| RECESSION WATCH
US private sector output contracts for the first time in over two years amid muted client demand
US private sector firms indicated the first contraction in business activity since June 2020 in July, according to latest ‘flash’ PMI™ data from S&P Global. The downturn in output signalled a further loss of momentum across the economy of a degree not seen outside of COVID-19 lockdowns since 2009. The downturn was led by a steep drop in service sector activity, though production at manufacturers also fell marginally, down for the first time in over two years.
The headline Flash US PMI Composite Output Index registered 47.5 in July, down notably from 52.3 in June to signal a solid contraction in private sector output. The rate of decline was the sharpest since the initial stages of the pandemic in May 2020, as both manufacturers and service providers reported subdued demand conditions.
Although new orders returned to expansion territory during July, following a contraction in demand during June, the increase was only modest and, with the exception of June’s decline, was the weakest in the past two years. Service providers registered only a marginal upturn in new business while manufacturers recorded a second successive fall in new order inflows. Companies noted that weak demand conditions stemmed from severe inflationary pressures and hikes in interest rates, which have exerted further strain on domestic client spending. Foreign client demand also weakened, causing new export orders to fall for a second successive month.
On the price front, firms continued to highlight marked upticks in input costs at suppliers, as fuel, transportation, raw material and wage expenses rose further. However, the pace of input price inflation eased again from May’s series peak and was the softest for six months, despite being faster than in any period seen before May 2021.
Similarly, US companies recorded a substantial hike in selling prices during July. Again, firms highlighted the pass-through of higher costs to their clients as a driving factor behind greater output charges. A number of firms stated that slower input cost inflation, greater competition and softer demand conditions led to some concessions being made to customers, however, helping to cool the pace of charge inflation to its slowest since March 2021.
Challenges retaining employees and some reports of cost-cutting initiatives led to the weakest rise in staffing numbers since February. Job creation was led by service sector firms who continued to register a strong upturn in employment. Manufacturers, on the other hand, recorded only a slight rise in workforce numbers.
A softer rise in hiring activity also stemmed from reduced pressure on capacity in July. Backlogs of work fell for the second month running and at the steepest rate since May 2020. Broadly unchanged levels of work-in-hand at manufacturing firms was accompanied by a solid decline in incomplete business at service providers as softer demand conditions allowed firms to catch up with work outstanding.
At the same time, business confidence among US companies slipped to the lowest since September 2020. Although firms hope for greater new order inflows and increased stability in supply chains, inflationary and recession concerns weighed on optimism amid muted demand conditions.
At 47.0 in July, down notably from 52.7 in June, the S&P Global Flash US Services Business Activity Index indicated a solid decline in business activity at service providers. The seasonally adjusted index continued its downward trajectory seen since March’s recent high and signalled the sharpest fall in output since May 2020.
Following a slight contraction in June, new business returned to expansion. The marginal upturn in client demand was much softer than that seen in the last two years, however. Inflation and weak demand conditions reportedly continued to weigh on new sales. At the same time, new export business decreased for the second successive month amid challenging economic conditions in key export destinations.
Input prices rose markedly in July, albeit at the softest pace since January. Alongside greater material and fuel costs, firms linked the uptick to hikes in wage expenses amid increased competition for skilled staff. Some reports of discounts made to customers, and slower input price increases, led to the softest rise in output charges since March 2021.
Meanwhile, service providers raised their workforce numbers strongly in July, as firms sought to fill long-held vacancies. The rate of job creation was the weakest for five months, however, as pressure on capacity subsided. Backlogs of work decreased at a faster pace, and one that was the sharpest since May 2020.
Relatively subdued client demand and growing inflationary concerns hampered expectations, as service providers signalled the lowest degree of confidence in the outlook for output since September 2020.
The S&P Global Flash US Manufacturing PMI posted at 52.3 in July, down from 52.7 in June, to signal weak improvements in operating conditions across the US manufacturing sector. A subdued improvement in the health of the goods-producing economy contrasted with marked upturns in April and May.
