THE DAILY EDGE: 3 JULY 2019: Earnings Warning!

U.S. Auto Sales Slipped in First Half of 2019

(…) The research firm J.D. Power estimates the annualized selling pace in June to come in at 17.3 million, lower than a year earlier. The U.S. auto industry in the first half has posted six straight months of weaker sales compared with the same period in 2018, according to Cox Automotive. (…)

In a research note last week, Morgan Stanley forecast global auto production to fall 4% this year, which will pressure profits for suppliers and car companies. (…)

COMPOSITE PMIs

USA: Subdued growth of business activity continues in June

June survey data indicated a marginal increase in business activity across the U.S service sector. Although the upturn was among the weakest over the last three years, the rate of growth quickened from May’s recent low. The faster expansion was supported by an acceleration in the rate of increase in new business. The slight pick up in client demand also led to a renewed rise in backlogs of work, with employment increasing moderately to accommodate greater pressure on capacity. Uncertainty regarding future new order growth dampened business confidence further as expectations hit a three-year low. Inflationary pressures meanwhile quickened slightly, but remained muted overall.

The seasonally adjusted final IHS Markit U.S. Services Business Activity Index registered 51.5 in June, up slightly from 50.9 in May. The latest index figure signalled a stronger expansion than the earlier ‘flash’ reading (50.7). That said, June data indicated only a marginal increase in output that was the second-slowest since August 2016 (behind May). Where a rise was reported, service providers linked this to a faster upturn in new business.

Domestic and external demand conditions improved slightly in June, with both new business and new export orders from abroad rising at quicker paces. Although the upturn in foreign demand was broadly in line with the series trend, total new orders increased at the second-slowest rate since April 2017. Some firms noted that greater advertising and marketing had improved new business intakes, but other continued to lament soft underlying demand conditions.

Subsequently, service providers registered a lower degree of business confidence in June, with the level of positive sentiment dropping to the lowest since June 2016. Optimism was weighed down by greater competition and concerns surrounding the strength of future new order growth.

A modest expansion in new business led to a renewed rise in the level of outstanding business in June, following no change in May. The rate of backlog accumulation was only marginal but accelerated to a three-month high.

Despite soft underlying demand conditions across the service sector in June, firms continued to expand their workforce numbers amid a tight labour market and difficulties finding skilled staff. The increase in employment was broadly in line with the average for 2019 to date.

Meanwhile, although input prices rose at a quicker pace, the rate of inflation remained historically subdued. Higher prices faced by service providers were linked to greater wage and fuel costs. Following broadly unchanged output charges in May, selling prices rose marginally in June and at the fastest rate for three months. Firms stated that higher charges were due to the pass through of increased cost burdens to clients.

The Composite PMI Output Index registered 51.5 in June, up from 50.9 in May. The expansion remained only marginal overall, despite quicker business activity growth across both the manufacturing and service sectors. Moreover, the rate of increase was the second slowest since August 2016 (behind May). The upturn in new business quickened in June, as manufacturers registered a renewed rise in client demand.

Service providers noted a moderate and faster increase. External demand conditions also picked up, with private sector firms recording a return to growth in new export orders. Meanwhile, pressure on capacity increased as backlogs of work rose at the fastest pace for three months. The upturn drove another marginal rise in employment. Inflationary pressures picked up in June, but remained historically subdued. Input prices rose at the fastest rate of three months, largely linked by manufacturers to trade tariffs. Output charges increased at a marginal pace, following broadly unchanged prices in May.

Business confidence dipped to a series low in June (since July 2012), despite a slight increase in optimism among manufacturers. The subdued level of positive sentiment was attributed to uncertainty surrounding future new order growth and global trade tensions.

Chris Williamson, Chief Business Economist at IHS Markit:

An improvement in service sector growth provides little cause for cheer, as the survey data still indicate a sharp slowing in the pace of economic growth in the second quarter. The PMI data for manufacturing and services collectively point to GDP expanding at an annualised rate of 1.5%.

A major change since the first quarter has been a broadening-out of the slowdown beyond manufacturing, with the service sector growth now also reporting much weaker business activity and orders trends than earlier in the year.

Hiring was hit as firms scaled back their expansion plans in the face of weaker than expected order inflows and gloomier prospects for the year ahead. Jobs growth was the weakest for over two years and future expectations across both services and manufacturing has slipped to the lowest seen since comparable data were first available in 2012.
(…)

CHINA: Manufacturing slowdown drags business activity growth down to eight-month low

The Caixin China Composite PMI™ data (which covers both manufacturing and services) showed that business activity in China rose only marginally overall. The rate of expansion slowed to the weakest since last October, as signalled by the Composite Output Index edging down from 51.5 in May to 50.6 in June.

The lower headline index reading was driven by falls in the sector headline readings for both services and manufacturing. The seasonally adjusted Chinese Services Business Activity Index fell from 52.7 in May to 52.0 in June, signalling only a modest rate of expansion that was the slowest since February. At the same time, manufacturing output declined for the first time in five months, albeit only marginally.

