THE DAILY EDGE: 4 AUGUST 2021

COMPOSITE PMIs Eurozone grows at fastest rate since June 2006 Eurozone business activity rose at its fastest rate in just over 15 years during July, with steep manufacturing output growth complemented by an accelerated expansion of services activity. After accounting for seasonal factors, the IHS Markit Eurozone PMI® Composite Output Index rose to 60.2, slightly below the preliminary ‘flash’ estimate of 60.6, but still surpassing June’s 15-year record of 59.5. This was the fifth successive month in which private sector output has expanded, the longest uninterrupted sequence since the pandemic began early last year. Driving the broad acceleration in output growth was services, where activity increased at its fastest pace since mid-2006. Although manufacturing production rose at its softest rate in five months, the expansion was considerable and still outstripped that seen in the services sector. Among the four largest eurozone economies, the quickest rise was in Germany, where again the rate of expansion accelerated to a record high. In Italy, private sector activity growth jumped to a three-and-a-half year high, while Spain and France registered softer increases in output. Latest survey data also revealed the quickest rise in demand for euro area goods and services since May 2000 in July. Again, trends in new orders were similar to output, with more rapid demand growth for services contrasting with a slower pick-up for goods. Nevertheless, increased order book volumes reflected improvements in both domestic and international markets, as indicated by a rise in new export business. Although foreign demand rose at a marginally weaker pace than in June, it was still the second-fastest recorded since comparable data were first published in September 2014. The consequence of steep month-to-month growth in new business strained operating capacities across the eurozone immensely in July. This was evidenced by a survey-record rise in outstanding business and extended the current period of backlog accumulation to five months. However, notable efforts to bolster output potential were seen as employment increased at the fastest rate in almost 21 years. Rates of job creation quickened in Germany and Italy, but eased in France and Spain. Meanwhile, inflationary trends showed some signs of stabilising in July. Input costs rose at the strongest rate since September 2000, although the pace of increase was only fractionally quicker than in June. Output charge inflation was unchanged from June’s record high. Lastly, businesses remained firmly optimistic that output would grow over the next 12 months, although the degree of confidence slipped from June’s high (since 2012) to a four-month low. The IHS Markit Eurozone PMI® Services Business Activity Index continued to rise further beyond the 50.0 mark, latest data showed, indicating accelerating growth in services output. At 59.8 in July, compared to 58.3 previously, the latest figure was the highest since June 2006 and consistent with a sharp rate of activity growth. Of the four largest eurozone economies, Spain registered the sharpest growth, and Italy the weakest. New business also continued to increase at a considerable pace, boosted by sharper growth in new export orders. Consequently, domestic and international demand combined rose at the quickest rate in 14 years. However, operating capacities were tested in July, as evidenced by a joint-record increase in backlogs of work. This encouraged the greatest expansion in employment across the eurozone service sector for almost three years. Surveyed firms retained an exceedingly optimistic view towards future activity prospects in July, although the level of positive sentiment receded to a three-month low. Lastly, inflationary pressures subsided slightly during the latest survey period, with both output price and input cost inflation slowing since June. Nevertheless, rates of increase remained historically elevated. Chris Williamson, Chief Business Economist at IHS Markit: (…) It’s not just the consumer sector that is booming, however, with business and financial service providers also enjoying a growth spurt as broader economic recovery hopes build. Alongside the sustained elevated growth recorded in the manufacturing sector, the impressive strength of the service sector’s expansion in July means the eurozone should see GDP growth accelerate in the third quarter. Worries about the Delta variant have become more widespread, however, subduing activity in some instances and raising concerns about the possibility of virus restrictions being tightened again. Hence services growth in July was slightly less marked than the earlier flash estimate and future expectations cooled to the lowest since March, presenting a significant downside risk to the outlook and hinting that growth could begin to slow again as we head toward the autumn. Furthermore, up to now companies have generally seen little resistance from customers to higher prices, but this could change after the current rebound from lockdown restrictions has passed. China: Service sector activity rebounds in July PMI survey data showed a steeper increase in Chinese services activity in July. The stronger upturn coincided with the successful containment of the recent uptick in COVID-19 cases, which in turn led to greater customer numbers and boosted new order intakes. As a result, firms registered a renewed increase in backlogs of work, which led to a slight rise in payroll numbers. Business confidence also strengthened from that seen in June. Finally, prices data showed steep increases in both input costs and output charges. At 54.9 in July, the headline seasonally adjusted Business Activity Index rebounded from June’s 14-month low of 50.3 and signalled a sharp and accelerated expansion of services activity. Growth was also quicker than that seen on average since the survey’s inception in late-2005 (54.1). Underpinning the sharper upturn in activity was a further rise in new business. Notably, the rate of new order growth quickened from June’s recent low and was steep overall. Panel members often mentioned that the containment of the virus domestically and firmer market conditions had helped to boost customer numbers and demand. However, the pandemic continued to weigh on new export business, which was broadly stagnant in the latest survey period. After a slight reduction in June, outstanding workloads increased at Chinese services companies in July. Though modest, the rate of accumulation was the fastest seen for over a year, with respondent often linking the upturn to greater amounts of new business and insufficient capacity. Service sector employment likewise returned to growth at the start of the third quarter. That said, the rate of job creation was only slight, as efforts to expand capacity were partly offset by other firms that looked to control their costs. After easing to a marginal pace in June, the rate of input cost inflation quickened notably in the latest survey period. Costs rose markedly overall, with the increase exceeding the long-run series average. Companies reported having higher staff, fuel and raw material costs during July. Consequently, prices charged by services companies also increased during July, as firms looked to alleviate pressure on their operating margins. The rate of inflation was the quickest seen in the year to date and solid overall. Business confidence regarding the one-year outlook for activity improved during July, picking up from June’s nine-month low.However, optimism remained softer than that seen on average over the series history. A number of firms hoped that an end to the pandemic would boost sales at home and abroad, and lead to stronger global economic conditions, while new product releases were also expected to lift activity levels.