Driving the decrease in the headline index reading were broadly unchanged production levels and a further fall in new order inflows. The seasonally adjusted Output Index dropped below the 50.0 no-change mark for the first time since June 2020, as total new sales and new export orders fell at the sharpest rates since the initial stages of the pandemic over two years ago.
Although softer than those seen during the second half of 2021, the pace of cost inflation was among the fastest on record. Greater energy, fuel, transportation and material prices reportedly pushed up expenses further. The rate of increase slowed to the softest since April 2021, however.
Manufacturers still sought to pass through higher costs to clients, as output charges rose further in July. In line with a softer uptick in input costs, selling prices increased at the slowest pace since February 2021.
Vendor performance deteriorated again in July. Despite lead times lengthening at one of the slowest rates in over a year-and-a-half, delays were substantial in the context of the series history and greater than any seen before December 2020. As a result, firms sought to build input inventories. Buying activity returned to expansion and stocks of purchases rose at a slightly faster pace.
At the same time, efforts to clear backlogs were successful as work-in-hand was broadly unchanged on the month. Subsequently, more firms mentioned plans to cut costs and reduce staffing numbers as the rate of job creation slowed to the second-weakest in the current two-year sequence of employment growth.
Finally, positive sentiment regarding the outlook for output was the lowest since October 2020. Although firms expressed hopes of a return to new order growth, weak client demand and the impact of further inflationary pressure on customer spending weighed on expectations.
Chris Williamson, Chief Business Economist at S&P Global Market Intelligence:
The preliminary PMI data for July point to a worrying deterioration in the economy. Excluding pandemic lockdown months, output is falling at a rate not seen since 2009 amid the global financial crisis, with the survey data indicative of GDP falling at an annualised rate of approximately 1%. Manufacturing has stalled and the service sector’s rebound from the pandemic has gone into reverse, as the tailwind of pent-up demand has been overcome by the rising cost of living, higher interest rates and growing gloom about the economic outlook.
An increased rate of order book deterioration, with backlogs of work dropping sharply in July, reflects an excess of operating capacity relative to demand growth and points to output across both manufacturing and services being cut back further in coming months unless demand revives. However, with companies’ expectations of future growth slumping to the lowest since the early days of the pandemic, any such revival is not being anticipated. Instead, firms are already reassessing their production and workforce needs, resulting in slower employment growth.
Although supply constraints remained problematic, constraining economic activity, the weakening demand environment has helped to alleviate inflationary pressures. Average prices charged for goods and services consequently rose at a much reduced rate in July, the rate of inflation still running high by historical standards but now down to a 16-month low to provide some much needed good news amid the ongoing cost of living crisis.
Some things are clear from this survey:
- the U.S. economy is contracting “solidly” in July, in both manufacturing and services;
- some price discounting is apparent;
- backlogs have disappeared;
- companies increasingly in cost cutting mode, including staffing.
Friday we saw how weak demand in the Eurozone is:
- New orders for goods and services fell “solidly”;
- July recorded the “biggest monthly drop in purchasing of inputs by manufacturers since the initial pandemic lockdowns of early-2020”…
- … and the “largest build-up of unsold finished goods ever recorded by the survey”.
In Japan: “new orders fell at the fastest pace since November 2020”.
Recall that 40% of S&P 500 companies’ revenues are foreign. These sales are not only weak and weakening, a rising percentage are lost in translation to a strong USD.
These are surveys of purchasing managers who receive their cues and instruction from sales managers.
From World Economics last week:
The US economy is very slowly tipping into recession according to the latest (July) data from the Sales Managers Monthly survey.
Sales managers are very much the “front line” in terms of sensitivity to changing business conditions. Sensitive to contractual negotiations being deliberately slowed down.
Sensitive to expected contracts “in the bag” being suddenly cancelled. And most of all sensitive to “budgetary problems” being increasingly cited as reasons for sales negotiations faltering.
All of these conditions are present today in many markets leading to the July Sales Managers Index remaining below the no-growth line. Very little general good news is apparent from the survey, although some sectors of economic activity continue to thrive, and price pressures do at last seem to be moderating.