Total new business at the composite level also rose at a softer pace in June compared to May. Services firms reported a slightly stronger increase in new work, supported by state policies that boosted client spending. There were also mentions of new product launches and a general improvement in market conditions. In stark contrast, factory orders received by Chinese manufacturing firms decreased during the month amid reports of trade tensions.

Disruptions to trade led to a slight reduction in new work from abroad at manufacturers in June. The latest data marked the third drop in external demand at Chinese factories in the year to-date, although the latest fall was only fractional overall. Notably though, a decline was also recorded at service companies for the first time in nine months.

With regards to employment, composite data indicated a second consecutive fall in job numbers across China’s private sector economy. Similar to that seen in May, the rate at which employment decreased was slight, and mainly driven by reduced staffing at manufacturing companies. Services firms meanwhile reported a broadly unchanged level of employment, as greater hiring to meet higher new business was weighed on by the non-replacement of voluntary leavers.

Outstanding business at Chinese private sector firms increased marginally in June. That said, this represented the fastest rise in backlogs since the end of 2018. As service providers continued to reduce the amount of work-in-hand, the rise was centred on goods producers who related this to lower production levels and sustained job shedding.

Price pressures remained historically subdued in June, as the rate of overall input price inflation at Chinese companies was broadly in line with that seen in May. Services firms saw a moderate increase in operating costs, reportedly linked to higher staff expenses and elevated purchasing activity. At the same time, manufacturers reported only a marginal uplift in input prices. However, this still represented the quickest rise in overall costs faced by goods producers since November 2018.

With input price inflation still soft, private sector companies afforded another marginal increase in selling charges. Both services and manufacturing firms recorded a similarly slight uptick, although the overall rise was the strongest for three months. For manufacturers, the mark-up in output prices during June followed an unchanged price level in May.

Lastly, expectations at Chinese firms regarding future activity fell to a record-low for the second consecutive month in June. While service sector companies remained strongly optimistic, the outlook among manufacturers was only marginally positive overall. Some companies expected the launch of new products and expansion plans to boost output in the year ahead, while others were concerned about the China-US trade tensions.

Solid growth of euro area signalled in June

After accounting for seasonal factors, the IHS Markit Eurozone PMI® Composite Output Index strengthened to 52.2, up from 51.8 in May (and slightly better than the earlier flash reading of 52.1). June’s PMI reading was also the highest recorded since November 2018, signalling a pick-up in economic growth of the single currency area.

However, the headline index masked notable divergences in sector performance during June. Whereas the services economy enjoyed a solid rise in activity that was the best in eight months, the recent downturn in manufacturing continued. Production amongst goods producers was reported to have fallen for a fifth successive month, and at a rate that was amongst the sharpest seen in the past six years. (…)

Solid growth of the eurozone economy was underpinned by a further rise in volumes of new work, the fourth in as many months. Despite being the best recorded since last November, growth in new work was modest overall. As with activity, overall gains in new work were restricted by another month of deteriorating manufacturing order books.

With overall activity rising at a faster rate than new business, companies continued to make inroads into their work outstanding. June’s survey data indicated that backlogs were reduced for a fourth successive month, albeit only slightly and at the slowest rate in the current sequence of contraction.

Staffing levels rose in June at a solid rate, extending the current record period of continuous expansion to 56 months. At the country level, Germany and Ireland led the way in terms of employment gains.

Price pressures showed further signs of waning during June. Input costs rose at the slowest rate since September 2016, pulled down in the main by a first fall in manufacturing input prices for three years. Although output charges continued to rise, they did so only modestly and at a rate amongst the weakest seen in the past two years.

Finally, ongoing worries over global trading conditions led to a second successive monthly fall in business confidence to a level that broadly matched last December’s 50-month low.

The IHS Markit Eurozone PMI® Services Business Activity Index remained comfortably above the 50.0 no-change mark that separates growth from contraction during June. Moreover, by rising to 53.6, from 52.9 in May, the index indicated the strongest growth of activity since October 2018.

All nations covered by the survey registered a rise in activity compared to the previous month, led by Ireland and Germany. In contrast, Italy recorded only a marginal increase in activity.

Higher overall services activity in the euro area was associated with a similar-sized and stronger increase in new business volumes. This led to some pressure on capacity, as highlighted by the strongest increase in backlogs of work since last November.

Jobs were subsequently created at a faster rate across the euro area services economy. The fastest increase in employment was seen in Germany, followed by Ireland. Solid employment gains were seen in Italy and France.

Rising employment costs remained a key driver of overall inflation of operating expenses in the latest survey period. However, the net rise in costs was the weakest recorded by the survey since September 2017. In contrast, charges rose at a slightly faster rate, though still one that remained well below that of costs.

Finally, business sentiment slumped to a four-and-a-half year low during June. According to the latest data, German and French service providers were the least confident of a rise in activity from present levels in 12 months’ time.

