Rate Cuts Aren’t as Certain as Markets Think Interest rate expectations have changed dramatically, despite few concrete signs of change in the economic outlook
(…) Moreover, the key reason the global economy is weakening isn’t tariffs, but the structural slowdown in the Chinese economy, which is hurting manufacturing orders around the world. There is little evidence that this structural issue has worsened in recent weeks, nor that Chinese policy makers have given up on ramping up fiscal and credit stimulus to offset them.
Of course, investors’ knee-jerk reaction on rates could still be justified if the Fed panics at the sight of trade negotiations breaking down. Or if China’s structural woes are worse than anticipated. Or if U.S. households, who have been tapping more into their savings, suddenly slash consumption.
However, there is no indication that any of this is true, particularly when it comes to the domestic economy, which is looking robust in the U.S. and even in Europe. Economists’ forecasts of U.S. growth haven’t been downgraded much, according to an average compiled by data provider FactSet. (…)
Robust? “In the U.S. and even in Europe”? Look again.
First chart is the USA:
Goldman Sachs’ U.S. Current Activity Indicator:
Globally synchronized slowdown. This is from Topdown Charts:
@Callum_Thomas
This Global Service chart is from J.P. Morgan:
True, we have seen similar weakness before. But central banks are done we their QEs and the U.S. tax reform is behind us and China is not stimulating like before and the tariffs and Brexit …
But no worry. We’ll be saved by the Service economy:
U.S. Service-Sector Economy Powers on Despite Global Headwinds Service-sector activity across the U.S. grew at a faster rate in May, signaling a key segment of the economy remains on solid ground despite slowing global growth and trade tensions.
The Institute for Supply Management on Wednesday said its nonmanufacturing index—tracking industries including health care, finance and restaurants—rose to 56.9 in May from 55.5 in April. (…)
The IHS Markit U.S. services business activity index logged in at 50.9 last month, down from 53 in April. This signaled an expansion in services but was the lowest reading since February 2016.
The two reports, based on separate surveys of businesses, fit with other signs that the overall economy was expanding at a good pace this spring, though more slowly than last year and despite some weak spots. Services accounts for about 88% of U.S. gross domestic product, according to ISM. (…)
“We’re not heading for an immediate downturn,” said Jonathan Millar, Barclays senior U.S. economist. “You have a services sector that is offsetting some of the weakness that’s coming from manufacturing.”
Employment activity in service industries was stronger in May than April, according to the ISM report, indicating the labor market is running strong but not too hot. New orders and business activity were also up last month. (…)
Yes says the ISM:
Hmmm…says Markit which saw its own U.S. Services PMI plunge in recent months. As shown on June 4, Markit’s Manufacturing PMI has proven more reliable than the ISM’s. I put more weight on Markit’s Services PMI.
(…) new orders received by service providers increased at only a marginal rate in May. The rise was the softest since March 2016 as firms commonly stated that less robust demand conditions weighed on new business growth. Meanwhile, new export orders were broadly unchanged during May, with the respective seasonally adjusted index posting fractionally above the 50.0 no change mark.
Subsequently, service sector firms registered a lower degree of optimism towards output over the coming 12 months. Business confidence was at its lowest level since June 2016 as service providers highlighted concerns surrounding softer demand conditions and uncertainty around ongoing global trade tensions. The level of positive sentiment was well below the series trend and muted overall.
Less robust client demand put pressure on firms to remain competitive as companies left output charges broadly unchanged in May. The respective seasonally adjusted index dipped below to crucial 50.0 neutral mark for the first time since February 2016, as some companies sought to retain clients through price discounting.
Fed’s Beige Book Sees Modest Growth
Economic activity picked up slightly this spring as firms largely shrugged off the effect of tariffs, according to a Federal Reserve report released Wednesday.
The Fed’s 12 regional districts reported modest growth in April and May, “a slight improvement over the previous period,” the central bank said in its “beige book” report collecting anecdotes from business contacts from around the country. The report was based on information collected through May 24, before President Trump announced plans for new tariffs on Mexico.
The report suggests the renewal of trade tensions with China has yet to have much of a significant impact on American manufacturers, although many expressed worries about the future. (…)
Meanwhile, contacts around the country said the labor market remained exceedingly tight, putting upward pressure on wages, particularly in the retail and tourism industries. (…) Retailers remained upbeat, with several citing growth in the online retail market. (…)
One note of concern in the report came from the agricultural sector, where heavy rains could result in lower corn and soy harvests in the Midwest.
Wet weather delayed crop plantings across the region and some farmers in the Minneapolis area worried they wouldn’t be able to get a crop in at all this year. Farm contacts in Nebraska and Missouri reported lower incomes and slower repayment rates on loans.
