Note: I will be travelling this month. Posting will be sporadic and shorter due to limited time and equipment.
Job Openings Rebound in August, But Turnover Settling Down
Total job openings in August rebounded to 9.6 million, an increase of nearly 700K from July. More than two-thirds of the net increase stemmed from professional & business services (+509K), while finance & insurance (+96K), government (+90K) and nondurable goods manufacturing (+59K) also saw vacancies rise.
With such a sizable share of the increase in job vacancies in August occurring in one category, the overall trend in what can be a volatile series is likely still down.
However, the pace of normalization appears to be less rapid than the previous few months of data had suggested. The slower pace of decline in labor demand implied by both the August jump and upward revision to July fits with the recent stabilization in Indeed job postings and see-saw moves in small business hiring plans since the start of the year. (…)
Unemployed workers relative to job openings, a frequently cited comparison by Fed officials, may on its own point to a tighter labor market than the traditional unemployment rate, but we view the direction as more telling than the level. The gradually rising trend is consistent with the supply and demand for workers continuing to become more balanced, even as pace remains slow.
Despite the surprisingly large jump in openings at the end of August, turnover during the month points to the jobs market continuing to cool off. The hire rate—the gross number of workers taking a new job as a share of employment—held steady in August at 3.7% and remains back below its pre-pandemic level.
Separations also suggest some normalcy returning to the labor market. The share of workers quitting their jobs remained the same in August at 2.3%, which is in line with its level prior to the pandemic in February 2020. The improved rate of retention comes as the pay premium for switching jobs has narrowed and a declining share of workers view jobs as plentiful.
The lower rate of voluntary turnover should further reduce wage pressures and job openings as employers have fewer positions to backfill.
While hiring and quits have settled down from the tumult of the pandemic, that only brings them back to the levels experienced in 2018-2019 in what was a tight labor market in its own right.
Moreover, layoffs and discharges remain unusually low by historic standards and add further evidence to the recent run of initial jobless claims that while demand for new workers is ebbing, demand for existing workers remains solid.
We expect that with increasingly less scope for catch-up hiring and a restrictive stance of monetary policy, momentum in hiring will continue to weaken in the months ahead. However, the weaker downward trend in openings and low rate of layoffs will likely help keep the debate within the FOMC focused on whether policy is sufficiently tight to bring inflation down on a sustained basis.
Massive capitulation in the utilities sector
Investors have abandoned the traditionally defensive equity sectors like Consumer Staples, Health Care, and Utilities, with Treasuries offering enticing yields not seen in over a decade.
In particular, the utility sector is witnessing unprecedented destruction, evident at the index level and by internal market breadth indicators, marking one of the most severe capitulation events in over 90 years.
On Monday, the 5-day rate of change spread between the Dow Jones Utility Average and the S&P 500 plunged by more than -9%, the 10th most severe period of underperformance since 1929.
When the Dow Jones Utility Average underperforms the S&P 500 by -9% or more over five days, the extreme selling pressure tends to diminish, with utilities bouncing back over the subsequent week. After some backing and filling in week two, the sector regroups but fails to extend upon the gains over the next few months. A year later, the median return was negative.
Except for October 1998 and June 2000, severe underperformance by the utility sector, like now, occurred in significant drawdown periods for the broad market. So, we need to be mindful of a potential market message.
A composite that contains six market breadth indicators with varying duration lengths plunged to the 5th lowest reading in history, indicating severe downside participation from components within the S&P 500 Utility sector.
While a composite score of -30% or greater is scarce, the annualized returns associated with similar conditions suggest a massive snapback can occur when utility stocks are oversold, like now.
When the composite score falls below -35%, the downside momentum in the S&P 500 Utility sector tends to persist over the following week. However, I would view further weakness as an opportunity, with returns, win rates, and z-scores showing outstanding results across medium and long-term horizons.
With the overall market in a drawdown, waiting for an oversold condition from other major indexes like the S&P 500 would be prudent to lend additional support to a mean revision rally.
The Utility sector, known for its ability to outperform during drawdown periods, has come under severe selling pressure as interest rates have climbed higher, providing a more compelling alternative for investors.
However, the pendulum may have swung too far as external and internal measures show one of history’s most severe oversold conditions. After similar circumstances, the sector tends to bounce back. I never catch a falling knife. So, waiting for a market-wide oversold condition and a reversal signal might be prudent before dipping a toe in the sand.
Apartment Market Benefiting From Constrained Single-Family Market
Like most other segments of real estate, the recent rise in interest rates has had a jarring impact on the multifamily market. Higher financing costs have been followed by an increase in cap rates and downturn in valuations.
