At the end of last year, the Federal Deposit Insurance Corp. took a 39% discount when it sold about $15 billion in loans backed by rent-regulated buildings. In another indication of the challenges facing these buildings, roughly 4.9% of New York City rent-stabilized buildings with securitized loans were in delinquency as of December, triple the rate for other apartment buildings, according to a Trepp analysis based on when the properties were built. (…)

“The percentage of loans that banks have so far been reported as delinquent are a drop in the bucket compared to the defaults that will occur throughout 2024 and 2025,” said Aviram. “Banks remain exposed to these significant risks, and the potential decline in interest rates in the next year won’t solve bank problems.”

Jefferies: “”We believe NYCB has several idiosyncratic characteristics, but the result and reaction are reminders of risks that remain in the regional banking space.”

A New Global Tax Is About to Raise Billions. The U.S. Is Missing Out. The 15% global minimum tax is here, and it is raising corporate tax payments—just not in the U.S., where Congress hasn’t changed tax law to conform with an international deal.

Johnson & Johnson, Baxter International and Zimmer Biomet are all warning investors that the 2021 international tax deal will make them pay higher taxes this year as Switzerland, South Korea, Japan and European Union countries implement the accord. 

U.S. companies that enjoyed single-digit tax rates in some foreign countries now must pay at least 15% in each. But even though Treasury officials were crucial in forging the international accord and President Biden has pushed to implement it, Congress hasn’t changed U.S. tax law to conform to it. Republicans generally oppose the global deal, contending that Biden administration negotiators gave away too much of the U.S. tax base.

So for now, the U.S. isn’t directly collecting any money from domestic or foreign companies because of the deal.

J&J is forecasting a roughly 1.5-percentage-point increase in its tax rate. (…) Other companies pointing to potentially higher taxes in 2024 include Johnson Controls, Henry Schein, Teleflex, Enovis, Edwards Lifesciences and Methode Electronics. (…)

Thirty-six countries have implemented the deal or have new rules in progress, and businesses with global revenues exceeding €750 million—equivalent to about $810 million—could pay new taxes on profits.

The Organization for Economic Cooperation and Development, which spearheads the minimum tax project, recently estimated that businesses altogether will pay additional taxes of between $155 billion and $192 billion annually, an increase of between 6.5% and 8.1% from current tax payments. Some analysts looking at company projections have said it could be lower.

The U.S. created a minimum tax on companies’ foreign income in 2017, but it applies to their global profits, not country-by-country as required by the international deal. The U.S. created a second minimum tax in 2022, but that, too, doesn’t align with other countries’ levies. China also hasn’t implemented the agreement.

American companies are facing higher tax bills even though the U.S. hasn’t changed its rules. That is because the deal allows countries to make global companies operating in their jurisdictions pay at least 15% there. So Switzerland can make U.S. and Japanese companies pay 15% tax on their Swiss operations.

In many cases, American companies have already maxed out U.S. foreign tax credits. So paying more abroad won’t reduce their U.S. taxes. Instead, they effectively will pay taxes in two countries on the same income.

Meanwhile, the U.S. isn’t benefiting directly. The rules say countries can require that their home companies pay 15% in every country where they operate. So South Korea can ensure that a South Korean company pays 15% in the U.K., the U.S. and France. If it doesn’t pay enough in those countries—for instance, because U.S. research incentives lower its tax rate there—it must pay more to South Korea, not the U.S.

The OECD estimates that the U.S. will get some new revenue even without implementing the global deal. That is because some companies may shift operations and profits to the U.S. as tax rates become more similar around the world.

“I’m not seeing so much of that actually happening yet,” said Jason Yen of Ernst & Young. (…)

December JOLTS: No Surprises to Finish 2023

The JOLTS report for the final month of 2023 signaled that supply and demand in the labor market continue to come into better balance. Job openings rose in December to 9.0 million, slightly above the upwardly-revised 8.9 million openings in November. Openings are currently 29% above their pre-pandemic level but have fallen by nearly the same amount from the peak in 2022.

