FLASH PMIs
US private sector ends year in stronger downturn as demand weakness and price pressures bite
US private sector firms signalled a further decline in output during December, according to latest ‘flash’ PMI™ data from S&P Global. The downturn gathered pace, as business activity fell at the joint-sharpest rate since May 2020. Manufacturers and service providers alike registered steeper decreases in output, as weaker demand conditions, inflation and hikes in interest rates dampened activity levels.
The headline Flash US PMI Composite Output Index registered 44.6 in December, down from 46.4 in November, to signal the joint-fastest decline in business activity for over two-and-a-half years as 2022 was brought to a close. Excluding the initial pandemic period, however, the downturn was the joint-sharpest since 2009.
Driving the fall in total activity was a quicker decrease in new business across the private sector. Pressure on purchasing power among customers and company balance sheets led to a strong decline in new orders, and one that was the fastest since May 2020. Weak demand conditions were broad-based, though manufacturing firms saw a steeper decrease in new orders compared to their service sector counterparts. While total new export orders contracted further in December, down for a seventh straight month, the rate of decline softened slightly.
Continuing the downward trend seen since June, average input prices increased at a notably softer pace in the final month of the year. Cost burdens rose at the slowest pace since October 2020 and at a rate that was broadly in line with the series’ long-run average. Companies noted that reduced demand for inputs dampened supplier price hikes, with lower costs reported for fuel and metals in particular.
In an effort to drive sales and pass through any cost savings, private sector firms recorded a softer uptick in output charges during December. Easing to the slowest in over two years, the rate of selling price inflation was only marginally faster than the long-run series average. Moderations in output price hikes were most notable in the manufacturing sector, though the rate of inflation also ticked lower in services.
In line with lower new order inflows, private sector hiring remained subdued in December. Employment rose only marginally as manufacturers signalled broadly unchanged workforce numbers on the month and service sector hiring slipped lower to register only a modest gain. Weighing on total employment growth were a growing number of reports of lay-offs following weak demand.
Meanwhile, backlogs of work declined for the third month running in December, albeit at a softer rate. The fall in outstanding business was solid overall and broad-based, though led by the manufacturing sector, which recorded a sharper decline. The arrival of key inputs and reduction in new orders reportedly allowed firms to work though their backlogs.
Private sector business confidence was weaker than the series trend again at the end of 2022. Although still anticipating higher output over the coming year, expectations were among the lowest in over two years. Higher borrowing costs, inflation and a broad economic slowdown dampened optimism.
The S&P Global Flash US Services Business Activity Index posted 44.4 in the final month of 2022, down from 46.2 in November. The latest data signalled a steep and sharper downturn in service sector output. The fall in activity was the fastest for four months, and among the quickest in the series history (since October 2009).
The decline in activity was led by a further solid decrease in new orders during December. Higher borrowing costs, housing and financial sector weakness, and inflationary pressures all weighed on customer spending. The rate of contraction was little-changed from November, but was the fastest since May 2020. New business from abroad, however, fell at the slowest rate since September.
Inflationary pressures in the service sector cooled notably in December, as input costs rose at the softest pace since October 2020. Despite some material and labor costs rising, reports of lower wholesale and fuel prices eased pressure on cost burdens.
Partly in response to softer input price hikes, but also in an effort to drive sales, service sector firms reported the slowest increase in selling prices for over two years.
Service providers continued to increase their workforce numbers during December, as employment rose marginally. The rate of job creation was the second-slowest since September 2021, however, as the non-replacement of voluntary leavers and reports of lay-offs increased.
At the same time, pressure on capacity waned further, as backlogs of work fell at a solid pace.
Business expectations at service sector firms remained upbeat at the end of the year. That said, the degree of confidence was among the weakest in two years as firms highlighted concerns regarding inflation, hikes in interest rates and dwindling demand.
The S&P Global Flash US Manufacturing PMI posted at 46.2 in December, down from 47.7 in November, to signal a solid deterioration in operating conditions across the goods-producing sector. The downturn was the fastest since the initial lockdown period in 2020 and driven by subdued demand and a faster fall in output.
Manufacturers registered one of the sharpest declines in new orders since the 2008-9 financial crisis during December, as customer spending waned. The further acceleration in the pace of contraction in new business led to a steeper decrease in production levels.
On a more positive note, inflationary pressures subsided notably at the end of the fourth quarter. Another monthly improvement in supplier delivery times, alongside muted demand for inputs, led to the slowest rise in cost burdens since July 2020. Lower prices for fuel and metals, especially steel, were often mentioned by panellists.