But the wet spring was a boon in Texas, where it helped the wheat crop and made for greener pastures for cattle. (…)
More from the Beige Book:
- stronger employment growth continued to be constrained by tight labor markets, with Districts citing shortages of both
high- and low-skill workers. Competition for workers reportedly applied some wage pressures across a wide range of
occupations and induced improvements in benefits to attract more workers and to improve retention of existing employees,
according to several Districts. However, overall wage pressures remained relatively subdued given low unemployment
rates; a majority of Districts reported modest or moderate wage growth. - Overall prices continued to increase at a modest pace in most Districts since the previous report. While several Districts
noted faster growth in input prices than in final selling prices. (…) Retailers generally reported flat to slightly increased selling prices. - The overall sentiment of the Beige Book language continues to soften. (The Daily Shot)
Source: @JeoffHall
Nothing “robust” in there!
But should we care much about Services?
As you can see below, the S&P 500 Index has closely tracked the global manufacturing PMI. When manufacturers expanded at a faster rate, stocks jumped higher year-over-year. And when they slowed or even shrank, stocks sold off. (U.S. Global Investors)
India cuts interest rate to lowest level in 9 years Central bank lowers forecast for GDP growth and signals possible further easing
EARNINGS WATCH
We now have 494 reports in for Q1 results. The beat rate is 76% and the surprise factor +6.1% (median +5.6%). The blended growth rate is +1.6% (+3.0% ex-Energy) but 5 sectors are in the red.
Q2 estimates keep coming down: now only +0.5% (same ex-E). Importantly, revenue growth is slowing big time from +5.6% in Q1 to +3.8% in Q2.
Trailing EPS are now $163.91. The Rule of 20 P/E is back to 19.4, slightly undervalued.
The Rule of 20 Fair Value ($163.91 x (20 – 2.1) is 2934, 3.3% above today’s pre-opening. The worry is that the FV is stalling along with EPS and inflation (yellow line).
A stalled or declining FV puts equity markets more susceptible to sentiment swings as the underlying fundamental support is not rising.
If GS is right (read below), inflation will act as a headwind in coming months.
(…) Economists at Goldman Sachs estimate U.S. tariffs imposed or proposed on steel, aluminum, solar panels, washing machines and imports from China now equal an annualized $200 billion. Adding all threatened tariffs on Mexico brings that to $288 billion by the end of October. At 1.4% of GDP, that is roughly equivalent to the Arab embargo “oil tax.” That doesn’t include the hit from China’s—and potentially Mexico’s—retaliatory tariffs, as well as severed supplier relationships because of U.S. sanctions on Huawei Technologies Co.(…)
So while Goldman estimates the tariffs could add up to 1.25 percentage points to inflation, the Fed is likely to worry more about their impact on growth and cut rates rather than raise them.
The benefit of higher prices on imported oil went to foreign oil producers. By contrast, tariffs are paid to the U.S. Treasury, which could spend the money to offset some harm from the levies. (…)
Rather than manufacture in the U.S., many importers are contemplating shifting Chinese production to Vietnam, raising prices or dropping products most affected by tariffs. Some had planned to shift production to Mexico but they may have to reconsider. As with the oil shock, these adjustments could take years and add countless inefficiencies, chipping away at productivity. (…)
And there remains an earnings risk:
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Stocks Lure Buyers With Cheapest Valuations in Months Threat of tariffs has muddied the outlook for equities
Stocks are at their cheapest valuations in months. Shares of companies in the S&P 500 are currently trading at 15.7 times their earnings over the next 12 months, down from nearly 17 times in early May, according to FactSet. (…)
(…) The tariffs on Chinese imports are expected to lower the S&P 500’s earnings per share by 1.2% for all of 2019, Bank of America Merrill Lynch said in a research note this week. Goldman Sachs cut its 2019 earnings forecast by 2% due to additional tariffs. But analysts’ consensus earnings estimates for the year have fallen just 0.1% since Mr. Trump threatened new tariffs last month, Bank of America added, suggesting much of the market hasn’t fully grasped the potential effects of the White House’s trade actions.
And the tariffs Mr. Trump said he plans to implement on imports from Mexico only muddies the outlook further. S&P 500 earnings-per-share could fall another 0.6% this year, if tariffs on Mexican imports reach 25% in the fall, assuming companies boost prices to offset the impact, according to Bank of America. Goldman Sachs, meanwhile, projects a 5% hit to the 2019 earnings of companies in the broad index. (…)
I showed this chart 2 weeks ago:
FYI, the last 6 months EPS average is $162.47. Less 10% = $146.22 which would take FV to $2617 is inflation is 2.1%.
Certainly not a time to bet the farm on equities, is it?
“It has become clear that the political conditions in France do not currently exist for such a combination to proceed successfully,” Fiat Chrysler said.
- “we see a 40% probability that the US will impose tariffs on EU autos this year.” (Goldman Sachs)