The number of job openings per unemployed person, an indicator cited by various FOMC officials when assessing labor market supply and demand imbalances, rose slightly to 1.44. This indicator was about 1.2 before the pandemic, surging to a two-to-one ratio when the labor market was at its tightest about two years ago. (…)

The layoffs and discharge rate, a measure of involuntary separations, was 1.0% in December, the fourth straight reading of 1.0%. This measure was 1.3% before the pandemic and is consistent with other layoff indicators, such as jobless claims, that show employers are hanging onto existing workers even as demand for new workers moderates. (…)

More up-to-date data from Indeed (through Jan. 26) indicate somewhat softer labor demand in January.

But, as Ed Yardeni explains, the latest Conference Board data say “the job market remains strong”:

The series for “jobs hard to get” dropped to 9.8% of respondents, almost a record low reading. It suggests that the unemployment rate remained below 4.0% this month.

The survey’s “jobs plentiful” series jumped to 45.5% during January.

If the labor market remains strong, wages are not about to slow down much. Hopefully productivity will be strong. Today we get the Employment Cost index just before Friday’s NFP.

Tomorrow, we get the manufacturing PMIs:

• the various regional Fed surveys point to a very soft ISM print. David Rosenberg: “updating our internal model, our work points to a whopping -2.8 point decline in the PMI — implying a falloff to 44.6 in January from 47.4 in December, and a significant downside surprise to the 47.2 penned in by the consensus.
• But S&P Global’s Flash PMI released last week had its own PMI at 50.3, up strongly from 47.9 in December, “to signal the first improvement in operating conditions at goods producers in nine months.”
• Even more important: “New business expanded for the third successive month at US companies in January, with the rate of growth quickening to the sharpest since June 2023. The upturn in new orders was broad-based, as manufacturers registered the first rise in new sales since October 2023, and the fastest uptick since May 2022. Service providers reported the strongest gain for seven months.”

More confusion ahead, but I keep relying on S&P Global data.

It looks like American consumers kept spending in January following strong Christmas sales. From The Transcript:

• “We are off to a solid start in 2024. Consumer spending remained resilient with first quarter year-over-year payments volume growth at 8%, U.S. payments volume grew 5% year-over-year, international payments volume grew 11%. Cross-border volume, excluding intra-Europe, rose 16% year-over-year in constant dollars with cross-border travel at 142% of 2019 levels, up from 139% in the fourth quarter… Consumer spend across all segments from low- to high-spend has remained relatively stable. Our data does not indicate any meaningful behavior change across consumer segments.” – Visa ($V ) CFO Chris Suh
  
• “We reached record levels of spending for both the full year and the fourth quarter in 2023. Total billed business grew 9% versus last year on an FX-adjusted basis. In the fourth quarter, billed business grew 6% as we continue to see more stable growth rates after lapping the prior year impact of Omicron back in the first quarter” – American Express ($AXP ) CFO Christophe Caillec

David Rosenberg, still wearing his recession frock, warns us that recent stats may be misleading:

(…) it was the balmiest December in recorded history, back to 1921 (40 degrees versus the norm of 33 degrees). The government statisticians are using December seasonal factors to massage the data and render them comparable sequentially when it felt more like March outside (warm weather and spending growth go together).

Monday, I wrote (So, You Think You Can Disinflate?) about the so-called immaculate disinflation:

(…) the decline in total PCE inflation from +5.9% to +2.7% from Q4’22 to Q4’23 was largely due to the stabilization in goods prices, itself largely due to deflating durable goods.

In truth, this so-called American “immaculate disinflation” is really the result of the U.S. having imported deflating goods with a strong currency coupled with very significant corporate cost reductions from much lower energy prices.