The challenging rate environment has arrived just as a torrent of new apartment buildings are expected to deliver over the next several years, especially in the Sun Belt region.
Although slower compared to the dramatic upturn registered in the wake of the pandemic, apartment demand has bounced back from a lull in 2022 and been surprisingly resilient so far in 2023.
The rise in rental demand coincides with the sturdy pace of economic growth as well as worsening affordability conditions in the single-family market caused by low supply, high prices and rising borrowing costs. While mortgage rates may gradually decline over the next few years once the Federal Reserve eases monetary policy, affordability in the single-family market is likely to remain adverse and be supportive of apartment demand. (…)
As of August, there were just over one million apartment units under construction, near a 54-year-high. The robust construction pipeline is increasingly turning into newly delivered supply, especially in the Sun Belt region.
Over 145,000 apartment units came to market in the second quarter of this year, the largest quarterly delivery on record going back to 2000. Stacked up against the 105,000 net units absorbed, Q2 marked the seventh consecutive quarter that apartment supply has outstripped demand. As a result, the apartment vacancy rate rose to 6.9% in Q2, up over two percentage points from a cycle low of 4.8% in Q3-2021.
The upturn in vacancy rates reflects both supply and demand factors. Despite a recent pickup, net absorption is running below the rapid pace experienced in 2021 when fiscal stimulus, robust household savings, and strong employment and income growth led to a marked upshift in household formation.
The knock-on effects of the pandemic were also evident, with many renters seeking larger units with fewer roommates. At the same time, remote work accelerated migration out to the suburbs and more affordable locations. As a result, demand for apartments soared during that period, prompting a sharp increase in rents as well as new construction.
The increase in multifamily construction over the past several years has been remarkable. Nationally, the count of apartment units under construction as a share of inventory reached 6.0% in Q4-2022, almost two percentage points above the average ratio registered in 2019. As displayed in the nearby chart, markets in the South, notably in the Southeast and Texas, have generally experienced the most rapid expansion in new development. Miami, Austin, Nashville, Raleigh and Charlotte all rank high by this measure.
Developers’ focus on the South region is not without reason. Over the past two decades, the South has been the fastest growing region in terms of population growth, largely driven by an influx of new residents from other regions. The pandemic served to accelerate this trend.
Between Q2-2022 and Q2-2023, the South added 1.2 million new households, a 2.5% gain that exceeded every other region. Many markets in the region also have experienced above average employment and income growth, factors which have also boosted rental demand. According to Costar, 37 of the top 40 markets for new deliveries in the year ending Q2-2023 also rank in the top 40 markets for net absorption during that time.
The upturn in apartment supply has subdued the rapid rise in rents. Annual effective rent growth peaked at 11.6% year-over-year in Q1-2022. Since then, annual rent growth has eased and registered a 1.0% year-over-year rate in Q2-2023.
Notably, rent growth has slowed in the supply-abundant Southern markets. The nearby chart shows that, while national effective rents are still on a positive trajectory, markets such as Austin, Atlanta, Orlando and Nashville have experienced declines over the past year.
Not every market has experienced a drop in rents, however. Rents continue to rise at a solid pace in New York City, Boston, Washington DC and other gateway markets where development has been relatively more conservative and where demand is reverting to pre-pandemic form.
New multifamily construction has been more balanced in Midwestern markets such as Chicago, Columbus and Indianapolis, and as a result, rents are now rising at more sturdy pace.
The bulk of new supply continues to be for upscale apartment units. More than two-thirds of new units delivered so far in 2023 are categorized as 4- and 5-star buildings, according to CoStar. Demand for higher rated buildings, which tend to be rich with amenities, are in desirable locations and typically come with higher price tags, has been more resilient recently.
In the first two quarters of 2023, net absorption of 4- and 5-star units took up 3.4% of inventory, compared to just 0.3% for 1- to 3-star buildings. Although demand has been relatively sturdy, supply of 4- and 5-star units has been even stronger, which has prompted a more pronounced deceleration in rent growth in those building classes.
Given the robust pipeline of multifamily units already under construction, an influx of new units hitting the market over the next few years seems certain. However, prospects for new rental demand are not quite as clear. On the one hand, a strong labor market likely has been a supportive factor for apartment demand in the years following the pandemic. If the pace of hiring continues to moderate and contracts next year as we currently anticipate, then apartment demand could weaken.
That said, although a recession in 2024 remains our base case, any downturn is likely to be mild. If the unemployment rate rises and peaks at 4.4% as we currently anticipate, then multifamily demand may hold up relatively well.