The Conference Board Leading Economic Index® (LEI) for the U.S. decreased by 0.8 percent in June 2022 to 117.1 (2016=100), after declining by 0.6 percent in May. The LEI was down by 1.8 percent over the first half of 2022, a reversal from its 3.3 percent growth over the second half of 2021.
“The US LEI declined for a fourth consecutive month suggesting economic growth is likely to slow further in the near-term as recession risks grow,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Consumer pessimism about future business conditions, moderating labor market conditions, falling stock prices, and weaker manufacturing new orders drove the LEI’s decline in June. The coincident economic index which rose in June suggests the economy grew through the second quarter. However, the forward-looking LEI points to a US economic downturn ahead.” (…)
A US recession around the end of this year and early next is now likely. (…)
David Rosenberg notes that
(…) the most important development following yesterday’s release is that this now marks four months in a row of a decline in the LEI and solidifies the belief that a recession is on its way. Not once in the full history of this index (which dates back to 1959) has there been such a streak without the economy either about to be in a recession or already in one. When the four-month losing stretch occurs prior to the recession beginning, the median lead-time is four months — putting the start date (if it is not happening already) somewhere around the end of Q3/beginning of Q4 of this year. This will come as a surprise to the Fed, who has 4%+ real GDP growth baked into their second half forecasts, while the economics community is closer to 3%. (…)
The only silver lining from the Flash PMIs is that inflation is easing from its high level:
- In the Eurozone, “average charges for goods and services continued to rise sharply in July, though the rate of inflation cooled for a third month in a row from April’s all-time high to reach the lowest since February. Rates of selling price inflation eased in both manufacturing and services.”
- In the USA, “the pace of input price inflation eased again from May’s series peak and was the softest for six months, despite being faster than in any period seen before May 2021. (…) slower input cost inflation, greater competition and softer demand conditions led to some concessions being made to customers, however, helping to cool the pace of charge inflation to its slowest since March 2021.”
- Significantly, from service providers, “Some reports of discounts made to customers, and slower input price increases, led to the softest rise in output charges since March 2021.”
- Last week, the Philly Fed survey also noted that “The prices paid index declined to a still-high 52.2 in July from 64.5 in June, registering the lowest reading since January 2021’s 47.4. The prices received index fell to 30.3, the lowest level since March 2021, from June’s 49.2.”
The FOMC is widely expected to boost interest rates this week justified on the need to raise rates above the elusive neutral rate, the rate above which monetary policy is presumed to begin to slow the economy. For the average American, the neutral rate is when inflation starts to erode his/her spending power. On a YoY basis, this is likely happening in July…
…but MoM, it started last March (red bars) with 3 bruising bites since.
Jay Powell noted in his recent Senate testimony that the FOMC “needed to accelerate the pace at which we get up to a level that is close to the longer-run neutral level”, currently estimated at 2.5% by the Fed.
A 0.75% hike in July would almost bring us there. The widely expected 0.5% increase at the next meeting (September 20-21) would get us over “the bar”, right after the important back-to-school season and just before the all-important Thanksgiving and Christmas holidays.
The risk of a major policy error is high with all this focus on getting over the neutral rate.
The truth is that the Fed failed to understand the inflation dynamics and now fails to understand that inflation is already slowing demand across the economy, even before reaching the magic neutral rate.
This is not a normal cycle when inflation slowly creeps up over several months enabling the Fed to gradually fine tune policy until it starts to impact demand. The inflation rate in the U.S. was 1.3% in December 2020. It jumped to 5.3% in June 2021 and to 9.0% in June 2022. Even the 1972-74 and 1978-80 inflationary episodes, both leading to big recessions, were spread over longer periods.
Hiking aggressively in a weak an weakening economy when inflation, though still high, might be about to decline under the weights of lower commodity prices, slowing demand, excess inventories and shrinking services sounds like overkill.
From my lens, the only thing that can save the economy, and the Fed, is a meaningful decline in oil prices. WTI is down 21% to $95/bbl since mid-June driving a 13% decline to $4.45/g on average for U.S. gas prices, though still a long way from the pre-war $3.25 level.