In truth, the Fed’s policies had little, if anything, to do with this recent disinflation, other than, perhaps, higher interest rates having prevented demand from exploding even more…

Wells Fargo yesterday:

Since peaking on a year-over-year basis at 9.1% in June 2022, inflation as measured by the Consumer Price Index has fallen 5.7 percentage points. The vast majority of that decline (4.9 points) has been attributable to lower goods inflation. After surging to 14.2% in March 2022—the loftiest one-year change since 1947—CPI goods inflation slowed to just 0.8% year-over-year in December. (Wells Fargo)

The retail apocalypse never happened

We haven’t seen the apocalypse everyone was expecting, Thomas LaSalvia, head of commercial real estate economics at Moody’s Analytics, tells Axios.

Retail commercial real estate is “back for good,” per a recent report from Cushman & Wakefield, a real estate services firm.

The vacancy rate at U.S. shopping centers — essentially any retail spaces outside the mall — fell to its lowest level since Cushman began tracking in 2007.

Average asking rents in the sector were 4.1% higher in Q4 compared with a year earlier. They’re up 17% cumulatively from 2019, and 41% over the past decade, per Cushman.

Demand for retail space stayed strong overall in 2023 thanks to a growing economy and strong labor market that kept Americans shopping. (…)

The sector ran a gauntlet of store closures and bankruptcies as it faced web competition — and then COVID hit, leading to worries it would never recover.
(…)

That’s meant depressed levels of retail construction for the past decade. “Lack of new retail construction has kept a ceiling on the vacancy rate since the start of the pandemic,” per the Cushman report.

Last year just 8 million square feet of new retail space was constructed — that’s compared to about 20 million in 2019.

Even those numbers are small compared to a decade ago. From 2008-2014, new construction averaged nearly 40.8 million square feet per year, per Cushman.

What’s emerged is a more resilient landscape. These days e-commerce and physical retail now complement each other. Opening a brick-and-mortar store can even increase a brand’s online sales, according to a study from late last year. Closing a store has the opposite effect.

Shopping centers became more diverse — there are medical offices, gyms, day care centers, and pickleball.

For all the transformation brought by the web, online shopping still only represents about 16% of overall retail sales.

Americans’ love of shopping is one more simple reason for brick-and-mortar retail’s staying power.

• “We are social beings, we enjoy being out and one of the things we like to do when we’re out is to shop,” says Moody’s LaSalvia.
• That’s why the whole notion of a retail apocalypse “never made sense in the first place.”

Retail’s evolution may hold lessons for what’s happening in the office market, which is struggling to adapt to a remote-friendly work world.

Landlords might need to get flexible with all those empty offices, some of them might go away entirely or get converted to residential buildings or transform into a new mixed-use situation.

It took more than a decade for retail to adapt to a new era, it’s reasonable to assume the office market will need a similar amount of time.

China Factory Activity Contracts for Fourth Straight Month A lackluster start to the year points to limits in exports’ ability to drive growth as real estate struggles.

(…) China’s official manufacturing purchasing managers index rose to 49.2 in January, from 49 in December, the country’s National Bureau of Statistics said Wednesday. Though the measure marked a slight improvement from the previous month, the index remained below 50, which indicates a contraction, for a ninth month out of the past 10. (…)

A subindex of new orders edged up to 49 in January, from 48.7 the previous month, though it remained in contraction for a fourth straight month. (…)

Meanwhile, a gauge of nonmanufacturing activity, which covers both construction and services sectors, edged up to 50.7 from December’s 50.4. A measure of construction activity dropped to 53.9 from 56.9 in December, reflecting China’s ongoing property woes.

The subindex tracking service activity rose to 50.1 from December’s 49.3, edging into expansion for the first time since October. Still, economists broadly expect services, which enjoyed a boost after China removed all pandemic-era curbs roughly a year ago, will provide less of a boost to overall growth than in 2023.