There are also several structural factors that could boost rental demand over the next few years. For one, the pool of potential renters is likely to remain relatively deep.
According to the Census, there are currently 72.9 million U.S. residents between the age of 20-35, a cohort which is roughly 22% of the total population. This group of “prime-aged” renters are set to enter into a housing market where there is a significant shortfall of available single-family homes.
Existing single-family inventories have fallen to near record lows with few signs of improvement on the horizon. The rapid rise in mortgage rates has removed much of the incentive for prospective sellers carrying low rates to list their homes. Even if resale supply improves to the levels experienced pre-pandemic, the past decade of sluggish new single-family construction has resulted in a structural shortfall of homes. Freddie Mac recently estimated that the United States faces a housing deficit of approximately four million homes.
A dearth of resale supply is one factor that explains the run-up in homeownership costs recently. Aside from a brief dip in the second half of 2022, lean single-family inventories have exerted significant upward pressure on home prices over the past few years, a trend that is likely to continue. According to S&P CoreLogic Case Shiller, home prices have risen for six consecutive months as of July, putting prices up nearly 43% since January 2020. What’s more, the average 30-year mortgage rate has risen in recent months and is currently hovering above 7%.
Consequently, the average monthly mortgage payment, which stood at $2,051 in Q2-2023, exceeds the average monthly effective rent payment for an apartment unit, which was $1,675 in the same period. The widening cost differential between renting and owning has likely contributed to the bounce back in multifamily demand this year.
Even if mortgage rates descend as we currently anticipate, single-family affordability is likely to remain under pressure for the foreseeable future. (…)
I know I sound like a broken record but it is important to have the right perspective before taking actions.
Charts on apartment vacancy rates stopped in 2018 like Wells Fargo’s above fail to show that 7% rental vacancy rates are actually not high vs history and how much higher vacancy rates need to get before meaningfully impacting rent growth.
The BLS CPI-Rent, which mainly measures existing leases (80-85% of all leases), has never been negative YoY, even when vacancy rates were much higher than currently.
PMI SERVICES
The seasonally adjusted HCOB Eurozone Composite PMI Output Index recorded a fourth consecutive sub-50.0 reading in September. At 47.2, this was up slightly from 46.7 in August, and indicative of a further moderate contraction in business activity levels across the euro area’s private sector economy.
Notably, as was the case in August, output across both manufacturing and services declined at the end of the third quarter, marking only the second time so far this year that both monitored sectors have contracted.
While the manufacturing sector’s malaise has been a prominent feature of the HCOB Eurozone PMI survey for the most part since the middle of last year, September data showed growing weakness in the services economy. Indeed, amid a sharper reduction in demand for services, total order book volumes across the eurozone fell at the sharpest rate since November 2020. A considerable slump in new business was also seen in non-domestic markets, as evidenced by a steep drop in new export orders. (…)
Nevertheless, demand-side fragility failed to hinder job creation during September, with employment levels rising for a thirty-second successive month. This was exclusively a reflection of services jobs, however, as factory workforce numbers continued to fall. The increase in staffing levels was only marginal and much weaker than those seen on average in the first half of 2023.
Meanwhile, September survey data signalled a further uptick in cost pressures, with the overall rate of input price inflation quickening for a second successive month to a four-month high. Prices charged were subsequently raised, albeit to the smallest extent since February 2021. Inflationary pressures came only from the services economy, however, as deflation persisted across the manufacturing sector.
The HCOB Eurozone Services PMI Business Activity Index registered below the critical 50.0 level which separates growth from contraction for a second month in a row during September, signalling a sustained reduction in services output across the euro area. At 48.7, this was up from 47.9 in August and signalled a mild, but slower rate of decline.
Weighing on activity was a further drop in demand for eurozone services. New business fell solidly and at the quickest pace since February 2021. Subdued sales performances were also seen with external clients, as new export business fell to the sharpest degree in over two-and-a-half years.
In turn, eurozone service providers were able to process outstanding business at a faster rate during September amid weaker demand pressures. The rate of backlog depletion was the strongest since early-2021. Employment continued to rise, albeit only modestly, while business confidence fell to a ten-month low.
Lastly, September survey data signalled the strongest rise in input prices for four months. The rate of increase remained steep overall and well above its long-run average. Prices charged were raised in response, albeit to the softest extent since August 2021.Bank of Canada deputy warns aggressive pricing could make it harder to get inflation under control
Bank of Canada deputy governor Nicolas Vincent said that companies continue to raise prices more frequently than before the pandemic and warned that this behaviour could become “self-perpetuating,” making it harder to get inflation back under control.