Nobody can solidly forecast oil prices these days but demand destruction from higher prices and recessionary conditions can surprise producers.
While Morgan Stanley strategists say it’s too early to expect the Fed to stop tightening its policy even as fears of a recession grow — suggesting stocks have more room to fall before finding a bottom, JPMorgan Chase & Co. strategists say bets that inflation has peaked will lead to a Fed pivot and improve the picture for equities in the second half.
Sticky inflation is what will keep the Fed hawkish for longer this time around, according to Morgan Stanley’s Michael J. Wilson. While during the past four cycles the US central bank had stopped tightening its policy before the start of an economic contraction, triggering a bullish signal for stocks, current historic levels of inflation mean the Fed will likely still be tightening when a recession arrives, Wilson wrote in a note.
Equity markets “may be trying to get ahead of the eventual pause by the Fed that is always a bullish signal,” Wilson said. “The problem this time is that the pause is likely to come too late.”
Wilson, who has been among the most vocal bears on US stocks and correctly predicted this year’s selloff, said that even though inflation could indeed have peaked “from a rate of change standpoint,” the impact on consumer demand won’t “easily disappear even if inflation declines sharply because prices are already out of reach in areas of the economy that are critical for the cycle to extend.”
Over at JPMorgan, Mislav Matejka said in a note on Monday that challenging activity momentum and softer labor markets could open doors to a more balanced Fed policy, leading to a peak in the US dollar and inflation. (…)
JPMorgan’s Matejka said that another factor that improves the outlook for equities in the second half of the year is the changing reaction to earnings, where weaker results can start being seen as good news.
Wilson disagrees, saying that earnings estimates for S&P 500 firms are still too high and that the second quarter is likely to be the first of “several disappointing quarters before estimates finally trough.”
As such, stocks may have further to fall before hitting a bottom, he said. “Recent positive price action to some earnings cuts is unlikely to be the low for most stocks as it’s usually unwise to buy the first cuts when we are entering a major revision cycle,” Wilson wrote on Monday.
Strategist David J. Kostin at Goldman Sachs Group Inc. also sees pressure on S&P 500 revenues from a stronger dollar. The bank’s top-down model shows that a 10% appreciation in the trade-weighted greenback should reduce earnings-per-share by 2% to 3%, he wrote in a note on July 22.
More than 60% of the 1,343 respondents in the latest MLIV Pulse survey said there’s a low or zero probability of the central bank reining in consumer-price pressures without causing an economic contraction.
EARNINGS WATCH
From Refinitiv//IBES:
Through July 22, 106 companies in the S&P 500 Index have reported earnings for Q2 2022. Of these companies, 75.5% reported earnings above analyst expectations and 20.8% reported earnings below analyst expectations. In a typical quarter (since 1994), 66% of companies beat estimates and 20% miss estimates. Over the past four quarters, 81% of companies beat the estimates and 16% missed estimates.
In aggregate, companies are reporting earnings that are 4.7% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.1% and the average surprise factor over the prior four quarters of 9.5%.
Of these companies, 68.9% reported revenue above analyst expectations and 31.1% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 78% of companies beat the estimates and 22% missed estimates.
In aggregate, companies are reporting revenues that are 1.3% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.2% and the average surprise factor over the prior four quarters of 3.4%.
The 106 companies having reported so far showed EPS down -4.3% in aggregate on revenues up 7.8%. Given that…
- The estimated earnings growth rate for the S&P 500 for 22Q2 is 6.2% [vs 5.6% on July 1]. If the energy sector is excluded, the growth rate declines to -3.2%.
- The estimated revenue growth rate for the S&P 500 for 22Q2 is 11.3% [vs 10.4%]. If the energy sector is excluded, the growth rate declines to 6.7%.
…the remaining 394 reports are expected to be quite positive.
- The estimated earnings growth rate for the S&P 500 for 22Q3 is 10.0%. If the energy sector is excluded, the growth rate declines to 3.8%.
