Economy Resumes Growth but Offers Mixed Signals GDP increased 2.6% in the third quarter after declining in the first half of the year, as the trade balance boosted growth. But Americans cut spending on goods and slowed spending on services, while businesses pared investment in buildings.

(…) Trade contributed the most to the third quarter’s turnaround as the U.S. exported more oil and natural gas with the Ukraine war disrupting supplies in Europe. (…)

Economists don’t expect the third-quarter rise in exports to endure, given a stronger dollar and weakening global economy. Many point to final sales to private domestic purchasers, a measure of consumer and business spending that gauges underlying demand in the economy, as a sign of a broader economic slowdown. That inched up at a 0.1% annual rate in the third quarter after it rose 0.5% in the second quarter and increased 2.1% in the first quarter. (…)

Axios explains that

In effect, the economic pain being wrought in order to reduce inflation is concentrated, to a remarkable degree, in a single sector.The sector contracted at a 26.4% annual rate in Q3, subtracting more from GDP than it has since 2007. Residential investment pulled more from total growth (1.37 percentage points) than consumption spending added (0.97 points). Yet residential investment is only about 4% of the total economy while personal consumption is 68%.

The 26.4% rate of contraction in the sector is nearly as bad as during the height of the pandemic (-27.4% in Q2 2020) and the global financial crisis (-33.6% in Q4 2008).

The grey and orange boxes are the most important:

Contributions to US quarterly annualised GDP growth

Source: Macrobond, ING

U.S. Durable Goods Orders Boosted by Transportation in September

Activity in the factory sector appears to be plateauing. New orders for durable goods increased 0.4% m/m (11.3% y/y) in September but this increase was more than accounted for by a 2.1% m/m increase in transportation orders. Excluding these, the remainder of durable goods orders fell 0.5% m/m (+5.1% y/y) after having been unchanged in August (revised down from a 0.3% monthly gain). Over the past three months, total orders have risen just 0.4% and excluding transportation, they have fallen 0.4%. The Action Economics Forecast Survey had looked for a 0.5% m/m increase in total orders in September. (…)

Business spending on equipment also sputtered in September. New orders for nondefense capital goods excluding aircraft fell 0.7% m/m (+7.9% y/y) in September after a downwardly revised 0.8% monthly gain in August (initially reported as +1.4%). This was the first monthly decline in seven months. An accurate coincident indicator of business spending on equipment is shipments of nondefense capital goods excluding aircraft.(…)

Quarterly orders (in nominal dollars) (blue) against PPI-Capex (red) QoQ:

Q3 looks better but the quarter ended poorly as September’s -0.74% decline completely erased August gain, particularly in real terms (-1.0% vs +0.4% MoM).

Another instance suggesting the economy hit a wall in recent weeks.

• Yesterday, Seagate Technology CEO said: “Global economic uncertainties and broad-based customer inventory corrections worsened in the latter stages of the September quarter, and these dynamics are reflected in both near-term industry demand and Seagate’s financial performance”.
• CEO Satya Nadella commented that corporate customers have moved to “optimize” their spending in response to a suddenly shaky economic outlook. During yesterday’s conference call, AMZN CFO said that cloud customers were in a cost cutting mode.
• Apple said yesterday that YoY sales growth in its December quarter will be lower than the 8% revenue increase in last quarter. BTW, “The average selling prices of the iPhone rose to $954 in the company’s June quarter, up from $783 [22%] in the 2019 September quarter, according to Consumer Intelligence Research Partners.”

Consumer expenditures for September are released at 8:30 this morning.

• Amazon’s Holiday Blues Come Early—and Hard Downbeat forecast sinks shares as both retail and cloud businesses feel pinch of slowing economy

The company’s third-quarter results included revenue that was slightly below analysts’ estimates and another sharp drop in operating income—the latter down 48% year-over-year. Adding insult to injury, growth in the company’s subscription service revenue fell into single-digit territory for the first time ever, despite the debut of its costly “Lord of the Rings” series for subscribers of its Prime streaming service.