Wednesday’s data release offered discouraging signs for the country’s labor market. The employment subindex for both the manufacturing and nonmanufacturing surveys came in below the 50 mark. Among manufacturers, the gauge fell to 47.6 from December’s 47.9, pointing to tepid appetite for more factory workers. (…)

EARNINGS, SENTIMENT WATCH

Microsoft, Alphabet and AMD Struggle to Meet AI Expectations Earnings disappoint investors despite companies’ AI inroads

Shares of the tech giants slipped in late trading Tuesday after they delivered results for the last three months of 2023 and forecasts for the current quarter. All three took pains to highlight progress on AI. In AMD’s case, the company predicted that its new AI processors will generate even more sales than expected. Microsoft touted how users were embracing its AI assistants, and Google said the technology was improving its search and cloud computing services.

But investors had bid up shares of the companies to record highs in recent weeks, betting that an AI bonanza would quickly fuel results. What they heard on Tuesday wasn’t enough to satisfy those hopes. (…)

Microsoft and Google, two rivals in AI software and cloud computing, delivered mostly good news in their reports — but still elicited a ho-hum from investors.

At Microsoft, revenue increased at the fastest rate since 2022, spurred in part by AI products helping drive adoption of its data-center services. Revenue from its Azure cloud-services unit jumped 30%.

AI demand boosted that growth rate by 6 percentage points, Chief Financial Officer Amy Hood said. That was up from 3 percentage points the previous quarter — an acceleration that that UBS Group AG analyst Karl Keirstead called “just extraordinary” on a call with company executives. Microsoft didn’t disclose how much it expected AI to bolster Azure in the current period.

Despite the momentum, Microsoft shares slipped in late trading. Wall Street wanted more clarity on how much AI will contribute to financial performance going forward, said CFRA Research analyst Angelo Zino. “Investors want them to quantify the AI potential over the next couple years,” he said. (…)

In November, Microsoft released its 365 Copilot — an AI assistant for Office programs like Outlook, Word, PowerPoint and Teams. The company didn’t give specifics on subscriptions for the product, but Chief Executive Officer Satya Nadella said on the conference call that adoption was “much faster” than with previous versions of the software.

With Google, softness in its core search advertising business raised concerns. But its quarterly report also sparked questions about whether it’s being aggressive enough in AI — and risks falling behind Microsoft. (…)

[AMD] said that its highly anticipated MI300 AI accelerator chip is generating much higher sales than expected.

The processor, similar to Nvidia’s popular H100, helps develop AI models by bombarding them with data. Demand is high enough for the product that AMD now expects to ring up more than $3.5 billion in sales this year, up from an earlier $2 billion forecast.

The catch: Some on Wall Street had been predicting numbers as high as $8 billion, according to Chris Caso, an analyst at Wolfe Research. AMD shares fell more than 6% in late trading.

• Risk taking is running rampant. The Mag 7 Beta is 1.4 and individual investors’ Beta is a near-historic high of 1.2. But #valuation determines longer-term returns and low beta #stocks are historically cheap. (@RBAdvisors)

  

• By the way, the consumer confidence survey cited above also has a series showing the percentage of respondents who believe that stock prices will be lower in 12 months. It fell sharply in January to only 24.9%. The bull market may be running out of bears! (Ed Yardeni)



• Markets Keep US Exceptionalism Going for a Reason Earnings of the Magnificent Seven are now practically a macro event, and no one else has anything like them.

(…) The US is currently seeing the widest gap between S&P 500 current earnings yield and MSCI Europe Index ever. Put simply, Europe has never been this cheap versus the US. The earnings yield investors get from European assets looks far more attractive than the American benchmark.

The same pattern emerges when comparing 12-month forward price/earnings multiples for the two markets. By Bernstein’s estimate, Europe is trading at an all-time deep discount of 33% compared to its US peers — steeper even than the pre-pandemic discount of 20%. That’s the widest based on the 35-year dataset that Bernstein tracks, and comfortably bigger even than during the Global Financial Crisis:

A valuation spread is warranted. Roughly 15 years of lower rates have favored the valuation of US equities. The so-called Magnificent Seven tech giants are all American, and European equities have a poor track record of delivering persistent positive earnings growth. Yet Bernstein noted the gaps in earnings-growth expectations, quality, or the economic outlook are not enough to justify the spread. (…)