DRY POWDER

Last June 4, after the U.S. savings rate was reported at 14.9% for April, down from March’s 27.7%, David Rosenberg wrote:

We have done the work on this, and the post-pandemic equilibrium savings rate is 10 per cent, whereas it was closer to seven per cent before the pandemic. The widespread consensus view is that there is a ton of dry powder left here, but that fails to take into account that a lot of things are going to change post-COVID-19, and one of them is an elevated precautionary personal savings rate. So much of the money from Uncle Sam has pretty well been spent already — it probably has a shelf life of one or two more months and that’s it. Party’s over.

The so-called dry powder would then have been around $900B at the 10% “equilibrium” savings rate. Well, June’s savings rate was reported at 9.4%, blowing all that remaining dry powder away while questioning the notion of elevated precautionary savings.

The glass half-empty narrative feeds on this and on the recent jump in inflation to conclude that the consumer is not only spent-up but is actually about to meaningfully retrench as real average weekly earnings have contracted in each of the past three months and four of the past five?

True, but average real wages remain 2.9% above their pre-pandemic levels:

The glass half-full narrative argues that, prior to the pandemic, the savings rate was around 7.5%, suggesting there might be another $400-500B in available dry powder, about 3% of annual expenditures. Add another $150B in borrowing power given that Americans cut their credit card balances by 10% in the last 18 months and you get pent-up demand up to 4%, exclusive of on-going labor income gains which could add another 8-10% assuming the Fed reaches its employment and inflation goals. In all, there could be another 8-14% growth in nominal consumer spending in this post-pandemic recovery.