More notably, Amazon projected revenue and operating income for the fourth quarter that was well below the consensus forecast, leading its shares to fall as much as 18% in after-hours trading.

(…) Amazon’s massive retail business, which now generates more than $350 billion in annual sales, is particularly exposed to consumers across the globe who are seeing their spending power crimped by rising inflation. And its typically strong cloud business isn’t immune either; Amazon Web Services segment revenue grew by a record-low 27% from a year earlier to about $20.5 billion in the quarter, as Chief Financial Officer Brian Olsavsky noted that the company saw a lot of its corporate customers “trying to cut back on their bills.” Archrival Microsoft also projected disappointing growth for its own cloud business, but AWS plays a more vital role in helping to offset Amazon’s thin margins on the retail side. AWS operating income rose only 11% year-over-year, well short of the 31% growth Wall Street had expected. (…)

The midpoint of Amazon’s fourth-quarter revenue forecast would represent growth of 5% year-over-year—record-low growth for a quarter that has historically accounted for nearly a third of the company’s annual revenue. Operating income is also projected to slide 42% year-over-year at the midpoint, as Amazon is still working to fully utilize an overbuild of fulfillment capacity put in place during the pandemic. (…)

• Meta Loses Nearly Quarter of Market Value

The metaverse effect?

(Bespoke)

Bloomberg: “Naturally Meta’s numbers and predictions were disappointing, but its greatest problem was a sudden return by investors to the basics of cash flow and balance sheet analysis. The decline in Meta’s free cash flow drew an apology even from previously ardent backer Jim Cramer on CNBC.”

Interestingly, this is the first chart in AMZN’s presentation yesterday:

AMAZON FREE CASH FLOW

• Intel to Cut Jobs in Cost-Savings Drive The chip maker is trying to navigate a plunge in PC demand, with quarterly sales slumping 20%.

ECB Raises Rates by 0.75 Point to Highest in More Than a Decade

• ECB convinces markets it is about to turn more dovish
• ECB’s Villeroy: next ECB hikes will not necessarily be like this week’s ‘jumbo’ increase

EARNINGS WATCH

(Before yesterday’s reports) We now have 227 reports in, a 74% beat rate and a +2.5% surprise factor. These 227 companies have reported actual earnings down 2.0% on a 9.5% revenue gain.

By comparison, after 245 reports in Q2, the beat rate was 76%, the surprise factor +5.0% and those 245 companies had reported actual earnings up 4.6% on revenues up 11.3%.

Q3 earnings are now expected up 2.5% (+4.1% on October 7). Ex-Energy: -4.1% (-2.6%).

Q4 earnings are now expected up 3.1% (+5.2% on October 7). Ex-Energy: -1.1% (+1.3%), the first time Q4 ex-E are seen declining.

The FX headwind was strong during Q3.

For the first time in months, the dollar is stumbling

The U.S. dollar has been an increasing focus of investors who don’t usually pay attention to it. A surge of media articles and earnings call excuses will always help zero in investors’ attention.

After an incessant rise into October, the buck has started to oscillate and, for the first time in months, closed below its 50-day moving average. This is one of the first warning signs of a potential trend change for trend followers.

There were four times – including the last one in August – when the dollar managed to shrug off this tendency by rising and then and trigger a second signal within about six months. The table below shows its returns after these second-chance sell signals.

Every time, the dollar lost ground up to two months later. Within the next couple of months, the dollar declined at least 3.5% at some point every time, averaging more than a 6% loss.

Positioning in futures contracts is one input to the Dollar Optimism Index (Optix), which has been persistently high. The 100-day average is now above 70% for only the 3rd time since we have data. The other times, early 1997 and late 2014, preceded a long slog for the buck.

