THE DAILY EDGE: 26 SEPTEMBER 2022

FLASH PMI US private sector output falls at softer pace as new orders return to growth in September US private sector firms registered a softer fall in output during September, according to latest ‘flash’ PMI™ data from S&P Global. Contractions in activity across the manufacturing and service sectors eased. The overall decrease was only marginal and signalled a notably slower rate of decline compared to that seen in August. The headline Flash US PMI Composite Output Index registered 49.3 in September, up from 44.6 in August, to signal a softer and only marginal decline in private sector business activity. The decrease was also the slowest in the current three-month sequence of contraction. Although manufacturers continued to register a slight fall in production, service providers signalled a much slower pace of decline in output. New orders received by private sector firms returned to expansionary territory in September, with growth broad-based across the manufacturing and service sectors. The upturn was only mild, despite being the quickest since May. Where an increase was noted, some firms linked this to the acquisition of new clients. The rate of expansion was historically subdued, however, as a number of companies suggested that inflationary pressures continued to weigh on customer spending. New export orders remained in contraction, with the rate of decrease the second-fastest since May 2020. For the fourth month running, the rate of input cost inflation eased during September. The pace of increase was the slowest since the start of 2021, as manufacturers and service providers recorded slower upticks in operating expenses. That said, cost burdens continued to rise at an historically elevated pace, with interest rate hikes and material and wage increases driving inflation. Reflecting softer rises in cost burdens, firms increased their selling prices at a slower pace at the end of the third quarter. That said, the moderation was led by service providers as manufacturers registered a sharper uptick in output charges in an effort to pass on higher costs to clients. In line with a renewed rise in new orders, private sector firms signalled growth in backlogs of work during September. The increase was only marginal overall, but contrasted with a solid decline in August. Manufacturers continued to note difficulties in working through orders due to transportation and supply chain disruption, with capacity constraints hampering service providers for the first time since May. Employment across the private sector rose further in September, albeit at a softer pace than in August. The moderate upturn in workforce numbers reflected expansions in manufacturing and service sector staffing levels. The rate of job creation at goods producers was the sharpest for six months amid greater success in hiring suitable candidates for vacancies. Private sector firms were more upbeat in their expectations for output over the coming 12 months at the end of the third quarter. The degree of confidence picked up to a four-month high and was only just below the series trend. Increased optimism was linked to hopes of further upticks in new orders and the acquisition of new customers. Greater positive sentiment stemmed from service providers as manufacturers registered a slight moderation in their expectations. The S&P Global Flash US Services Business Activity Index posted at 49.2 in September, up notably from 43.7 in August to signal a much slower decline in output. The fall in business activity was the softest for three months as firms stated that a pick up in new orders and client demand dampened the contraction. Meanwhile, new orders rose following a decline during August. The upturn was only slight overall, however, as reports of strong inflation and interest rates hampering sales persisted. In contrast to a rise in total new business, new export orders fell for the fourth month running. Inflationary pressures across the service sector remained substantial in September. That said, the rate of cost inflation softened to the slowest since January 2021 amid reports of drops in some material costs. In an effort to drive sales, firms passed on cost savings to their clients where possible, which led to the slowest uptick in output charges for almost two years. At the same time, backlogs of work returned to growth as staff and parts shortages, alongside greater new orders, put pressure on capacity. The rise was only marginal, however. Firms sought to expand workforce numbers, but higher wage costs and challenges finding suitable candidates weighed on overall job creation, which eased to the slowest in 2022 so far. Service providers were more confident of a rise in output over the coming year, as the level of optimism reached the highest since May amid improved expectations around client demand. At 51.8 in September, up slightly from 51.5 in August, the S&P Global Flash US Manufacturing PMI continued to signal a relatively subdued improvement in the health of the manufacturing sector. The September headline reading was the second-lowest since July 2020. Weighing on the overall upturn was a further contraction in production in September. The fall was only marginal, but broadly in line with that seen in August. Relatively muted demand and supply chain constraints continued to hamper output and capacity, with backlogs of work increasing again. New orders grew for the first time in four months at the end of the third quarter, albeit only slightly. Subdued demand conditions reportedly stemmed from concerns regarding inflation and economic uncertainty. New export orders remained in contraction