That should be a worthwhile reminder that it’s the big tech groups that really place the US apart. Judging the S&P 500 on an equal-weighted basis (so that the tech giants aren’t weighted higher than anyone else) leaves the European Stoxx 600 more or less on equal terms since the beginning of 2021. (…)

But it’s still the US whose data is coming in furthest ahead of expectations, as illustrated by the Citi Economic Surprise indexes:

To Don Rissmiller of Strategas Research Partners, the world is trying for what he calls an “economic landing.” How might this appear? “In some countries, this looks like a hard landing (China), and elsewhere, it has been bumpy (e.g., Europe). But the US is seeing solid growth with tame inflation — that’s the pathway to a soft landing, especially given developing fiscal cushions (e.g., as the current tax bill being considered in DC) and likely Fed rate cuts in 2024.”

Or put differently, it’s still going to take a lot of guts to bet against American exceptionalism.

BTW:

Six of the seven companies in the “Magnificent 7” are projected to be the top six positive contributors to year-over-year earnings for the S&P 500 for Q4 2023: NVIDIA, Amazon.com, Meta Platforms, Alphabet, Microsoft, and Apple. In aggregate, these six companies are expected to report year-over-year earnings growth of 53.7% for the fourth quarter. Excluding these six companies, the blended (combines actual and estimated results) earnings decline for the remaining 494 companies in the S&P 500 would be -10.5% for Q4 2023. Overall, the blended earnings decline for the entire S&P 500 for Q4 2023 is -1.4%. (…)

It is interesting to note that four of these six companies are also projected to be the top four contributors to earnings growth for the S&P 500 for Q1 2024: NVIDA, Amazon.com, Meta Platforms, and Alphabet. In aggregate, these four companies are projected to report year-over-year earnings growth of 79.7% for Q1 2024. Excluding these four companies, the remaining 496 companies in the S&P 500 would be projected to report year-over-year earnings growth of 0.3% for Q1 2024. Overall, the estimated earnings growth rate for the entire S&P 500 for Q1 2024 is 4.6%. (Factset)

• America’s money mojo (Axios)

The U.S. economy grew faster than any other advanced economy last year — by a wide margin — and is on track to do so again in 2024, Axios’ Neil Irwin writes.

America’s outperformance is rooted in its distinctive structural strengths, policy choices and some luck. It reflects a fundamental resilience in the world’s largest economy that’s easy to overlook with the nation’s problems. (…)

It’s not just that the U.S. is doing well. It’s that other major economies have distinctive problems holding back growth.

Data: IMF World Economic Outlook. Chart: Axios Visuals

• Nassim Taleb Says US Faces a ‘Death Spiral’ of Swelling Debt Black Swan author says it’s hard to see a way out of problem

“So long as you have Congress keep extending the debt limit and doing deals because they’re afraid of the consequences of doing the right thing, that’s the political structure of the political system, eventually you’re going to have a debt spiral,” he said Monday night at an event for Universa Investments, the hedge fund firm he advises. “And a debt spiral is like a death spiral.”

Taleb defined the ballooning debt load as a “white swan,” a risk that’s more probable than a surprise “black swan” event. While he didn’t identify specific outcomes in markets, he did say white swans include both the US deficit and an economy that’s far more vulnerable to shocks than in prior years.

The reason for that, he said, is that the world is far more interconnected due to globalization, with issues in one region able to ricochet around the world. (…)

This month, former Treasury Secretary Robert Rubin said the world’s biggest economy is in a “terrible place” with regard to its federal deficits, while BlackRock Inc. Vice Chairman Philipp Hildebrand has warned that any default could imperil the dollar as a global currency. (…)

• ‘Big Short’ Investor Steve Eisman Shrugs Off Warnings on US Deficit, Stocks Suggests deficit worries overblown, countering Taleb, Rubin

The Neuberger Berman Group portfolio manager said there’s no real sign that elevated US debt poses a problem for markets or the US government. He’s equally sanguine on equities, despite the parallels t hat some perceive between today’s market and the dot-com bubble era. (…)

“This argument about the deficit has been going on for forty years,” Eisman said, adding there are few reasons to worry “until I see real signs there’s a problem.” (…)

Iran Vows to Retaliate Against Any Attack as US Readies Response Biden said he had made a decision on how to retaliate against the assault in Jordan.