Anyone trying to use contrary analysis on the dollar has been nursing a bruised ego and brokerage account. Currencies are one of the rare markets that tend to be ruled more by forces other than sentiment. Even so, the uptrend has gone on so long that it’s being taken as a given, which is always dangerous. Now that there are nascent signs of a stumble, the risk of a long dollar position has increased substantially.

LIQUIDITY RISKS

This is from Jonathan Ruffer, Chairman, Ruffer LLP which says about itself: “Our preoccupation is with not losing money, rather than charging headlong for growth. It’s by putting safety first that we have made good money for our clients. Through boom and bust. Successfully navigating three major market corrections – the dot.com bust, global financial crisis and covid-19.” (A 27 year track record, 8.9% net annualised returns)

In the forty-five years I have been an investor, I cannot recall a more dangerous period than today. It sometimes happens that markets are about to fall sharply, and we are no stranger to navigating them – my first as a stand-alone fund manager was in 1987. But each of these falls, so far, has been partial, in that there were asset-classes which did not participate in the decline, or – as has more recently been the case – there have been insurances which had been overlooked or disdained, and offered a good risk/reward. In 1987, for instance, the real-yield on index-linked stocks approached 5% – it was hard, really, to own anything else; today, those yields are negative, meaning that you are bound to lose money in them (in real terms) if you hold them to maturity.

This chronic sense that investments are dangerous is now accompanied by an acute sense of specific danger to the markets – the rumblings of a liquidity crisis, perhaps the first in a series in the years ahead. What is liquidity? When money’s a-plenty, the question to ask is: ‘do I want to buy it?’ When there’s no money, then the question is more fundamental: ‘can I buy it?’ (…)

Over the last generation, there have been several liquidity crises, but central banks (the Federal Reserve, in practice) have always created the necessary money. This is not magic – banks, both commercial and central, create money routinely – the granting of a loan by either one of them is itself a creative act: it is, in accounting terms, merely the creation of a liability, matching the loan to a customer/counterparty, which is a corresponding asset in its books. (…)

The Federal Reserve is the ultimate source of money-creation. It has expanded its supply of money to the point where its credibility is coming into question, and so must contract it. But the Fed needs to tread carefully, and indeed it is being careful, notwithstanding its need to rein in that money because of inflationary pressures. (…) As well as battling to keep the quantity of money in check, the Fed is simultaneously straining to make sure the transmission of its interest rates to the real economy is working.

As interest rates go up, savers expect to see that paid to them – but the commercial banks aren’t passing it on. One of the big savings vehicles in the US are Money-Market Funds – roughly 90% of which only invest in government quality instruments. There aren’t enough of these bonds, so the Fed is providing interest at its desired level to these funds, and now has tied up $2.36 trillion of money-market cash, in this service to the community.

The key is that, unlike regular bank deposits, this $2.36 trillion cannot be injected into the US financial system if it’s needed. The Fed’s inflation-busting rhetoric means too, that it is shrinking its balance sheet. Commercial banks can, in theory, create money as easily and effectively as the Fed, except they, too, had whoopsies in 2008, and are now so regulated that they can’t create money in necessary size either. Indeed, their commercial imperative is to keep existing businesses supplied with liquidity, at a time when inflation is driving up the latter’s cash requirements – and, anyhow, the commercial banks make good margins on these loans, so why not divert more of their balance sheets to these activities, and away from lower-margin financial market funding activities?

We see danger ahead. Markets are still too high, and protection is expensive in an increasingly nervous world; common sense suggests one should invest conservatively, and in safe assets. In a world where people find themselves without the ability to pay commitments as they arise, forced selling drives prices.

Among risky assets like equities, one of the counter-intuitive things in a liquidity crisis is that securities perceived as safest and most liquid go down sharply, because investors are forced to sell what they can, not what they want to. We therefore regard plentiful liquidity in the portfolio as overwhelmingly attractive; it allows us to make the most of the opportunities that arise in the aftermath of a crisis. But first we have to get through the storm.

