On to Greener Pastures: Smallest LEI Decline Since 2022

While the Leading Economic Index continues to signal recession, a milder pace of contraction and broad-based improvements in the index’s components suggest activity, especially in interest-rate sensitive sectors, has found a floor.

Source: The Conference Board and Wells Fargo Economics

The Leading Economic Index (LEI) continues to signal recession. Falling 0.1% in December, the LEI has slid for 22 consecutive months and currently stands only three points higher than its low point during the initial pandemic lockdown in 2020.

While the index remains in the red, the monthly outturn clocked in well below the 0.7% decline averaged over the previous three months and marked the smallest decrease since March 2022 when activity was wavering amid the start of the Federal Reserve’s tightening cycle. The milder pace of contraction suggests that activity, especially in interest-rate sensitive sectors, has found a floor.

Six components positively contributed to the LEI in December—the most since early 2022. Stock prices distantly led the pack, adding 0.20 percentage points to the headline index, as the S&P 500 was in the midst of a run toward another record high that it set last week. Initial claims for unemployment insurance (+0.09) and home building permits (+0.06) were modestly additive as well.

Notably, the Leading Credit Index, which consists of financial tightness indicators, such as the 2-year swap spread and debit balances on margin accounts, was revised to show a positive contribution in November (+0.05) and December (+0.10) for the first time since the summer of 2022. Expectations for the Fed to ease policy this year have helped to relax financial conditions.

On the flip side, sentiment remains weak. The new order component of the ISM manufacturing index chopped 0.18 percentage points off the LEI in December, nearly canceling out the gain from stock prices. Consumer expectations (-0.12) also sliced the monthly change. Yet the recent strength seen in the University of Michigan’s Consumer Sentiment index and the Conference Board’s Consumer Confidence index suggest household confidence is turning a corner as real income has strengthened amid improving inflation.

In short, while recession risks remain elevated, incremental improvements in the LEI’s components suggest the likelihood of an economic downturn is fading.

These 2 charts from Advisor Perspectives illustrate the current unusual no-landing:

  

Between 1959 and 2020, the LEI provided an average lead time to a recession of 10.6 months (range of 1 to 20!). The last peak was 24 months ago.

Meanwhile, the Coincident Economic Index shows no inclination towards any landing, hard or soft.

Since 1959, a declining LEI/CEI ratio led recessions by 6.8 months on average with a nice tight range of 2-9. It has now been declining for 21 months!

More useful/useless stats?

• Historically, a recession has started 23 months after the first increase of a persistent hiking cycle. In fact, only three of the last 12 persistent hiking cycles (since the late 1950s) saw a recession begin by this point [August 2023]. Given how far behind the curve the Fed was coming into this hiking cycle with nearly double-digit inflation and federal-funds rate starting at 0%, it is understandable that recession headwinds need more time to coalesce. (Franklin Templeton)
• The longest it took to enter recession after the first rate hike was 84 months.
• Not every Fed hiking cycle leads to a recession, but all hiking cycles that invert the curve have led to recessions within 1 to 3 years (Deutsche Bank).
• “Remember, it takes an average of 26 months between the time the Fed first hikes rates in a cycle and the onset of a recession. That means that it would be perfectly normal for the recession nobody sees happening to commence in the second quarter. The bull market is really impatient and tempestuous. As for the yield curve, the maximum odds of recession occur between 5 and 19 months after the inversion starts, so again, we must respect the fact that there are long lags at play.
  Delayed does not mean derailed. As things currently stand, the latest Beige Book showed half the country in or about to enter recession while the other half is hanging in; likewise, the move in the unemployment rate from the cycle lows also confirms that half the country is in recession — and the other half is not. (…) we also had 21 straight months of decline in the LEI from April 2007 to December 2008. Before that, June 1973 to February 1975. Don’t throw the recession towel in just yet — delayed does not mean derailed.(David Rosenberg)

That said:

The LEADING Indicators are bottoming. The OECD’s tends to…um…lead the Conference Board’s and it appears to be doing so again in this #cycle. Remember the #Fed is a lagging indicator. (@RBAdvisors)

Desperate Chinese Property Developers Resort to Bizarre Marketing Tactics The country’s real-estate slump is getting worse—and looks set to drag on for years.