Chris Williamson, Chief Business Economist at IHS Markit:

The June PMI surveys indicate that the pace of eurozone economic growth picked up at the end of the second quarter, though it would be wrong to get overly excited by the upturn. The survey is indicative of GDP merely rising by just over 0.2% in the second quarter, and a deterioration of business expectations for the year ahead to one of the lowest
seen for over four years suggests the business mood remains sombre. Downside risks to the outlook prevail amid trade war worries, rising geopolitical uncertainty and slowing global economic growth.

Looking at the largest states, the survey data are consistent with GDP growth easing sharply to 0.4% in Spain and only modest 0.2% expansions in both France and Germany. Italy is on course to see a 0.1% decline. (…)

U.S. government staff told to treat Huawei as blacklisted

A senior U.S. official told the Commerce Department’s enforcement staff this week that China’s Huawei should still be treated as blacklisted, days after U.S. President Donald Trump sowed confusion with a vow to ease a ban on sales to the firm. (…)

In an email to enforcement staff on Monday that was seen by Reuters, John Sonderman, Deputy Director of the Office of Export Enforcement, in the Commerce Department’s Bureau of Industry and Security (BIS), sought to clarify how agents should approach license requests by firms seeking approval to sell to Huawei.

All such applications should be considered on merit and flagged with language noting that “This party is on the Entity List. Evaluate the associated license review policy under part 744,” he wrote, citing regulations that include the Entity List and the “presumption of denial” licensing policy that is applied to blacklisted companies. (…)

A person familiar with the matter said the letter was the only guidance that enforcement officials had received after Trump’s surprise announcement on Saturday. A presumption of denial implies strict review and most licenses reviewed under it are not approved. (…)

HP, Dell to Shift Up to 30% of Laptop Production From China, Report Says

Microsoft Corp., Amazon.com Inc., Sony Corp. and Nintendo Co. are also looking to move some of their game console and smart speaker manufacturing away from the country, the Nikkei Asian Review cited those sources as saying. (…)

Alphabet Inc.’s Google has already shifted much of its production of U.S.-bound motherboards to Taiwan, averting a 25% tariff, Bloomberg News reported last month.

Reshoring to other foreign shores…

U.S. Slaps Import Duties of More Than 400% on Vietnam Steel

(…) In three preliminary circumvention rulings on Vietnamese steel, the Commerce Department said certain products produced in South Korea and Taiwan were shipped to Vietnam for minor processing before being exported to U.S. as corrosion-resistant steel products and cold-rolled steel. (…)

The U.S. is hardening its rhetoric against Vietnam, one of its major trading partners and an economy that’s benefiting from President Donald Trump’s trade war with China. Trump described Vietnam last week as “almost the single-worst abuser of everybody” when asked if he wanted to impose tariffs on the nation. (…)

Amazon’s Deal Making Threatened by D.C. Scrutiny Amazon.com has been on a buying spree in recent years, but the U.S. government’s increased scrutiny of large tech companies threatens to slow that pace.

The company has struck more than $20 billion worth of acquisitions and investments since the start of 2017, more than its deal volume in all of the previous 23 years in the online retailer’s history, according to data provider Dealogic. The spree’s biggest was Amazon’s $13.7 billion purchase of Whole Foods Inc. in 2017.

Amazon’s deal-making style is to act quickly, quietly and frequently without investment bankers, according to people familiar with the company’s thinking. But the closer attention from Washington will likely result in Amazon throttling down on acquisitions, especially larger deals. (…)

EARNINGS WATCH

Grim Earnings Forecasts Are Getting Worse by the Week

(…) In and of itself, a flurry of downward revisions is nothing unusual at this time of year. Companies are always more likely to disclose bad news, and a few may be interested in lowering estimates before they report. But the extent of the negativity this time around is notable and is another burden for investors struggling to formulate views on the economy, global trade and the Federal Reserve.

Of S&P 500 companies that have revised their profit outlook over the past couple months, 82% cut, data compiled by Bloomberg show. The proportion bears an eerie similarity to the third quarter of last year, right before stocks plunged nearly 20%. Before that, you have to go back to 2015 to find more pessimism.

Wall Street analysts have been forcefully downgrading estimates too. In June, they cut forecasts on 116 more stocks than they upgraded them for, the worst reading since September 2017, according to Sundial Capital Research. (…)

Grim forecasts you say? How about very grim actual reports?

Monday I noted that 20 S&P 500 companies with May quarter ends had already reported their Q2. While the beat rate is 85% and the surprise factor is +6.3%, I emphasized that their actual earnings were down 11.2% on a 2.8% revenue growth.

  Digging further this morning, i found these same companies’ reports for Q4’18 and Q1’19. This is not a good trend!!! Look at the sharp drop in revenue growth. Composition: 6 in Consumer Staples, 6 in Consumer Discretionary, 6 in Tech and 2 in Industrials.