Happy, Healthy New Year! This is my 15th.
You might have missed my Economic Perspectives, Dec 27. 2022
Big Banks Predict Recession, Fed Pivot in 2023 More than two-thirds of economists at 23 major financial institutions expect the U.S. to have an economic downturn this year.
(…) They cite a number of red flags: Americans are spending down their pandemic savings. The housing market is in decline, and banks are tightening their lending standards. (…)
The main culprit is the Federal Reserve, economists said, which has been raising rates for months to try to slow the economy and curb inflation. (…)
Most of the economists surveyed by The Wall Street Journal expect the higher rates will push the unemployment level from November’s 3.7% to above 5%—still low by historical standards, but that increase would mean that millions of Americans would lose their jobs. (…)
Of course, almost everyone on Wall Street and in Washington got 2022 wrong—from the Fed’s insistence that inflation would be transitory to top Wall Street analysts who projected a banal year of growth for stock and bond prices. The extent to which investors, analysts and economists were wrong-footed has left many looking at the coming year with a sense of unease. (…)
The Conference Board’s collection of leading economic indicators has fallen for nine months in a row, reaching levels that have historically preceded recessions. And gauges that track overall business activity and the services and manufacturing sectors have fallen to some of the lowest levels since the Covid-induced 2020 recession.
Further, U.S. government bonds maturing between three months and two years hold higher yields than bonds maturing in 10, 20 or 30 years. This so-called inverted yield curve is a warning sign that has occurred before every U.S. recession since World War II. (…)
The excess savings that Americans socked away at the height of the pandemic have dwindled to $1.2 trillion from about $2.3 trillion, according to data from the Fed. Deutsche Bank analysts expect that to be fully exhausted by October. (…)
Businesses will also likely have to pull back on capital expenditures, Mr. Ryan said.
To be sure, a majority of the economists who expect the U.S. economy to contract predict it will be a “shallow” or “mild” recession. They expect the economy and U.S. equity markets to rebound late in 2023, thanks largely to the Fed pivoting to rate cuts. They largely expect bonds to deliver strong returns in 2023, while stocks finish the year up slightly.
Most outlooks predict the Fed will raise interest rates in the first quarter, pause in the second and begin cutting rates in the third or fourth quarter. (…)
The average outlook targets have the S&P 500 about 5% higher than its current level at the end of 2023. (…)
Just five of the 23 financial institutions surveyed by the Journal said they expect the U.S. to avoid recession in 2023 and 2024: Credit Suisse Group AG, Goldman Sachs Group Inc., HSBC Holdings PLC, JPMorgan Chase & Co. and Morgan Stanley.
“Several historically reliable lead indicators are sending recession signals, but in our view these measures are unable to correctly gauge recession risk in the current environment,” Jeremy Schwartz, senior U.S. economist at Credit Suisse, wrote in the bank’s 2023 economic outlook.
But even these relatively optimistic economists predict the U.S. economy will grow much more slowly than it has over the past 20 years.
They project growth for the year will slow to about 0.5%, on average. (…) Goldman has the rosiest outlook for 2023, predicting 1% growth in U.S. gross domestic product.
This would be the most highly anticipated recession ever, by a group which generally can’t see one until we’re in it.
Virtually all recessions are uncalled the year before they occur, and fewer than 25% get called the year they actually occur. And they generally turn out stronger than predicted (see this IMF paper).
- John Maynard Keynes: “The inevitable never happens. It is the unexpected always.”
- Bob Farrell’s rule #9: When all the experts and forecasts agree – something else is going to happen.
MANUFACTURING PMIs
The intensity of the eurozone manufacturing sector downturn eased in the final month of 2022 as softening inflationary pressures and more stable supply-chain conditions created some respite for goods producers. Weakness in client demand remained evident through slumping new order intakes, leading firms to make further inroads into their backlogs instead. Meanwhile, additional increases in pre- and post-production inventories were seen during December despite purchasing activity and production volumes falling. Nevertheless, employment growth continued, while business confidence also edged up to a seven-month high.
The S&P Global Eurozone Manufacturing PMI® posted below the 50.0 no-change mark in December for a sixth successive month, indicating a deterioration in business conditions facing goods producers across the euro area. However at 47.8, this was up from 47.1 in November and its highest reading for three months, signalling a softer downturn.
Market groups data showed continued deteriorations across consumer and intermediate goods makers, while capital goods producers recorded a marginal improvement.