Musk’s $55 Billion Pay Package Voided, Threatening World’s Biggest Fortune Largest-ever compensation package struck down in ruling.

Elon Musk’s $55 billion pay package at Tesla Inc. was struck down by a Delaware judge after a shareholder challenged it as excessive, a ruling that would take a giant bite out of Musk’s wealth and put the fate of his companies in question.

That is if the ruling survives a likely appeal.

The decision Tuesday, which amounts to his first major loss in court, means that more than five years after the electric-car maker’s co-founder was granted the largest executive compensation plan in history, Tesla’s board will have to start over and come up with a new proposal. Musk never attempted to exercise his options since they’d been challenged in Delaware Chancery Court. (…)

Musk has repeatedly urged Tesla’s board to arrange another massive stock award for him, years after he sold a significant chunk of his shares in the company to acquire Twitter. The billionaire has said he needs a bigger stake in Tesla to maintain control of the electric-car maker and expand further into artificial intelligence.

The ruling leaves the future of Musk’s fortune in limbo. Worth some $51.1 billion, the options were one of his most valuable assets. Without them his net worth would drop to $154.3 billion (…).

Following a trial that ended more than a year ago, Delaware Chancery Court Chief Judge Kathaleen St. J. McCormick sided with an investor who complained Tesla directors didn’t make proper disclosures about the 2018 executive compensation package and the performance benchmarks required of Musk. She also found that conflicts of interest marred the board’s consideration of the pay plan.

“In the final analysis, Musk launched a self-driving process, recalibrating the speed and direction along the way as he saw fit,” the judge wrote in a 200-page ruling. “The process arrived at an unfair price. And through this litigation, the plaintiff requests a recall.” (…)

Speaking of Elon Musk:

EVs vs. bugs (Axios)

General Motors is racing to diagnose and fix software issues that have caused flickering screens, looping error messages and glitchy charging in some of its most important new electric vehicles (EVs), Joann reports.

Similar problems are plaguing the entire auto industry as vehicles morph into battery-powered “supercomputers on wheels.”

Software bugs on your phone or laptop are an annoyance. A software snafu in a car isn’t just aggravating, it could be life-threatening.

Cars are exponentially more complex than smartphones, and software updates can have unintended consequences that affect other systems.

Multiple carmakers, including GM, Volkswagen, Volvo Cars and Polestar, have delayed new EVs while they rethink their approach to software development.

I have been driving Tesla cars (X, 3, and Y models) since 2020 without any meaningful software issues. Tesla software is completely Tesla-coded, unlike other car manufacturers which rely on various suppliers and struggle to integrate them.

Most traditional automakers don’t have the required software skills and are struggling to reorient their businesses around this approach, Sam Abuelsamid, principal research analyst at Guidehouse Insights, tells Axios.

GM is a prime example of the software headaches automakers are facing.

• It stopped selling its new Chevrolet Blazer EV in December after early owners and reviewers encountered software issues and other problems.
• GM’s software and services team, led by former Apple exec Mike Abbott, is working “with a huge sense of urgency” to get the Blazer EV back on sale, CEO Mary Barra told investors yesterday during a fourth-quarter earnings call.
• “We disappointed these customers, and we know it,” Barra said. “We are determined to get the software right, and we will.”

Barra described “several organizational and process improvements” in GM’s software and services team, including a new software quality division and revamped testing and validation procedures.

• That group has been quality-auditing the Blazer EV and other delayed models in GM’s pipeline to root out coding problems, a company spokesperson said.

It’s still a work in progress, Barra noted.

• GM postponed an investor update previously scheduled for March in part to give the software team more time to complete its work. (…)

Legacy automakers are great at hardware — it’s software that’s the challenge.