Customer demand weakness, however, and efforts to stay competitive, resulted in a moderation in the pace of output charge inflation during December. Selling prices rose at the softest pace since October 2020 as firms sought to pass through any cost savings made.
Sufficient stocks of inputs and a further reduction in new orders led to the sharpest contraction in purchasing activity in over two-and-a-half years. Firms worked through safety stocks built earlier in the year, as pre-production inventories fell steeply. Meanwhile, stocks of finished goods increased for the second month running amid lower than anticipated new order inflows and the processing of backlogs of work.
The level of work-in-hand (but not yet completed) fell at one of the sharpest rates since 2009, as sales contracted and delayed material deliveries arrived. Lower levels of incomplete work and muted demand led to broadly unchanged employment during December. Manufacturers noted that some lay-offs were due to a lack of new work, whereas others chose not to replace voluntary leavers.
Finally, output expectations among manufacturing firms strengthened during December. The degree of optimism reached the highest for three months, but was notably still far weaker than the long-run series trend. Hopes of greater new orders and investment remained, but some companies expressed concern regarding industry downturns and inflationary pressures.
Chris Williamson, Chief Business Economist at S&P Global Market Intelligence:
“Business conditions are worsening as 2022 draws to a close, with a steep fall in the PMI indicative of GDP contracting in the fourth quarter at an annualised rate of around 1.5%. Jobs growth has meanwhile slowed to a crawl as firms across both manufacturing and services take a much more cautious approach to hiring amid the slump in customer demand.
“The upside is that weaker demand has taken pressure off supply chains which had been stretched during the pandemic. December saw a second successive month of faster supplier delivery times, a phenomenon which not only signals improving supply conditions but also tends to herald the shifting of pricing power away from the seller towards the buyer.
“Hence price pressures continue to moderate sharply. In fact, December saw the largest monthly cooling of firms’ input cost inflation seen in the 13 year history of the survey barring only the lockdown related slump in April 2020.
“In short, the survey data suggest that Fed rate hikes are having the desired effect on inflation, but that the economic cost is building and recession risks are consequently mounting.”
Eurozone downturn eases and inflation pressures fall as supply improves
The seasonally adjusted S&P Global Eurozone PMI® Composite Output Index rose for a second successive month in December, increasing from 47.8 in November to a four-month high of 48.8, according to the preliminary ‘flash’ reading based on approximately 85% of usual survey responses. Although remaining below the neutral 50.0 level to indicate a sixth successive fall in business activity, the PMI has now signalled an easing in the rate of contraction for two months in a row.
The subdued level of the PMI nevertheless means that the fourth quarter as a whole has seen a worse performance than the third quarter, with the average PMI for the three months to December indicative of the sharpest economic contraction since 2013 if pandemic lockdown months are excluded.
While manufacturing continued to lead the downturn, with factory output dropping for a seventh straight month, the rate of production decline eased to indicate a further marked cooling in the pace of contraction compared to October’s steep fall. The manufacturing output index rose to 47.9, a six-month high, against 46.0 in November.
Service sector output meanwhile fell, down for a fifth successive month, but likewise saw a moderation in the rate of decline. The sector’s activity index rose from 48.5 to a four-month high of 49.1, indicative of only a modest monthly deterioration of output. (…)
Overall new orders meanwhile fell for a sixth straight month as companies continued to report weakening demand from customers, though the rate of decline eased for a second month running to the softest since August. Although new orders continued to fall at an especially steep rate in manufacturing, down for an eighth successive month, the rate of loss cooled markedly. New business in the service sector also continued to deteriorate, down for a sixth consecutive month, dropping at a similar rate to the prior two months.
The ongoing deterioration of order books led to another month of only modest net job creation, with employment rising at a marginally improved rate compared to November yet still showing the second-smallest gain since February 2021. Similar subdued hiring rates were seen in both manufacturing and services. (…)
Factories meanwhile reported the first – albeit marginal – improvement in supplier delivery times since January 2020. However, delivery times were often faster only because suppliers were less busy due to lower demand for inputs, which fell sharply again in December.
An upside of improving supply and falling demand was a marked cooling of input cost inflation in manufacturing to the weakest since December 2020, and in services to the weakest since January 2022. Measured overall, input costs consequently rose at the slowest rate since May 2021, albeit still rising at an historically elevated rate.
Prices charged for goods and services also continued to rise at a steep rate, though the rate of inflation moderated to the lowest for a year, reflecting weaker rates of increase in both main sectors. Slower selling price inflation was linked often to the slower growth of costs, but also in some cases to the need to offer discounts to help stimulate sales. (…)
Chris Williamson, Chief Business Economist at S&P Global Market Intelligence:
“While the further fall in business activity in December signals a strong possibility of recession, the survey also hints that any downturn will be milder than thought likely a few months ago. The data for the fourth quarter are consistent with GDP contracting at a quarterly rate of just less than 0.2%, and forward-looking indicators are currently boding well for the rate of decline to ease further in the first quarter.