All of the monitored eurozone constituents (which together account for an estimated 89% of eurozone manufacturing activity) registered a Manufacturing PMI below the crucial 50.0 mark in December, signalling broad-based weakness. That said, downturns eased with the exception of Greece, which saw a sharper decline in December,
Eurozone manufacturing output fell in December, marking a seventh successive month of contraction. That said, the decrease was only moderate and the weakest since June. The drop in production coincided with a further slump in new order inflows as demand for eurozone goods remained generally subdued. In line with the trend in output, the decline in factory sales weakened since November and was the softest in four months. A slower fall in new export business also helped to alleviate the downturn in overall order books.
In the absence of new business growth, eurozone manufacturers turned attention to their incomplete workloads. The latest survey data pointed to a sharp monthly fall in backlogs in December. Eurozone goods producers subsequently tapered their hiring activity, with the rate of job creation slowing to a 22-month low.
To adjust to lower demand, eurozone manufacturers cut their purchases of raw materials and other components at the end of the year. The reduction was steep, but the slowest in three months. Falling input demand helped take pressure off suppliers, with average input lead times stabilising in December amid reports of improving raw material availability.
Stocks of purchases also increased in December, despite the sharp drop in purchasing activity. The rate of accumulation was only marginal and the weakest in 15 months. Meanwhile, following the historically strong expansions in post-production inventories seen in recent months, December data showed the weakest increase over the current seven-month sequence.
Inflationary pressures eased across the euro area manufacturing sector in December. The rate of input cost inflation was still sharp, but the weakest since November 2020. Output charges were subsequently raised to a weaker extent as some companies chose to pass through lower expenses to their clients. Overall, the increase in selling charges was the slowest since March 2021.
Finally, business confidence improved for a second month in a row, rising further from October’s two-and-a-half-year low. In fact, future output expectations moved back into optimistic territory for the first time since August. Nevertheless, business sentiment remained historically subdued as inflation, high energy bills and recession risks clouded the outlook.
- Caixin China General Manufacturing PMI™: COVID-19 containment continues to dampen output at end of 2022
Chinese manufacturers signalled a further slight deterioration in overall business conditions at the end of 2022, as efforts to stop the spread of COVID-19 continued to disrupt operations and dampen client demand. While output fell at a softer rate compared to November, total new orders fell at a quicker pace as firms cited relatively weak market conditions. As a result, companies cut back on purchasing activity and reduced their headcounts further.
Encouragingly, business confidence around the 12-month outlook for output improved to the highest since February. Inflationary pressures meanwhile remained muted, as input costs rose modestly and prices charged fell slightly.
The headline seasonally adjusted Purchasing Managers’ Index™ (PMI™) edged down from 49.4 in November to 49.0 in December. The reading signalled a fifth successive monthly deterioration in operating conditions. Although quickening on the month to its strongest since September, the pace of decline remained marginal overall.
Weighing on the headline index was a quicker fall in overall new business during December. Though modest, the latest reduction in sales was the fastest seen for three months, with companies citing relatively weak demand conditions amid the ongoing pandemic. Foreign demand for Chinese manufactured goods also fell, and at a quicker pace than in November. Lower amounts of export work was often blamed on sluggish global economic conditions and the pandemic.
COVID-19 containment measures, including temporary factory closures, combined with softer customer demand to drive a further fall in manufacturing production at the end of the fourth quarter. The pace of contraction was the softest for four months and mild, however, with some firms noting a relative improvement in their operations compared to November.
In line with the trend observed for new orders, companies trimmed their purchasing activity at a quicker pace during December. Notably, the rate of decline was the strongest seen since April. At the same time, inventories of both purchased items and finished goods fell further.
The ongoing implementation of COVID-19 containment measures continued to impact logistics, with suppliers delivery times lengthening for the sixth month running. Though not as severe as that seen in November, the rate of deterioration was nonetheless solid overall.
Lower production requirements and difficulties sourcing workers due to pandemic-related disruption led to a further fall in employment. The rate of reduction was only fractionally slower than November’s 33-month record. Firms signalled little pressure on capacity though, as backlogs of work fell slightly for the third time in four months.
On the costs front, average input prices rose only slightly in December, with some firms noting an increase in expenses for some materials (notably metals). However, firms continued to lower their selling prices slightly as part of efforts to boost competitiveness and gain new business.
Chinese manufacturers expressed stronger optimism towards the year-ahead outlook for production in December. The level of positive sentiment improved to the highest for ten months, with companies often anticipating output to increase as the pandemic situation improves and market conditions strengthen.
- China’s official PMI declined from 47.8 t 47.0. Its non-manufacturing PMI sunk from 46.7 to 41.6 with new orders at 39.0.