If the Philadelphia Phillies Win the World Series, Prepare for an Economic Crisis It happens every time a team from the city succeeds

(…) It started with the old Philadelphia Athletics (before they left town). Their 1929 championship preceded the stock crash and Great Depression. In 1980, the Phillies won their first World Series, and a recession raged right through 1983, when the team again got to the final round and lost. The Phils won the World Series a second time in 2008, and boom: a home-run financial crisis. (…)

Sam Stovall, chief equity strategist at investment-research firm CFRA Research in New York, notes there is a reverse correlation here. Phillies pain might mean stock gains. The markets did well, rising 14.6%, in 1964—that awful baseball year for Philadelphia when the team blew an almost-sure berth in the World Series, scarring a generation of fans. (…)

International Discord Undercuts Global Growth, Worsens Inflation Many of the world’s biggest powers are now intent on undermining each other, with unsettling economic implications.

Russia Warns US Non-Military Satellites Are “Legitimate Targets”

U.S. New Home Sales Drop Back in September

Last month, new single-family home sales declined 10.9% (-17.6% y/y) to 603,000 (AR) from 677,00 in August, revised from 685,000. July sales totaled 543,000. Sales have fallen 40.1% from their peak of 1.007 million in July 2020. The Action Economics Forecast Survey expected sales of 594,000 new homes.

Last month’s decline in new home sales was concentrated in the South where they declined 20.2% (-19.3% y/y) to 356,000. The decline fully reversed the August increase to 446,000. Sales in the West eased 0.7% in September (-30.4% y/y) to 135,000 which came after a 24.8% August rise. Moving 56.0% higher last month (25.8% y/y) were sales in the Northeast to 39,000, the highest level since April. New home sales in the Midwest gained 4.3% (10.6% y/y) in September to 73,000, a six-month high.

The median price of a new home increased 8.0% last month (13.9% y/y) to $470, 600 after weakening 9.2% in August. The average sales price of a new home fell 2.1% (+10.0% y/y) to $517,700 following a 6.6% August decline. These sales price data are not seasonally adjusted.

The number of unsold new homes on the market fell 1.1% (+23.2% y/y) to a seasonally adjusted 462,000, up from a low of 142,000 in July 2012. (…)

Recession eclipses U.S. midterm result (BlackRock)

Equities usually do well after U.S. midterms. Why? Gridlock is common and prevents policy change that could spook stocks. We don’t see that past playbook working this time due to the recession we expect from the Fed ratcheting up rates. Gridlock dims any prospect of fiscal stimulus that only works at cross-purposes with monetary policy in the new regime – take the UK. We stay underweight DM stocks but see the politics of higher rates taking over from the politics of inflation.

We see a bigger problem for stocks than any potential positives from the midterm election outcome: a looming recession. We have argued how central banks rushing to hike policy rates to get inflation back to target would need to crush interest rate-sensitive parts of the economy first. That’s because higher inflation is driven by production constraints. Recession will pressure other sectors in time, but we’ re already seeing damage in important rate-sensitive sectors like housing. (…)

The slide in housing starts this year is already steeper than past mega Fed rate-hike cycles such as in the 1970s and early 1980s – as well as the unwind of the mid- 2000s U.S. housing boom. (…)

We see political focus increasingly shifting to the economy. We expect inflation to come down, but stay above target – and recession will still hit. We then think the politics of inflation could switch to the politics of higher interest rates. We see the politics of rates creeping into the politicization of everything with more voices beginning to decry the aggressive rise in interest rates that is causing recession. We see the Fed stopping its hikes amid the economic damage and pressure to ease up on tightening, but price pressures will persist. That’s why we think it will eventually have to live with some inflation.

Mortgage rates now exceed 7.0%, killing demand:

Mortgage rates are unusually high vs Treasuries. Coincidence? The Fed is no longer a buyer of MBS.