“The manufacturing downturn has moderated especially for prices charged for both goods and services.
“The downside is that this improving inflation outlook is primarily a symptom of falling demand, which has removed pricing power from many companies and their suppliers, and the business environment remains one in which confidence remains very subdued by historical standards. Thus, while the downturn is looking likely to be less steep this winter than previously anticipated by many, there remain few signs of any meaningful return to growth evident as 2022 comes to an end.”
Japan: Private sector output stabilises amid stronger service sector expansion
Flash Composite Output Index, December: 50.0 (November Final: 48.9)
The headline au Jibun Bank Flash Japan Manufacturing Purchasing Managers’ Index™ (PMI)® posted 48.8 in December, down from 49.0 in November to signal the strongest contraction in the Japanese manufacturing sector since October 2020. Amid ongoing reports of muted customer demand, both output and new orders fell solidly, but at slightly softer rates than in November, and input buying declined at the quickest pace since September 2020. (…)
Price Pressures Ease in U.S. and Europe, Businesses Say With household demand for goods weakening across the globe, price pressures eased at the end of the year.
This is the headline of a WSJ piece “summarizing” the above flash PMIs. It’s a sign of times and of the current strong focus on inflation that the article barely mentions the steep downturns in demand across both manufacturing and services.
True, inflation is slowing, though the PMI Input Price Index remains at the very high end of its 2010-2022 range:
The real problem is that, outside of the pandemic, the economy is currently shrinking at a rate only seen in 2008 and 2001, two periods when the Fed was aggressively… easing.
The demand downturn is broad based, hitting both manufacturing and services, the latter not at all buffering the manufacturing slowdown:
New orders, the corporate lifeblood, are dropping steeply, implying continued economic weakness into Q1’23. Mr. Powell’s “very, very strong job market” looks very shaky, unless companies elect to sacrifice profits to protect their employees.
BTW, the Philly Fed last week released a report that refutes the notion of a “very, very strong job market”, rather showing that there was actually no growth in U.S. employment in 2022:
Estimates by the Federal Reserve Bank of Philadelphia indicate that the employment changes from March through June 2022 were significantly different in 33 states and the District of Columbia compared with current state estimates from the Bureau of Labor Statistics’ (BLS) Current Employment Statistics (CES). (…)
In the aggregate, 10,500 net new jobs were added during the period rather than the 1,121,500 jobs estimated by the sum of the states; the U.S. CES estimated net growth of 1,047,000 jobs for the period.
So, the Philly Fed says that the BLS’ job numbers for Q2’22 were overstated by about 1 million jobs annualized, or about 0.6%.
Explanation: the BLS monthly report comes out on the first Friday of every month, very timely but at some cost on accuracy. Every year, it reviews the previous year to incorporate all other data to paint a more accurate picture. The BLS says that over the last 10 years, “the annual benchmark revision at the total nonfarm level has averaged 0.1 percent (in absolute terms), with a range of −0.3 percent to 0.3 percent.” The largest revision was in 2019 when it reduced its original figure by 489,000.
The Philly Fed data, which incorporate “more comprehensive, accurate job estimates released by the BLS as part of its Quarterly Census of Employment and Wages (QCEW) program to augment the sample data from the BLS’s CES that are issued monthly”, shows that the BLS overstatement really began in April. The reported payrolls grew 2.8% during Q2 but the Philly Fed’s “more accurate” numbers actually show zero growth.
Interestingly, based on various data I was observing last June, I wrote that the economy appeared to have hit a wall in March. Last December 12, I observed that, since March, “household employment has been unusually weaker than establishment employment”. In fact, YtD, household employment is up 1.6% while payroll employment is up 2.9%, a difference of 1.8 million jobs.
The two employment series have a correlation of 98.7% since 1950. Between 1990 and 2019, household based employment has grown 2.1% per year, slightly faster than establishment based jobs’ 1.9%. Since the pandemic, payroll employment has outpaced household employment, 1.66% per year vs 1.24%.
Either the unemployment rate is understated or payroll employment is overstated. The Philly Fed work strongly suggests the latter.
We can suspect that reported Q3 employment growth, reported at +2.8%, is also overstated, perhaps by another 1 million jobs and that Q4 is also quite weak, if not even weaker. PMI surveys during the last several months support this view:
- July: manufacturing payroll growth was the lowest for six months; the pace of services job creation was the slowest since January.