Data: New York Fed; Chart: Axios Visuals

The recent Fed’s Senior Loan Officer Opinion Survey suggests that banks will also be very accommodating:

Over the second quarter, a significant net share of banks eased standards for credit card loans, and moderate net shares of banks eased standards for auto loans and for other consumer loans. Consistent with easier lending standards, a significant net share of banks reduced the minimum required credit score on credit card loans, and moderate net shares of banks did so on auto and other consumer loans. Additionally, a significant net share of banks increased credit limits on credit card accounts. (…) Regarding demand for consumer loans, significant net shares of banks reported stronger demand for auto and credit card loans.

This would be enough to keep the economy humming nicely for a while but now add the significant inventory rebuilding cycle ahead and the domestic seeds are there for a booming economy through 2023.

But the dry powder may actually be much thicker and long lasting. J.P. Morgan Asset Management developed a model for consumer spending that takes into account taxable income and  transfer payments, but also housing and financial wealth. As can be seen below, their model’s fit with actual consumption growth has been remarkable since 1972. The model currently estimates that Americans’ spending growth could reach 25% compared to its current 5% growth rate. Quite a powder keg!

A blast seems unlikely, however. This powder will likely be used over a few years given that consumers are troubled by the recent shortages and price spikes in some major spending categories:

• Businesses Are Loading Up on Credit. Spending Could Follow. At JPMorgan and Bank of America, undrawn credit commitments total nearly $1 trillion, a 20% increase from a year ago.

Bank executives said their business clients have in recent months ramped up requests for credit lines that can be drawn quickly for spending on inventory, labor or expansions.

Companies aren’t actually drawing the money into their bank accounts just yet. Businesses are already stuffed with cash, and supply-chain issues and labor shortages have crimped their ability to spend it. But bankers say the activity in recent months is evidence that businesses are planning to turn on the spending spigot. That could help the economy shoot higher. (…)

“I’ve never seen anything quite like it,” said Jim Glassman, the head economist at JPMorgan’s commercial bank. He said businesses are planning ambitious spending projects, especially on automation and technology. (…)

The lingering memory of the shutdowns may spur businesses to keep their powder dry for some time to come, especially during a surge of new infections from the highly contagious Delta variant. (…)

From the Fed’s Senior Loan Officer Opinion Survey:

Over the second quarter, banks reported having eased standards and terms on C&I loans to firms of all sizes. On net, significant shares of banks reported having eased standards on loans to large and middle-market firms and small firms.³ Banks eased all queried lending terms on loans to large and middle-market firms and eased most their lending terms on loans to small firms.⁴ Easing was most widely reported for spreads of loan rates over the cost of funds and costs of credit lines, with significant net shares of banks reporting easing these terms for C&I loans to small and large and middle-market firms. Additionally, significant net shares of banks reported easing the following terms on C&I loans to large and middle-market firms: the maximum size of credit lines, loan covenants, the use of interest rate floors, and premiums charged on riskier loans. (…)

Major net shares of banks that reported easing standards or terms cited a more-favorable or less uncertain economic outlook, more-aggressive competition from other banks on nonbank lenders, and improvements in industry-specific problems as important reasons for doing so. Significant net shares of banks also mentioned increased tolerance for risk and improvements in their current or expected liquidity or capital positions as important reasons for easing lending standards and terms. (…)

Furthermore, a significant net share of banks reported a higher number of inquiries from potential borrowers regarding the availability and terms of new credit lines or increases in existing lines over the second quarter. (…)

Major shares of banks that reported stronger demand cited increases in customers’ needs to finance inventory, accounts receivable, investment in plant or equipment, and mergers and acquisitions as important reasons for stronger demand. (…)

Interestingly, loan officers are not reporting overall demand that strong, at least nothing like “I’ve never seen anything quite like it”.

However, what may be happening is that American banks are gaining market share from foreign banks. Per the same loan officers survey:

Foreign banks reported having left standards and most of their lending terms on C&I loans unchanged. (…) Meanwhile, a modest net fraction of foreign banks reported stronger demand for C&I loans.