Sales of newly built homes in China fell 6% last year, returning to a level not seen since 2016, according to China’s statistics bureau. Secondhand home prices in its four wealthiest cities—Beijing, Shanghai, Guangzhou and Shenzhen—declined by between 11% and 14% in December from the year before, according to the broker Centaline Property.

Developers are starting fewer projects. Homeowners are paying back their mortgages early and borrowing less. Once-thriving property companies are stuck in protracted negotiations with foreign investors, following defaults on about $125 billion of overseas bonds between 2020 and late 2023, according to figures from S&P Global Ratings. (…)

Earlier this month, Sheng Songcheng, former head of the statistics department at the People’s Bank of China, told a local conference that the housing downturn would last another two years. He thinks new-home sales will fall more than 5% in both 2024 and 2025. (…)

Liu Yuan, head of property research at Centaline, said that without the government’s help, new-home prices will need to drop by another 50% from current levels before they reach a bottom. This is based on the assumption that the tipping point will only come when it is cheaper to buy than to rent houses, Liu said. (…)

More than 50 developers—mostly privately owned—have defaulted on their debt. Developers still have millions of unfinished homes that were sold but not delivered. Chinese authorities have set aside billions of dollars to help builders complete apartments but the logjam is growing.

The crisis has drained the coffers of some Chinese local governments, which previously relied on land sales as a main source of income. Economists estimate they have hidden debt worth anything from $400 billion to more than $800 billion. To quiet talk of potential defaults, the central government has set up debt-swap programs to help some of them refinance. (…)

• China Weighs Stock Market Rescue Package Backed by $278 Billion

Chinese authorities are considering a package of measures to stabilize the slumping stock market, according to people familiar with the matter, after earlier attempts to restore investor confidence fell short and prompted Premier Li Qiang to call for “forceful” steps.

Policymakers are seeking to mobilize about 2 trillion yuan ($278 billion), mainly from the offshore accounts of Chinese state-owned enterprises, as part of a stabilization fund to buy shares onshore through the Hong Kong exchange link, said the people, asking not to be identified discussing a private matter. They have also earmarked at least 300 billion yuan of local funds to invest in onshore shares through China Securities Finance Corp. or Central Huijin Investment Ltd., the people said.

The deliberations underscore the elevated sense of urgency among Chinese authorities to stem a selloff that sent the benchmark CSI 300 Index to a five-year low this week.

Calming the nation’s retail investors, many of whom have been bruised by the protracted property downturn, is also seen as key to maintaining social stability. (…)

In all, more than $6 trillion has been wiped out from the market value of Chinese and Hong Kong stocks since a peak reached in 2021, underscoring the challenge that Beijing faces as it seeks to arrest a decline in investor confidence. (…)

During the 2015 rout, Beijing tapped China Securities Finance Corp. as its main stabilization vehicle by allowing it to access as much as 3 trillion yuan of borrowed funds from sources including the central bank and commercial lenders. The money was used to buy stocks directly and provide liquidity to brokerages. Even so, the turbulence didn’t end until a year later. (…)

The stock meltdown is adding pressure on so-called snowball derivatives, which are structured products that promise bond-like coupons as long as the underlying assets trade within a certain range. The CSI Smallcap 500 Index, a pricing reference for some of these products, slipped 4.7% on Monday, taking it below an earlier estimated threshold that may trigger widespread losses on the snowballs.

• China Snowballs and Their Role in This Year’s Stock Selloff: Q&A

Chinese stocks’ brutal start to the year is being at least partly blamed on the impact of a relatively new financial derivative known as a snowball. The products are tied to indexes, and a key feature is that when the gauges fall below built-in levels, brokerages will sell their related futures positions.

Stock declines are most pronounced in indexes to which snowballs are known to be linked, possibly revealing their impact. There’s also great uncertainty over just how many snowballs have been sold, which adds to their potential menace. (…)

There isn’t any single level that analysts agree as a major trigger for knock-ins. CICC in October estimated the levels where most investors would lose coupons would be 4,865 points on the CSI 500 Index, and 4,997 for the CSI 1000. Both of these have been breached this month, though the latter only on an intraday basis.