- August: Weak client demand led to a slower rise in services employment during August, with the rate of job creation slipping to the softest since January; manufacturing employment rose at the second-slowest rate in over two years.
- September: manufacturing employment rose at the sharpest pace since March in September but there was only a modest rise in employment at service providers. The rate of job creation was the slowest since December 2021.
- October: Although manufacturers saw a marginal uptick in workforce numbers, service providers kept staffing levels broadly unchanged.
- November: Manufacturing employment rose at the joint-slowest pace since
January. n services, the uptick in staffing numbers was only marginal and the second-slowest since
September 2020. - December: Employment rose only marginally as manufacturers signalled broadly unchanged workforce numbers on the month and service sector hiring slipped lower to register only a modest gain. Weighing on total employment growth were a growing number of reports of lay-offs following weak demand.
If so, the FOMC’s main argument to justify its current tightening policy, “a very, very tight labor market”, is based on flawed data. Here’s what seems to be the reality in the U.S.:
- On a YoY basis, employment could be up 1-0-1.5% in Q4, not +3.3% as reported numbers show. Payroll employment may actually be flat since March, in line with household employment, and PMI surveys suggest only marginal sequential growth in jobs in the final quarter of the year (“a crawl”).
- GDP growth numbers would thus also prove to be overstated. S&P Global says that its PMI data are “indicative of GDP contracting in the fourth quarter at an annualised rate of around 1.5%.” The Atlanta Fed’s latest GDPNow is +2.8%!
- The sharp slowdown in inflation since March is not only due to “transitory elements” (improved supply chains, lower energy costs and overstocked merchants); there is a genuine broad decline in demand. The recent significant slowdown in services inflation, in spite of accelerating wage and shelter costs, is indicative of lost pricing power due to waning demand.
- If employment is actually much weaker than reported, productivity will be revised up. If so, rising wages may not be as inflationary as presumed.
- If the U.S. economy is in or near recession, commodity prices, particularly energy, will remain weaker for longer, keeping goods inflation low if not negative even after the Christmas markdowns. Combined with more subdued growth in services inflation (+4.6% a.r. in the last 2 months, +4.1% in November), core inflation could rapidly decline.
- Jerome Powell could soon realize he is not the new Volcker, but a modern Don Quixote fixated on fighting illusionary enemies.
From an economic standpoint, the only positive from all this is that we can hope that employers will be cautious and minimize layoffs to hold on to admittedly scarce employees. With slower inflation, particularly on food and energy, consumer demand could hold up enough to prevent a deep recession.
That assumes that the Fed quickly stops fighting windmills and wakes up to the reality that it seriously risks a major policy mistake.
Remember his latest press conference:
- “I just don’t think anyone knows whether we’re going to have a recession or not — and if we do, whether it’s going to be a deep one or not. It’s just…It’s not knowable.”
- “Historical experience cautions strongly against prematurely loosening policy. I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way.”
How about that? Blindfolded and backward looking!
How good has this committee been on inflation?
Powell and Co. are convinced that the recent inflation lull is due to transitory factors, much like they were convinced that the 2021 inflation spike was also transitory…
For investors, however, the problem is that profits are likely to decline faster than inflation. S&P 500 earnings decline 10-15% in “normal” recessions. If many companies favor employees over margins, the higher end may be in store.
Trailing EPS peaked in November at $223.37. A 12-15% cut would take them to $190-195.
If core CPI up: +3.0%: fair P/E = 17 = ~3275 (-15%)
+4.0%: fair P/E = 16 = ~3080 (-20%)
+5.0%: fair P/E = 15 = ~2900 (-25%)
The recession call is important. The conventional P/E ratio is 17.3x trailing EPS and 17.1x forward EPS, right in the middle of its range when inflation is benign:
While the median P/E is 18.8x trailing EPS, it is 17.7x on forward EPS. Based on the current market wisdom, the S&P 500 index looks fairly valued if
- no recession so earnings hold and/or
- inflation retreats around 3%, which may not be possible if no recession…
End of October, the 6 largest weights on the S&P 500 index (24.2%) averaged a trailing P/E of 43.5x and a forward P/E of 28.9x.
Currently: the 6 largest weights on the S&P 500 index (21.7%) average a trailing P/E of 37.0x (26.6x ex-AMZN) and a forward P/E of 25.7x (21.0x ex-AMZN).
AAPL’s P/E (6.8% of the index) is now 21.5x, it was 31.6x one year ago.
MSFT’s P/E (5.8% of the index) is now 25.8x, it was 40.0x one year ago.