territory amid challenging economic conditions in key export markets. Although input costs increased at a softer pace during September, firms raised their output charges at a sharper rate. Average operating expenses rose at the slowest pace since November 2020, as some material prices reportedly fell. Historically elevated increases in costs were, however, partially passed on to customers. A greater ability to hire new workers led to a solid upturn in employment at manufacturers in September. The rate of job creation was the fastest since March. The softer rise in input costs was also partially due to a less marked deterioration in vendor performance. Lead times lengthened to the smallest extent since October 2020, as some firms noted reprieves in the supply of certain materials and less severe transportation delays. That said, higher input costs led to a further decline in purchasing activity in September, with firms opting to utilise stocks to supplement production. As a result, pre-production inventories fell at a solid pace. Finally, manufacturers remained broadly confident of a rise in output over the coming year amid increased new orders and investment in product development. The degree of optimism was dampened by ongoing concerns regarding economic uncertainty and the impact of inflation on customer spending, however. S&P Global’s August PMI’s big drop to 44.6 and falling new orders contrasted with the ISM PMI which rose to 56.9 with rising new orders. This flash PMI suggests that the ISM was closer to reality in August, at least on the trends. The U.S. economy is not “sharply contracting” as S&P Global signaled last month. Note also the apparent slowdown in employment and the “slowest uptick in output charges for almost two years” in services. On the CPI services price index, that would be +0.1% MoM in September after after +0.6% in August and +0.35% in July for +4.2% annualized over the last 3 months, nearly half the pace of the previous 3 months. Coupled with services “job creation, which eased to the slowest in 2022 so far”, September data could offer hopes of more subdued employment demand and inflation in the crucial services sector. Job openings in services are down 2.8% since their December 2021 peak. Manufacturing job openings rose 11.8% during the same period although still below their July 2021 peak. Now that Powell and co. have convinced the world of their resolve to bring inflation down to the 2% range whatever it takes, it may be time to think about taking the under on the inflation bet and watch for signs of faster slowdown and faster disinflation than is now generally expected. The OECD said the global economy will expand just 2.2% in 2023, down from a previous forecast of 2.8%, as it slashed GDP estimates for most of the G-20. It predicts Europe will be hardest hit, but even US growth will be a mere 0.5% next year. The Conference Board’s Leading Economic Index is now signalling a recession: The ten components of the Conference Board LEI are: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; ISM Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Index of Stock Prices; Leading Credit Index; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions. Based on FOMC members’ public statements, their focus (and the media’s) is currently on income (payroll employment and wages) and inflation data which, in fact, are coincident and lagging indicators. This when “among the LEI’s components, only initial unemployment claims and the yield spread contributed positively over the last six months—and the contribution of the yield spread has narrowed recently.” So the LEI has been falling for 6 months and is now signalling a recession. So are the 10-2 yield curve and the equity and credit markets. Yet, the Fed is aggressively tightening based on trends in coincident or lagging indicators. On employment, the slowdown scenario gets support from these facts: Employment growth has slowed from +600k per month on average early this year to the +350-375k range in recent months, lately highly concentrated in services. The September flash PMI supports a continued slowdown. Full-time employment declined in each of the last 3 months (-155k on average vs +522k on average in the first 5 months of the year). Average weekly hours have declined steadily all year. Walmart recently announced hiring plans for just 40,000 seasonal workers, down significantly from the 150,000 the company announced last year. Amazon, which since 2012 has announced an average of over 106,500 seasonal jobs each year – with 125,000 last year, according to Challenger tracking – has yet to announce a seasonal hiring plan. (Challenger, Gray) Job openings in services peaked in March and have declined 5.2% through July. Wage growth for job stayers has slowed to 5.6% in August from 5.9% in June. Quit rates have been dropping across all trades since December, more so in sectors like leisure, hospitality and food services where quit rates exploded during the pandemic. On inflation, the jury is still out but: supply channels have improved in China and are slowly improving in the U.S.. “A continued steady normalization of supply chains is necessary to increase chip and vehicle production and bring down vehicle prices, which continues to be a significant source of inflation. It is also critical for the supply of building materials and appliances necessary to support new housing construction and quell rent growth and housing cost inflation.” (Moody’s)

• Producer prices for consumer durable goods (blue bars) and services have slowed to a +0.35% monthly change (4.1% a.r.) in the last 3 months from +0.7% between April 2021 and April 2022.