- Upward revisions to EPS estimates for companies in the Energy sector and positive earnings surprises reported by companies in the Health Care sector were substantial contributors to the increase in the earnings growth rate over the past week. Upward revisions to EPS estimates for companies in the Energy sector have been the largest contributor to the overall increase in earnings for the index since the end of the second quarter (June 30). (Facset)
Trailing EPS are now $218.25. Full year 2022: $228.27e. 12m FW EPS: $239.37e.
Yellen Says Signs of US Recession Aren’t in Sight for Now
Summers Says Fed Needs to Take Strong Action to Curb Inflation
(…) A surge in strikes and other labor protests is threatening industries all over the world, and especially the ones that involve moving goods, people and energy around. From railway and port workers in the US to natural-gas fields in Australia and truck drivers in Peru, employees are demanding a better deal as inflation eats into their wages.
Precisely because their work is so crucial to the world economy right now –- with supply chains still fragile and job markets tight –- those workers have leverage at the bargaining table. Any disruptions caused by labor disputes could add to the shortages and soaring prices that threaten to trigger recessions. (…)
BTW: Axios informs us that
- “The driver supply flipped from shortage to surplus in early 2022,” notes a report from ACT, a transportation market research group. The surge in hiring comes amid big increases in wages and demand for trucks to deliver all the stuff we’ve been buying for the past few years. Plus, some of the health constraints of the pandemic have faded.
- 20,000 more long-haul truckers gained employment in May— the largest monthly addition of new truckers since 1997 when the Bureau of Labor Statistics started tracking, according to a Goldman research note.
- Long-haul trucking employment is now 2% above pre-pandemic levels.
- Average weekly earnings were 10.8% higher in May, compared to a year ago, for drivers in freight trucking, according to BLS data.
- “A lot of people who wouldn’t normally be a truck driver” became truck drivers, said Kenny Vieth, president of ACT.
 
Data: Bureau of Labor Statistics; Chart: Kavya Beheraj & Erin Davis/Axios
Much like the debate around the broader economy, freight-watchers largely fall into two camps.
- Some say the industry is simply coming into balance after two years of unsustainable activity.
- Others say the sector is rolling over, and a “freight recession” — with harsh consequences for some truckers — is imminent.
- Excluding fuel, spot rates have plummeted by a sharp 30%, but remain above pre-pandemic levels, according to Freight Waves. “To see prices deteriorate by one-third in three months is pretty dire,” says the site’s CEO Craig Fuller.
- In earnings calls this week, the country’s biggest trucking firms confirmed that the pandemic-era gravy train has slowed. Yet none pointed to a catastrophic slowdown.
Covid or Vacation? Workers Aren’t Showing Up This Summer Some companies report difficulty keeping operations going due to illness and vacations, saying that maintaining workforces is tougher than at any previous time during the pandemic.
Benchmark home prices could fall more than 12% through early next year from the market’s peak, a bigger decline than any of the four national downturns of the past 40 years, according to a report Friday by Royal Bank of Canada economist Robert Hogue.
Sales are also expected to slump 23% this year and 15% next year, RBC said. That total decline of 42% since early 2021 would outrank the 38% drop in 2008 and 2009. (…)
German Ifo adds to recessionary evidence A sharp fall in the July Ifo index adds to the long list of downside risks for the German economy
Germany’s most prominent leading indicator, the Ifo index, took a strong nosedive at the start of the third quarter. In July, the Ifo index fell sharply to 88.6, from 92.3 in June. Both the current assessment and expectations component dropped, with the expectations component experiencing the sharpest drop since March and the third largest drop since the pandemic started.
The Indian economy is slowly tipping back into recession according to the latest (July) data from the Sales Managers Monthly survey.
The overall Sales Managers Index fell further under the 50 no growth line to a 22 month low. The Sales Growth Index fell sharply losing 2.6 Index points, and plunging to a 22 month low. The Market Growth and Business Confidence Indexes both fell to new year-plus lows. The Staffing Index fell dramatically again to record a 12 month year-on-year low. Despite the downbeat sales data, prices continue to rise fast, but the good news is, the rise has slackened significantly.
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