GOOG’s P/E (3.5% of the index) is now 17.2x, it was 30.5x one year ago.
Even TSLA, no longer among the 6 largest weight, now has a P/E of 26.1 on forward EPS!
JPM, the country’s largest and best managed bank, is at 10.1x forward EPS. How often has JPM traded this low?
If no recession!!! Bank profits can really tumble in a recession.
INFLATION WATCH
The NY Fed’s UIG has 2 measures, one from a large number of CPI price series mixed with various macroeconomic and financial variables and a second one with the prices-only data set. Correlations with the headline CPI: 81.3% for the full data set and 90% with the prices-only set.
- The UIG “full data set” measure for November is currently estimated at 4.1%, a 0.2 percentage point decrease from the current estimate of the previous month.
- The “prices-only” measure for November is currently estimated at 5.6%, a 0.1 percentage point decrease from the current estimate of the previous month.
The prices-only estimate of +5.6% YoY in November would mean that the December headline CPI would decline 0.9% MoM coming after -0.1% in November.
The full data set’s +4.1% would mean a huge -2.3% drop MoM in December.
FYI, the Truflation index, updated daily, measures the price data of millions of items across the economy. This index is +5.76% YoY on December 18, implying a -0.7% MoM decline in December.
While not the core CPI, another negative monthly CPI print would put pressure on the Fed but also provide some needed relief to American consumers.
EARNINGS WATCH
From Factset:
On a per-share basis, estimated earnings for the fourth quarter have decreased by 6.1% since September 30. This decline is smaller than the decline of -6.8% recorded in Q3 2022, but larger than the 5-year average of -2.5% and the 10-year average of -3.3% for a quarter.
The number of S&P 500 companies that have issued negative EPS guidance for Q4 2022 is smaller than the number for the previous quarter, but higher than the 5-year average. At this point in time, 97 companies in the index have issued EPS guidance for Q4 2022, Of these 97 companies, 63 have issued negative EPS guidance and 34 have issued positive EPS guidance.
The number of S&P 500 companies issuing negative EPS guidance for Q4 2022 is lower than the numbers for Q3 2022 (66), Q2 2022 (72), and Q1 2022 (68). However, it is higher than the 5-year average of 57 (but lower than the 10-year average of 65).
As of today, the S&P 500 is expected to report a (year-over-year) earnings decline of -2.8%, compared to estimated (year-over-year) earnings growth of 3.7% on September 30. Four of the eleven sectors are projected to report year-over-year earnings growth, led by the Energy and Industrials sectors. On the other hand, seven sectors are predicted to report a year-over-year decline in earnings, led by the Materials, Communication Services, and Consumer Discretionary sectors.
If the Energy sector were excluded, the expected earnings decline for the index would increase to -7.3% from -2.8%.
Ex-pandemic, the last time S&P 500 quarterly EPS declined by 7.3% YoY or more was in Q1’2009.
(…) “Our advice — don’t assume the market is pricing this kind of outcome until it actually happens,” Wilson said.
The strategist — a stalwart equities bear who called this year’s slump — said that although inflation has started easing from historic highs, recent signs of weakening in the US economy were worrying.
Morgan Stanley’s team is now leaning toward its bear case forecast for earnings of $180 per share in 2023 compared with analysts’ expectations of $231. That — combined with the fact that the current equity risk premium is lower than in August 2008 even though valuations are higher — could see the S&P 500 sinking to as low as 3,000 points next year, they said, implying declines of 22% from its Friday close. (…)
TECHNICALS WATCH
S&P 500 Large Cap Index – 13/34–Week EMA Trend (as of December 15 close of 3895)
Technical resistance and the 200d moving average for a solid ceiling. The apparent floor is 12% lower and slipping…
Individual Investors Hang On to Stocks While Pros Sell In a wild year for markets, small investors have been doubling down on stocks as hedge funds and other institutional investors grow more bearish.
U.S. equity mutual and exchange-traded funds, which are popular among individual investors, have attracted more than $100 billion in net inflows this year, one of the highest amounts on record in EPFR data going back to 2000.
Hedge funds, meanwhile, have been paring how much risk they are taking in stocks or making outright bets that major U.S. indexes will tumble. Mutual funds have increased their cash positions to about 2.5% of their portfolios this fall, up from around 1.5% at the end of last year and the highest level since early 2020, according to Goldman Sachs Group Inc. (…)
Meanwhile, one measure of how exposed hedge funds are to the stock market—the share of their positions invested in bullish stock positions versus bearish—has fallen to the lowest level since early 2019 among funds tracked by Goldman. (…)