Another Railroad Union Rejects Contract The vote by the Brotherhood of Signalmen complicates the outlook for labor peace after White House had brokered a deal in July.

The latest vote, by the Brotherhood of Railroad Signalmen, sends the two sides back to the negotiating table. Failure to agree on a revised deal could result in a strike as early as December.

The Brotherhood of Railroad Signalmen is the third union whose members have rejected their respective agreements initially reached with the National Carriers’ Conference Committee, which represents the freight railroads in collective bargaining.

Of the 12 labor unions involved in bargaining, six have ratified their agreements.

Two of the largest unions, the Brotherhood of Locomotive Engineers and Trainmen and the Transportation Division of the International Association of Sheet Metal, Air, Rail, and Transportation Workers, are still in the process of ratification and are expected to announce results in mid-November. (…)

Biden Touts Steps to Curb Consumer Fees President says the administration is seeking to rein in billions of dollars in charges across industries including banking, entertainment and travel

• French President Emmanuel Macron says his government will unveil measures to shield more companies from rising electricity prices on Friday (Bloomberg)

Bank of Canada Surprises With Half-Point Interest-Rate Rise to 3.75% Bank of Canada Gov. Tiff Macklem says the bank’s tightening phase is getting closer to ending

(…) “We judged that it was appropriate to slow the pace of increase in our policy rates from very big steps to a big step,” Mr. Macklem said. (…)

(…) Three-quarters of economists surveyed last week by The Wall Street Journal expected the Bank of Canada to deliver a second straight 0.75-percentage-point rate increase, citing elevated inflation.

Instead, Bank of Canada Gov. Tiff Macklem said officials were trying to balance the risks of delivering too many rate increases to contain historically elevated inflation and failing to raise rates enough for fear of triggering a severe recession.

“This tightening phase will draw to a close. We are getting closer, but we are not there yet,” Mr. Macklem said at a press conference, adding that the central bank will need to raise rates further before inflation returns to its preferred target of 2%. He said future rate increases would be tied to how the economy is responding to higher rates. (…)

The Bank of Canada’s quarterly economic report envisages household spending to decline starting in the fourth quarter until mid-2023. It expects businesses to markedly scale back business investment next year, due to higher borrowing costs. (…)

The Bank of Canada forecasts growth to essentially stall beginning in the fourth quarter and predicts the economy won’t pick up strength until the second half of 2023. Officials downgraded growth in 2022 to 3.3% from 3.5% and anticipate a 0.9% expansion next year, versus its previous call for a 1.8% advance. While the central bank isn’t officially forecasting a recession, it said two consecutive quarters of growth slightly below zero “is just as likely as a couple of quarters with small positive growth.” (…)

Peak Fossil-Fuel Demand Possible in a Few Years The energy crisis stemming from Russia’s invasion of Ukraine is seen as hastening a shift to lower-emission sources, according to the International Energy Agency.

The International Energy Agency, a Paris-based group of some of the world’s biggest energy users, said the war and the disruption to energy markets that it has unleashed has set off a realignment of global supply and demand. If governments make good on policy goals they have set in motion recently in response to the crisis, they would speed up the shift from fossil fuels to cleaner renewable energy, the agency said.

Based on such a scenario, the IEA said additional coal demand prompted by the energy crisis would be temporary, while natural-gas demand would plateau by the end of this decade. As a result of the increased use of electric vehicles, the IEA said, oil demand would peak sometime in the middle of the next decade, plateauing until about 2050, and then falling. (…)

While the IEA previously said it expects near-plateauing oil demand starting in the mid-2030s, a report from the agency Thursday marks the first time it has set out a possible timeline for declining or plateauing demand across all fossil fuels. (…)

The IEA’s scenario doesn’t forecast a rapid deterioration in the world’s thirst for oil, gas and coal. Instead, it provides a timeline for a near-term peak in demand. As a share of global energy supplies, fossil fuels have held steady at 80% for decades. The IEA said the shift presaged by the current energy crisis will reduce that to below 75% by 2030 and to 60% by 2050.