• The strong U.S. dollar is making imported goods and services cheaper for Americans.
• Energy prices may be stabilizing at the current high levels which in itself would contribute to more subdued inflation rates. We are more concerned on the prospective change in prices than on absolute price levels.

• The supply crunch in semiconductors may be nearing the end as the Covid-19 crisis eases, particularly in Asia and South-East Asia (e.g Malaysia), and more capacity comes on stream over the next 12 months

Currently, capacity is being freed up due to weakness in some end markets, particularly PCs, smartphones and consumer electronics, where sales have been falling since March 2022. Foundries in Taiwan are beginning to reallocate some of this capacity to the automobile and industrial end markets, which lost out to other sectors during the COVID-19 pandemic. However, autos generally require older chips, which are fundamentally different to those used in PCs and smartphones. (J.P. Morgan)

• A big wild card is the war in Ukraine which is meaningfully impacting prices of food, energy and many goods through more complex supply channels. A welcome surprise would be any relief in tensions, one way or the other
• But what about services? Goldman analysed the major components of services inflation to conclude, assuming 4% wage growth in 2023:

Taken together, we continue to expect that services categories will not contribute much towards disinflation until 2024, barring a recession. We forecast core services PCE inflation rising from 4.2% in July to 4.6% at end-2022, then falling back to 4.2% at end-2023. The decline in 2023 reflects a partial normalization in shelter and discretionary services categories partially offset by a 15-year-high pace for healthcare.

Not unreasonable overall. If services prices rise 4.2% in 2023, they will contribute 2.5% to headline PCE inflation. I continue to bet on subdued goodsflation with the appropriate caveat on food and energy.

Core PCE inflation looks set for below 5.0% next year, perhaps much less in a genuine recession, decelerating as the year progresses.

In all, there are shades of grey, even perhaps blueish spots, in the dark inflation sky most people are seeing.

At a minimum, inflation trends are not worsening: the trailing 3-month average core CPI has stabilized in the 0.5% MoM range (6% a.r.). Core PCE inflation has also stabilized in the 0.35% range (4.0-4.5% a.r.).

The Fed’s forceful message that it will not tolerate a price-wage spiral, even if it means a recession, might help cool people’s expectations and demands.

The ensuing rout in financial markets will help dampen demand from the high net worth segment of the population which was reportedly supporting demand this year.

For what it’s worth given its young age, as of September 24, 7 of the 12 categories surveyed by the Truflation website have deflated in the last month.

• Rents Drop for First Time in Two Years After Climbing to Records Nationwide, rents declined on a monthly basis in August amid new apartment construction and weaker consumer sentiment

August apartment asking rents nationally fell 0.1% from July, according to a report from property data company CoStar Group. It was the first monthly decline in rent since December 2020, the company said.

Apartment-listing website Rent.com showed a 2.8% decrease in rent for one-bedroom apartments during the same month. A third measure, by the listings website Realtor.com, also noted a slight monthly decline in rent this August. (…)

As more households feel priced out of the sales market because of rising mortgage rates and near-record sales prices, overall demand for rentals is unlikely to fall drastically, said Orphe Divounguy, an economist at Zillow Group.

Yet many economists say the rental market is likely to see more declines in the coming months. Prices typically dip during the fall and winter. (…)

Most apartment tenants have signed one- or two-year leases at a fixed monthly price. The lag between today’s market rental prices and what most tenants actually pay is also part of why housing costs, as tracked in the Bureau of Labor Statistics’ consumer-price index, are still shown to be rising. (…)

• Stocks, Oil Slump Over Worries About Global Growth The Dow industrials dropped nearly 500 points and closed at a low for the year, extending a selloff amid new signs of slowing global growth. Treasury yields rose to their highest level in more than a decade. The 10-year U.S. Treasury yield rose to 3.695% this week, notching an eighth consecutive week of gains. Two-year Treasury yields climbed to 4.212%, the highest since October 2007. Yields rise as bond prices fall.