- China’s Economy Likely Contracted Last Quarter, Beige Book Says
Indexes measuring profits, sales and employment at manufacturing and services companies slumped in the last three months of 2022 from the previous quarter and a year ago, China Beige Book International said Monday. The results are based on a survey of 4,354 businesses conducted last quarter.
Metrics for the property sector, including transactions and prices, plunged close to all-time lows, CBBI said.
The figures imply that China’s gross domestic product likely contracted in the fourth quarter from a year ago in real terms and grew only 2% for the whole year of 2022, CBBI, a provider of independent economic data, said in its report. (…)
The CBBI survey showed businesses remaining in distress in the fourth quarter. Companies obtained 46% of their loans from non-bank lenders in the final three months of 2022, up from 33% in the third quarter.
The rise in so-called shadow banking suggests firms are struggling to qualify for bank credit lines, with the cost of borrowing climbing to the highest in more than a decade, according to the CBBI report.
China Official Raises Covid Alarm Ahead of Holiday Infections are exploding across China weeks ahead of the Lunar New Year, when tens of millions of people typically travel to celebrate the holiday.
(…) “There could be a retaliatory rush of people from the cities to the countryside,” she said.
In recent weeks, China’s biggest cities have seen hospital emergency rooms and crematoria fill up as the country’s elderly population, whose vaccination rates lag those of their younger counterparts, contracts Covid in large numbers. But experts say the problem is likely to be far more acute in China’s vast countryside, where doctors and nurses are less prepared for Covid and medical facilities are poorer. (…)
How many city workers won’t immediately come back because they need to take care of sick parents?
European Cities Break Temperature Records as Warm Winter Holds
Unhappy New Tax Year for U.S. Business
The tax hikes arrive for two reasons: provisions of the 2017 GOP tax reform that are phasing out, and big tax increases that passed as part of the Democrats’ Inflation Reduction Act.
• Capital expensing. The biggest business tax hit is the end of full, immediate expensing for equipment. The 2017 tax reform spurred investment by letting businesses immediately deduct the full cost of hardware like trucks and machines, but that policy is set to phase out. The maximum early deduction drops this year to 80%, and it will continue to decrease each year until it disappears in 2026. (…)
• R&D expensing. This big hit has already arrived. January 2022 marked the end of full expensing for corporate research and development, a benefit that began in 1954. Companies could previously deduct R&D spending from their next tax bill, but they now have to spread the deduction over several years (five years for domestic spending, 15 for international).
In a letter to Congressional leaders last spring, the CEOs of 36 large companies estimated that the spaced-out research deduction would cost businesses $29 billion by year end.
• Interest expensing. The cap on the business interest deduction dropped last year when the formula changed to exclude amortization. This is justifiable as part of tax reform, since the tax code shouldn’t have a subsidy for debt over equity. But the timing now is bad.
The cost of borrowing is climbing in step with the Federal Reserve’s interest-rate hikes, and the smaller deduction compounds the pain. That’s especially true for manufacturers and other capital-heavy companies with significant multiyear costs. (…)
Meantime, two provisions of the Inflation Reduction Act also took effect Jan. 1:
• A new corporate minimum tax. This 15% levy hits large U.S. firms earning more than $1 billion in book income annually. The tax will fall heavily on industries like real estate and mining that currently benefit from Congressional carve-outs, according to the Tax Foundation. The levy will raise the average effective tax rate on corporate income to 19.3% from 18.7%.
• The stock buyback tax. This 1% tax applies to repurchases of stock by publicly traded companies. This is essentially an alternative way of taxing dividends and is a drag on the efficient allocation of capital. It will cause more cash to sit longer on company books rather than going toward investment. (…)
One Year’s Loss Is Not the Next Year’s Gain
(…) Over the course of the index’s history, there have only been nine other years in which the S&P 500 has fallen at least 15% for the full year. Of course, turning the page of the calendar does not mean all the issues dragging stocks lower magically go away, and a big decline one year does not in and of itself mean we’re due for a big gain the next year.
In the chart below we plot the annual percentage change of the S&P 500 versus its move the following year. Taking a linear regression shows that performance one year is not a good explainer for next-year performance with a miniscule R squared of 0.0003. Looking just at those years where the S&P fell 15%+, five times the index posted gains the next year, while four times the index posted further declines.
(Bespoke)
China’s New Foreign Minister ‘Deeply Impressed’ With Americans His effusive praise signals ties between the world’s biggest economies appear to be warming.
(…) “I have been deeply impressed by so many hard-working, friendly and talented American people that I met,” Qin said in a Tweet on Tuesday, adding that he had “made many friends across the US.”
Qin said he’d continue to “support the growth of China-US relations,” and promote peace and development — comments that add to signs Beijing is adopting a softer diplomatic touch. (…)