(…) the market has been on edge over any possible contagion effect. (…)

No doubt, the Party is worried the people may be getting more than angsty having seen their life long savings (housing, equities) tumble, with no end in sight, and a largely unemployed youth. That could also snowball.

From today’s John Authers’ column:

Thanks to its sheer size, and to the legacy of previous crude but effective attempts to dampen the birth rate, China’s demography tends to dominate perception. As this chart from Ernan Cui of Gavekal Dragonomics demonstrates, Chinese births are falling much faster than recent projections had predicted. Continuing declines in the number of women of child-bearing age will likely bring them down further:

Other countries have seen sharp falls in births in the past, notably Japan, where births started to decline in 1973. The country began to lapse into its long economic malaise in 2000 as that cohort began to reach parenting age. But as Cui shows, the decline in China since its recent peak in 2016 has been much faster:

• Meanwhile, India has become the world’s fourth-largest stock market, overtaking Hong Kong, where some of China’s most influential and innovative firms are listed, as global capital pours out of Chinese equities on stalling growth and regulatory uncertainty. (Bloomberg)

INTO RARIFIED AIR!

@RBAdvisors

Humanoid robots will join BMW’s production line

Figure, a humanoid robot made by an eponymous California company, can walk and manipulate things with dexterous hands. Photo courtesy of Figure

BMW’s newest autoworker is 5’6,” 130 pounds, walks on two legs, uses five-fingered hands to assemble machines — and takes a break every five hours to stroll to a charging station and plug itself in.

Under a first-of-its-kind deal, humanoid robots from a California company called Figure will begin working in BMW manufacturing plants, starting in Spartanburg, South Carolina.

Robots have long been essential tools on auto assembly lines, but this is the first time that autonomous human-shaped robots will join the fray — with big potential labor market implications.

• Humanoid robots are already being tested in warehouses, and are eventually expected to help out in hospitals and nursing homes.
• “I think the next 24 months you’ll start seeing humanoid robots in the real world,” Brett Adcock, Figure’s CEO and driving force, tells Axios.

While it’s a bit nebulous what the robots will be doing for the automaker, the agreement between Figure and BMW calls for the “deployment of humanoid robots in an automotive manufacturing environment” using a “milestone-based approach.”

• In the first phase, Figure will “identify initial use cases to apply the Figure robots in automotive production.”
• Next, the robots will “begin staged deployment at BMW’s manufacturing facility” in Spartanburg.
• BMW and Figure will also “explore advanced technology topics such as artificial intelligence, robot control, manufacturing virtualization and robot integration.”

Adcock, a serial entrepreneur, tells Axios that his robots “can do basically everything a human can.”

• “There’s just a lot of work in these facilities that’s really hard to automate,” he added. “Being mobile on the floors, being dexterous — there’s a lot of work we can do.”
• “We need humanoid [robots] in the real world, doing real work — that’s a big milestone for the whole space,” Adcock said.
• Car production is evolving rapidly, and robots have “the potential to make productivity more efficient” and “enable our team to focus on the transformation ahead of us,” Robert Engelhorn, president and CEO of BMW Manufacturing, said in a statement.

Figure robots stand at attention at the Figure factory. Photo courtesy of Figure

Automakers have been looking to lean more heavily on robots to combat rising labor costs, the Wall Street Journal reports.

• The UAW won historic labor agreements with the Big Three automakers last fall, which will translate to raises and more generous pay packages for workers.
• When asked how Ford plans to cover the cost of its new labor contract, CFO John Lawler “pointed to ‘opportunities in automation,'” per the Journal.
• Robots can do dangerous tasks or operate in hard-to-reach places — but there can be trade-offs in terms of performance and wise judgment.

Humanoid robots that can walk and use their hands are formidably hard to build — hence the small number of companies thriving in this space.

• Agility Robotics makes a robot called Digit that’s being tested by Amazon toting containers in a warehouse. (Agility is poised to open a robot-making factory called RoboFab.)
• A company called Apptronik has a new robot named Apollo that’s starting to do warehouse work. It’s also working with NASA on humanoid robot commercialization.
• Other players include Tesla’s Optimus (which recently folded a shirt, prompting jeers from observers who were underwhelmed) and Boston Dynamics’ Atlas, which does parkour.