US light vehicle sales at a seasonally adjusted annualized rate (SAAR) were about 14.75 mn per Wards and 14.73 mn per Motor Intelligence. While total unit sales in July declined by less than 1% sequentially to 1.288 mn (from 1.295 mn in June), when factoring in the seasonality adjustment, July US SAAR declined by about 4% sequentially (US SAAR was 15.4 mn in June; per Wards). (…) July’s industry incentive spending per vehicle was down about 37% yoy and down about 7% sequentially to about $2.5k per vehicle (per Motor Intelligence). We expect industry pricing to remain strong as components shortages continue to weigh on production in the short term, and dealer inventory remains low. Inventory at US dealers decreased sequentially to ~1.0 mn from 1.3 mn in June 2021, and was down from 2.5 mn in July 2020. Industry DOI came in at 22 days compared to 25 days in June 2021 and 53 days in July 2020. (…) (Goldman Sachs)

Toyota Motor Corp (7203.T) posted a record quarterly profit on Wednesday and Honda Motor Co (7267.T) raised its annual profit estimate as pandemic-hit sales rebounded, but the automakers saw no end in sight to the global chip shortage. (…) Toyota has been stockpiling semiconductors, used in everything from engine maintenance to car safety and entertainment systems, amid a global supply shortage that has hit production at rivals such as Hyundai Motor Co (005380.KS) and Ford Motor Co (F.N). (Reuters)

The shares of Clorox yesterday sank 9.4% after reporting EPS 28% below consensus. Gross margins narrowed by 970 bps YoY in Q2 and management said it expects gross margins in the current fiscal first quarter to contract by 1,000 to 1,300 bps YoY due to “significant cost inflation.” To help correct the squeeze, CLX is raising prices on 50% of its products and planning more hikes “at a later date”.

Eurozone retail sales jumped in June as consumers return to high street

Retail sales increased by 1.5% in June as stores reopened. Sales were higher than ever before, which shows that the rebound from lockdown is now stronger than that seen last year. With more restrictions lifted and vaccinations proving to be a gamechanger, this makes sense. The growth in July was mainly seen in non-food products, while internet sales decreased. This is in line with some rebalancing from online to offline shopping as stores reopen and consumers feel safer to visit. (…)

The Delta variant does not seem to have had much impact on behaviour so far, but has provided a warning about the service sector’s performance in the months ahead. Either way, after a weak April due to shops closing again, the third quarter will probably be set for favourable consumption growth. This adds to our positive outlook for GDP growth this quarter as the economic rebound continues.

EARNINGS WATCH

We now have 340 reports in, an 88% beat rate and a +16.3% surprise factor.

Trailing EPS are now $181.56. Full year est: $201.06. 2022e: $221.86.

Importantly, Refinitiv published its first tally of pre-announcements for Q3 and, with about half of typical guidance givers, it looks like Q3 results will remain upbeat:

COVID-19

(CalculatedRisk)

Data: Harris Poll. Chart: Axios Visuals

• The outbreak of the highly transmissible delta variant has just pushed the threshold for herd immunity higher to more than 80% and possibly almost 90%, according to the Infectious Diseases Society of America. (Bloomberg)

• Florida Sees Record Covid-19 Hospitalizations

• NYC to Require Vaccines for Many Indoor Activities

Crypto ‘Wild West’ Needs Stronger Investor Protection, SEC Chief Says The Securities and Exchange Commission will regulate cryptocurrency markets to the maximum extent possible, Chairman Gary Gensler said, as he called on Congress to grant the agency more authority and resources to regulate the sector.

Shares of Robinhood closed up 24%, closing above its $38 IPO price for the first time since last week’s debut.

Only 40% of candidates passed the CFA Institute’s Level II exam in May and June, the first time it was given using computers. The success rate was the lowest since 2010 and down from the 55% of applicants who passed the second level of the chartered financial analyst exam in December 2020, which was a 15-year high. At least it was a better showing than the Level I results.

Just to show my age, I was part of the highest pass rate on this chart…