OPEC has said that demand for oil should peak in wealthier nations starting in the mid-2020s, but that demand in poorer countries will continue to grow at least until 2045. (…)

The IEA said that Russia’s falling output is a significant factor in the agency’s timeline and that the reduction is likely to be permanent. Europe’s pivot to renewables will make it an unlikely future market for Russian energy. While Russia has sought to redirect its gas-and-oil supplies to Asian economies such as China and India, it faces challenges there too. The EU aims to levy new sanctions on shipping Russian crude worldwide. Meanwhile, a lack of gas pipelines in Russia’s eastern regions will make sending its gas supplies to China difficult, the IEA said. (…)

Natural gas prices are plunging, as warm weather and growing stockpiles have massively alleviated pressure. (Axios)

• European stockpiling of natural gas has pushed storage levels to over 90% of capacity.
• Warm weather on the continent has cut heating needs.
• European officials continue to move toward price caps on the TTF contract.

“Europe has enough gas stored to survive this winter unless it gets very, very cold,” wrote analysts with research firm Rystad Energy in a note yesterday.

Data: FactSet; Chart: Axios Visuals

EARNINGS WATCH

JPM yesterday published a list of EPS changes for the next fiscal year: 21 ups, 33 downs.

Goldman Sachs:

(…) unlike earnings, even the potential for recession could weigh on management decision-making and spending priorities in 2023. We expect continued growth in R&D (+10%), dividends (+5%), and capex (+3%). However, we expect buybacks will decline by 10% year/year. Following the collapse in cash M&A YTD, we expect a slight rebound in 2023 (+3%).

Cash M&A and buybacks are the most volatile uses of cash. During the four recessions since 1990, cash M&A typically fell by 60% and buybacks fell by 46%. Corporates typically pulled back on capex, but to a lesser extent (-16%), while dividends and R&D were the stickiest. We introduce recession scenario forecasts for the five uses of cash. In a 2023 recession scenario, we expect the declines would be largest among buybacks (-40%) and cash M&A (-20%). Capex would likely fall by 15%, dividends would fall by 1%, and R&D would be flat.

  Xi Says China Can Work With US Before Possible Biden Meeting 

Chinese President Xi Jinping said his nation is willing to work with the US to find ways to cooperate, comments that come before a potential meeting with President Joe Biden at a Group of 20 summit next month.

Better communication between the two nations would bolster global peace and development, Xi said in a letter to the National Committee on US-China Relations’ annual dinner Wednesday, the official Xinhua News Agency reported.

“China stands ready to work with the United States to find the right way to get along with each other in the new era on the basis of mutual respect, peaceful coexistence and win-win cooperation, which will benefit not only the two countries but also the whole world,” Xi said, according to the report on Thursday.

Xi’s remarks echoed his message last year to the same gala for the group that aims to promote China-US cooperation. That event similarly came before a video summit with the US leader in November. Still, they signal an effort to maintain ties despite disputes over Taiwan, the semiconductor industry and Beijing’s response to Russia’s invasion of Ukraine.

Speaking to Department of Defense leaders on Wednesday, Biden emphasized that even as the US maintains its military advantage over China, “we’re making it clear that we don’t seek conflict.”

“There’ll be stiff competition, but there doesn’t need to be conflict,” he added. (…)

• Missing Data

Chinese economic data always comes with an implicit asterisk. It’s hard to know what to believe from a government that exercises such ruthless control, and which isn’t shy about rewarding those who make it look good and punishing those who reveal too much. One way this happens is by simply not reporting as much data. A recent Financial Times analysis indicates that’s exactly what happened since Xi Jinping’s elevation in 2012.

Let’s hope that Xi still receives these data…