Americans Are Suddenly a Lot More Upbeat About the Economy  Consumer sentiment gauge posted the largest two-month gain since 1991

Consumer sentiment surged 29% since November, the biggest two-month increase since 1991, the University of Michigan said Friday, adding to gauges showing improving moods. (…)

Consumer sentiment leapt 13% in the first half of January from December, the Michigan survey said, after a sharp rise the prior month. The pickup in sentiment was broad-based, spanning consumers of different age, income, education and geography. (…)

What has changed is that inflation is cooling rapidly, while mortgage rates are down sharply from last year (…).

Consumers’ expectations for inflation a year ahead dropped to 2.9% in January, the lowest level since December 2020, and down from 4.5% in November, according to the Michigan survey.

Fannie Mae’s index of home-buying sentiment jumped 10% in December from a year earlier. That was driven in part by a surge in the share of consumers anticipating lower mortgage rates over the next year. (…)

Media coverage might be rubbing off on consumers, too. The mood of economy-related articles has rebounded since November to the highest level since 2018, according to the San Francisco Fed’s Daily News Sentiment Index. Coverage had skewed much more negatively in the past three years relative to economic fundamentals, a Brookings Institution analysis found. (…)

Wells Fargo:

The fact this outturn comes on the heels of a big December gain means that over the last two months, sentiment has climbed a cumulative 29%, the largest two-month increase since 1991. Back then, a recession was just ending, today expectations of imminent recession are fading. (…)

Income expectations are on the rise as well. When asked “what do you think is the percent chance that your income in the next twelve months will be higher than your income in the past twelve months?”, 60% responded ‘yes’. Not only does this mark the largest share on record in data going back to the early 2000s, but as long as consumers think their income will be higher, so too will their spending. (…)

Longer term inflation expectations also declined to 2.8% in January from 2.9% in December. This is the lowest reading for five-to-ten year inflation expectations in a year and a half, demonstrating expectations remain well anchored—a welcome sign for the Fed. For context, longer term expectations are now approaching the average rate of 2.7% that prevailed in the measure during the 2010-20 decade. Consumers are thus presently taking note of slowing inflation.

Gas prices have declined thus far in January with the average price of a gallon of gas down about $0.10 to $3.01 from the start of the month, according to AAA. As prices at the pump are one of the most visible measures of the cost of living to U.S. consumers, it is a major driver of month-to-month movement in inflation expectations. The remarkable decline in gas prices since summer 2023 is without a doubt affecting how consumers feel about the cost of living, and this in turn can affect how consumers feel about the economy more broadly.

Source: The University of Michigan, AAA and Wells Fargo Economics

Take big swings in sentiment with a grain of salt. Despite how they “feel” about their income prospects, the labor market is losing momentum. The reality may fall short of the euphoria that has taken hold in terms of income expectations. Also, if consumers rush out and spend more, the increased demand could cause the trend decline in inflation to slow or even reverse course.

Existing Home Sales Dip in December Despite Lower Rates, Home Buying Constrained by Low Supply and Rising Prices

Existing home sales ended last year on a low note and declined 1.0% in December. Single-family sales and condo sales both declined during the month. The 3.78 million-unit pace of total resales hit during the month marks a fresh cycle low and was the slowest sales pace since 2010.

December’s unexpected dip is a reminder that financing costs are just one factor in the decision to purchase a home. Mortgage rates have dropped by over a full percentage point since last October, yet buyers still need to contend with low supply and rising prices.

That noted, there is plenty of evidence that buyers are starting to come out of hibernation as rates move lower. Mortgage applications for purchase, which have risen nearly 30% since bottoming in October at a low not seen since the 1990s, registered another solid gain in the second week of January. The upturn suggests resale activity should begin to gain momentum in coming months.

  

      Freddie Mac and Wells Fargo Economics                         NAR, Mortgage Bankers Association and Wells Fargo Economics

Pending Home Sales Rose 4% in December—Biggest Jump in Over Two Years

Pending home sales rose 4.1% month over month in December on a seasonally adjusted basis—the biggest increase since September 2021—to the highest level in more than a year. They climbed 5.9% from a year earlier, the biggest annual gain since June 2021.