In his first speech since becoming deputy governor, Mr. Vincent described how business price-setting changed during the COVID-19 pandemic and after restrictions lifted, with companies raising prices more frequently and by larger amounts than usual.
There are signs that pricing behaviour is slowly returning to normal, he told the Montreal Chamber of Commerce. But there’s also a risk that companies will continue pushing cost increases rapidly along to customers. (…)
The change in price-setting during the pandemic caught central bankers off guard. Economists rely on models to predict inflation, and the Bank of Canada’s models assume prices are relatively “sticky” – that is, companies change them infrequently because of competitive pressures and because it costs money to change prices.
This core assumption was challenged during the pandemic and the reopening of the economy as COVID-19 receded. (…)
“During the recovery from the pandemic, firms started to mention that they were experiencing a rapid increase in their costs as well as high demand for their products and services. Meanwhile, customers had few choices because supply was low across several industries,” Mr. Vincent said.
“This may explain why firms told us that their customers, aware of the widespread cost pressures firms were facing, appeared willing to pay higher prices. Confronted with these changes in their business environment, firms reacted by raising prices more often than usual and by larger amounts.”
Evidence from other countries, as well as from the Bank of Canada’s own business surveys, suggests that companies are becoming less able to pass cost increases along to customers. That could be in response to falling demand for goods and services – something central banks are trying to engineer by raising interest rates – as well as increasing competitive pressures.
Still, Mr. Vincent said that central bankers need to keep their eye on structural changes in the economy that might mean companies “continue to make larger and more frequent price changes even when many of the factors driving those changes have gone away.”
“This could be due to permanent shifts in pricing strategies driven by technology or industrial structure. For example, the electronic price tags that you’ve seen in some supermarkets reduce the costs of frequent price changes. And consolidation in some industries may reduce the competitive pressures that restrain price increases,” he said.
Also today, by coincidence, the WSJ has this story:
- Amazon Used Secret Algorithm to Raise Prices Amazon.com used an algorithm code-named “Project Nessie” to test how much it could raise prices in a way that competitors would follow, according to redacted portions of the FTC’s monopoly lawsuit.
The algorithm helped Amazon improve its profit on items across shopping categories, and because of the power the company has in e-commerce, led competitors to raise their prices and charge customers more, according to people familiar with the allegations in the complaint. In instances where competitors didn’t raise their prices to Amazon’s level, the algorithm—which is no longer in use—automatically returned the item to its normal price point. (…)
The algorithm helped Amazon recoup money and improve margins. The FTC’s lawsuit redacted an estimate of how much it alleges the practice “extracted from American households,” and it also says it helped the company generate a redacted amount of “excess profit.” Amazon made more than $1 billion in revenue through use of the algorithm, according to a person familiar with the matter.
“The FTC’s allegations grossly mischaracterize this tool,” an Amazon spokesman said. “Project Nessie was a project with a simple purpose—to try to stop our price matching from resulting in unusual outcomes where prices became so low that they were unsustainable. The project ran for a few years on a subset of products, but didn’t work as intended, so we scrapped it several years ago.”
Project Nessie is one of a number of instances where the FTC’s complaint contends that Amazon’s monopoly power had broad impacts on raising consumer prices across retail.
A central argument the FTC makes is that Amazon’s power over third-party sellers on its website leads to higher prices for consumers, even those who are buying goods from a rival.
Essentially, sellers feel they have no choice but to use Amazon because of its reach, consumer base and logistics prowess, but the company prohibits them from offering their products at a lower price at other retailers than on Amazon, where nearly 40% of all e-commerce in the U.S. occurs, the FTC alleges. If they offer lower prices elsewhere, Amazon “punishes” them, according to the FTC, downgrading their listings so that shoppers don’t see them.
The FTC alleges that because Amazon’s cost to sell is higher than other platforms due to its fees, it creates a higher price point for goods across retail, since sellers must use their Amazon price as their floor.
Fees and charges to Amazon sellers have exploded in recent years, and the company now pockets nearly half of the dollar amount for every sale a third-party makes on the platform.
A new report from the Institute for Local Self-Reliance, a research and advocacy group, found that between 2014 and 2023, Amazon’s cut of third-party seller sales rose from 19% to 45%. The report includes Amazon’s fees related to selling on the platform, advertising on it and fulfillment of orders. More than 60% of Amazon’s retail sales come from third-party sellers.
The FTC alleges that sellers feel compelled to use Amazon’s logistics program to be eligible for inclusion in Amazon’s Prime program, and they buy advertisements on Amazon.com to ensure they reach its vast pool of customers.