“The market is worried about growth and this is sending commodity prices down,” said Ole Hansen, head of commodity strategy at Saxo Bank. “It’s a very bad cocktail of this and a stronger dollar.”

• Oil Falls as ‘Wrecking Ball’ Dollar Piles On Commodity Losses Brent sinks below $85 after tumbling by almost 6% last week

(…) “The market is highly concerned that central banks will drive economies into recession,” said Bjarne Schieldrop, chief commodities analyst at SEB AB. That puts heightened focus on the next OPEC+ meeting on October 5, he added. (…)

EARNINGS WATCH

Q3 estimates keep getting shaved, but very slowly and very little. S&P 500 EPS are now seen up 4.6% (5.1% on 09/02) and -1.9% ex-Energy (-1.5%). Q4 estimates have barely changed and are now +6.0% (+2.1%).

Trailing EPS are now $220.09. Full year 2022: $223.83 and 12-m forward $230.68.

Under its soft landing scenario, Goldman Sachs sees EPS of $234 for 2022 rising to $238 in mid-2023. It assumes a 15x P/E (the long-term median) and a resulting S&P index level of 3600.

Under a hard landing scenario, Goldman Sachs sees EPS of $230 for 2022 dropping to $220 in mid-2023. It assumes a 14.3x P/E and a resulting S&P index level of 3150.

Morgan Stanley via The Market Ear

  

@IanRHarnett                                          @MichaelAArouet

That would not be such a hard landing since current EPS are $220. In typical recessions, earnings decline 10-15% which would bring them between $185 and $200. In a hard landing, inflation and interest rates would eventually decline. At some point, investors would normalize EPS and P/E multiples would stop falling and actually, likely rise.

• Tech Stocks Face Another 10% Drop or More as Strong Dollar Hits Profits

• Amazon, Berkshire Hathaway Could Be Among Top Payers of New Minimum Tax Researchers analyzed securities filings to determine what companies would have paid if the tax had been in place last year and found just six would have paid half of the estimated $32 billion the levy would have generated.

They found fewer than 80 publicly traded U.S. companies would have paid any corporate minimum tax in 2021, and just six—including Amazon and Warren Buffett’s conglomerate—would have paid half of the estimated $32 billion in revenue the levy would have generated.

The tax, which takes effect in January, is the largest revenue-raising provision in Democrats’ climate, healthcare and tax law. The provision, projected to generate $222 billion over a decade, alters tax incentives and complicates corporate tax decisions. Democrats aimed the provision at large companies that report profits to shareholders but pay relatively little tax. (…)

The UNC analysis comes with caveats. Lacking confidential tax returns that would allow precise calculations, the authors used publicly available financial data. Companies might change behavior to minimize taxes. A one-year snapshot includes unusual situations that cause companies to pay the minimum tax once, generating tax credits that can be used in future years.

Under the new law, companies averaging more than $1 billion in publicly reported annual profits calculate their taxes twice: once under the regular system with a 21% rate and again with a 15% rate and different rules for deductions and credits. They pay whichever is higher.

The new system, known as the book minimum tax, starts with income reported on the financial statement, not traditional taxable income. Differences between the two—the treatment of stock-based compensation, for example—could drive a company into paying the new tax.

Linking taxes closer to publicly reported profits is intentional. It will become harder for companies to maximize profits to impress shareholders while managing taxable profits downward to minimize payments to governments, tax advisers say. (…)

By early next year, companies will start providing earnings guidance, making estimated-tax payments and reflecting the tax in quarterly earnings. They might also start crafting mitigation strategies and looking for flexibility in the accounting rules for when income and expenses are counted. (…)

In reality, we will have to wait corporate disclosures in Q1’23 for clarity on individual companies. “An AT&T spokesman said the company doesn’t expect the minimum tax to affect its 2023 tax bill. “Academics don’t prepare our taxes; trained and expert tax professionals do that work,” the spokesman said.”