Pending sales jumped because a steep drop in mortgage rates lured buyers to the market. The average 30-year-fixed mortgage rate fell to 6.82% in December from 7.44% in November, the biggest monthly decline since 2008. Buyers who were casually looking when rates were above 7% are now getting serious, Redfin agents say.

The dip in mortgage rates has also brought sellers off of the sidelines, though they haven’t returned with as much intensity as buyers, likely because a majority of them don’t want to give up the ultra low mortgage rate they scored during the pandemic. New listings rose 0.1% month over month to the highest seasonally adjusted level since September 2022, and were up 2.7% year over year—the largest increase since July 2021.

While housing supply has ticked up, it remains below pre-pandemic levels. Active listings, or the total number of homes for sale, rose 3.1% month over month on a seasonally adjusted basis but fell 5.1% from a year earlier. (…)

“Bidding wars are happening again, but they’re much more reasonable than they were during the pandemic homebuying frenzy,” Alwan said. “Houses are getting between one and five competing bids, and instead of offering one or two hundred thousand dollars over the asking price, competitive buyers are offering 3% to 5% over.” (…)

• Renting vs. owning:

Source: @WSJ

• FYI: KB Home last week indicated that selling conditions improved substantially in December with the fall in interest rates. It provided strong guidance on all important metrics for Q1’24 and FY24.

China Buys Near-Record $40 Billion of Chip Gear to Beat US Curbs Imports of machines to make chips rose 14% last year

(…) China’s imports from the Netherlands soared last year ahead of new export controls, which will further limit the ability of companies such as Semiconductor Manufacturing International Corp. to get the latest machinery.

In December, imports of lithography equipment from the Netherlands jumped almost 1,000% from a year earlier to $1.1 billion as firms rushed to buy ahead of the start of Dutch restrictions this month. (…)

EARNINGS WATCH

We now have 52 reports in: the beat rate is 85% and the surprise factor +3.7%.

The actual earnings growth rate of these 52 companies is –0.1% on a +5.2% revenue growth rate.

Trailing EPS are now $220.05 and full year 2024 estimates $243.17.

From The Transcript: CEO confidence is improving

“We’re seeing improved confidence among CEOs and we like our pipeline, but of course, the timing for a robust recovery is uncertain.” – Citigroup © CEO Jane Fraser

“Corporate confidence will ultimately drive the cycle forward, and we are encouraged that CEO and boardroom optimism is growing evidenced by the build of our advisory and IPO pipeline.” – Morgan Stanley (MS ) CFO Sharon Yeshaya

From Callum Thomas:

Fund Manager Performance Cycles:  It’s harder for stock pickers (who get measured against cap-weighted indexes) to outperform the index when leadership is very narrow and the index gets increasingly concentrated (e.g. dot com bubble, US big-tech decade). But it’s precisely those conditions which improve the odds for fund managers to outperform in the future (market cap-weighted indexes end up becoming more concentrated and exposed to the most expensive stocks during a sector-specific boom e.g. dot-com, mag-7), meanwhile the out-of-favor stocks get cheaper. So active management likely makes a come back in the coming years.

Source: Cambridge Associates via Snippet Finance

US Stockmarket Valuations — Tech vs The Rest:  An important chart from my Q1 Strategy Pack, often requested, and highly relevant to some of the themes throughout this edition — it shows the combined PE ratio (average of cyclically adjusted PE, trailing PE, forward PE) for US tech stocks (blue line) and for the rest of the market.

Basically the takeaway is that tech stocks are expensive, and the rest of the market is not.

Ed Yardeni offers several complementary charts:

• IT P/Es are back to their recent peaks, unlike the S&P 500 Index P/E:

• Yardeni’s Megacap-8 now account for more than 27.8% of the S&P 500 market cap and 50.8% of its growth component:

• The S&P 500 ex-Megacap-8 P/E is 16.7. Using the Rule of 20, the R20 P/E is 20.6, roughly fair value.

• The Megacap-8’s expected long term earnings growth rate is above 40x. Unrealistic given their size.

• But this is not a homogeneous group…