The few estimates I have seen so far are that S&P 500 EPS could be reduced by $3-4 in 2023.

The S&P 500 median trailing P/E is now 17.7 (18.7 last week). On forward: 15.7x (16.8).

The 6 largest stocks by weight (21.4% of the index) have an average P/E of 47.0 (50.2). On forward: 29.9.

39% (37%) of the companies have a P/E below 15.0. On forward: 48%.

19.6% (16%) are below 10x. On forward: 20.0%.

SENTIMENT WATCH

• What is the Fed Doing? Don’t fight the Fed used to be a positive slogan. That’s not the case anymore. If anything, it feels like the Fed wants to fight us, all of us, including the stock market and the economy. The Fed is actively trying to crash the stock market, break the housing market and push the economy into a recession. How do I know this? Because Fed officials are literally telling us this every time they speak. (Wealth of Common Sense)
• Stock Downturn Brings Pain to Buy-the-Dip Investors It is the worst year for buying the dip since the 1930s. Instead of rebounding after a tumble, stocks have continued to fall, denting a strategy that soared in popularity over the past decade.

• Slide in Transportation Stocks Flashes Warning About Economy

• Mohamed A. El Erian: Why Investors Are Facing Even More Market Instability

(…) In terms of the distribution of possible economic and financial outcomes, the baseline is becoming less attractive and more uncertain, and the possibility of highly negative scenarios become greater.

Last week’s market developments, including the eye-popping price moves in fixed income and foreign exchange, went beyond investors and traders having to deal with these three inconvenient paradigm shifts. Two additional factors made the week particularly unsettling.

The first was the accelerated loss of trust in policy making. Markets, which for years appreciated the US Federal Reserve and the UK government as volatility suppressors, have shifted into viewing them as significant sources of unsettling instability.

After being seduced by the notion of “transitory” inflation and falling asleep at the policy wheel, the Fed is playing massive catch-up to counter high and damaging inflation. But having fallen so far behind, it is now forced to aggressively raise rates into a slowing domestic and global economy. With that, the once wide-open window for a soft landing has been replaced by the uncomfortably high probability of the central bank tipping the US into a recession, with the resulting damage extending well beyond the domestic economy.

In the UK, the new government of Prime Minister Liz Truss has opted not just for structural reforms and energy price stabilization but also for unfunded tax cuts of a magnitude not seen for 50 years. Concerned about the implications for inflation and borrowing needs, the markets drove the value of the pound down to a level last seen in 1985. They also delivered the largest-ever surge in borrowing costs as measured by the yield on five-year government bonds. (…)

The second additional factor relates to the flows of funds and the implications for market liquidity.

According to data compiled by Bank of America, some $30 billion flowed out of equity and bond retail funds and into cash. This and other indicators, such as the record surge in option-related protection against equity declines, points to the possibility of large asset reallocations that have strained the orderly functioning of markets. (…)

Last week’s developments point to the risk of more front-loaded instability that complicates an already bumpy journey to new economic and financial equilibria — one that makes behavioral investing mistakes more likely.

• AAII Bears: Most bearish reading since 2009. According to SentimenTrader “This week joins just 4 others in 35 years with more than 60% of respondents being despondent in the AAII survey. One year returns after the others: +22.4%, +31.5%, +7.4%, +56.9%”.

So bearish that it’s bullish?

@sentimentrader

I personally prefer the Investors Intelligence Bears indicator and it is not showing capitulation just yet (as of 09/20):

• Consumers Feel Worse Now Than They Did During Covid Lockdowns (Wall Street Journal)

And in previous recessions I would add.

TECHNICALS WATCH

S&P 500 Large Cap Index – 13/34–Week EMA Trend:

Traders bet on emergency interest rate rise after pound hits record low Currency tumbles further after UK chancellor announced biggest tax cuts in 50 years