THE DAILY EDGE: 7 JULY 2021

U.S. Services PMI: Strong business activity growth rounds off best quarter in PMI survey history

June PMI™ data indicated a further marked upturn in business activity across the U.S. service sector, supported by a substantial rise in client demand. Business confidence in the outlook also improved to the second-highest in seven years. Rates of output and new order growth eased from May’s record highs, however, and capacity constraints meant backlogs of work grew at the quickest rate for ten months. Although firms continued to hire new workers, challenges finding suitable candidates weighed on the pace of job creation.

Meanwhile, input prices increased at the second-fastest rate on record as supplier price hikes and greater wage bills pushed up cost burdens. Nonetheless, accommodative demand conditions allowed firms to partially pass on higher costs to clients.

The seasonally adjusted final IHS Markit US Services PMI Business Activity Index registered 64.6 in June, down from 70.4 in May and slightly below the earlier released ‘flash’ estimate of 64.8. The latest expansion in output was the third-fastest since data collection began in October 2009, only slower than recent upturns in May and April, respectively.

Contributing to the robust rise in activity across the service sector was a further marked increase in new business at the end of the second quarter. Alongside strong customer demand, firms attributed the upturn in new sales to the acquisition of new clients. Although the rate of new business growth slipped to a three-month low, it was still the third-fastest on record.

Mirroring the trend for total sales, new export orders rose at a strong pace that was only slightly slower than May’s recent peak and among the steepest in the history of the survey. The fourth successive monthly expansion in foreign client demand was linked by companies to the relaxation of COVID-19 restrictions in key export markets.

At the same time, service providers registered the second-steepest rise in input costs on record in June. Although the rate of input price inflation eased from May’s recent high, firms continued to highlight rising supplier, fuel and wage costs.

Service sector firms were able to partially pass on higher cost burdens to clients, however, as output charges increased at the second-steepest rate on record, albeit with the rate of inflation cooling from May’s peak.

Greater new order inflows placed greater pressure on output capacity during June, as the level of outstanding business expanded at the sharpest rate for ten months. Labour shortages reportedly exacerbated strains meeting demand following sustained and robust increases in new sales. The rate of job creation was strong overall, but softened amid challenges enticing workers back to employment.

Finally, business expectations regarding the outlook for output over the coming year improved at the end of the second quarter. The degree of optimism strengthened to the highest since November 2020, as firms gained confidence following a more extensive reopening of the economy and expressed hopes of further boosts to client demand. Survey respondents also cited a reduction in concerns over inflation.

The IHS Markit U.S. Composite PMI Output Index posted 63.7 in June, down from May’s recent high of 68.7. The overall upturn eased following slower output expansions across both the manufacturing and service sectors. Nonetheless, the rate of growth in activity was substantial and the second-fastest on record.

Contributing to the softer upturn in output was a slight moderation in the rate of new business growth during June. With the exception of April and May data, the latest pace of expansion was the sharpest since data collection for the series began in October 2009. Similarly, the rate of increase in new export orders was historically elevated despite softening to a three-month low.

At the same time, cost pressures remained marked in June. Further raw material shortages and hikes in supplier and fuel costs reportedly pushed input prices higher, according to panellists. The rate of cost inflation was the second-quickest on record. Firms passed on greater costs to clients via the second-sharpest increase in average selling prices for goods and services since data collection began in 2009.

Challenges hiring new employees persisted in June, causing the rate of job creation to ease in the manufacturing and service sectors. Labour and material shortages reportedly resulted in greater strains on output capacity, as private sector backlogs of work rose at the quickest rate on record.

“TRANSITORY” WATCH:

• What respondents in the ISM Services PMI are saying:
• “Our restaurants are quickly — maybe too quickly — returning to 2019 sales levels. Strong consumer demand for dining out is clearly evident as COVID-19 restrictions ease, but the challenges are supply chain outages, logistics delays and employee- and management-staffing constraints. Some locations cannot open for business or (have) limited hours, as we cannot staff the restaurant to meet consumer demand.” [Accommodation & Food Services]
• “Severe supply chain disruptions and inflation are continuing in the marketplace, in all sectors.” [Arts, Entertainment & Recreation]
• “COVID-19 continues to cause troubles for all of our deliveries, as well as short supply a lot of materials. (Shortages of) lumber, copper, and steel continue, which is driving up pricing and lead times.” [Construction]
• “The declining positive test rates for COVID-19 is already having a significant impact, as virtually all aspects of our operations are picking up rapidly. The summer is normally the slow period, as limited teaching is taking place, but this year, preparations for the fall semester are already underway.” [Educational Services]
• “New business is actively trending up locally, nationally and internationally.” [Finance & Insurance]
• “Employees globally are returning to the office where possible. We expect to have most employees in the office starting in September.” [Information]
• “Business conditions continue to rebound; however, like everywhere, the challenges in the supply chain are numerous. We continue to see cost increases, delayed shipments, pushed-out lead times, and no clarity as to when predictive balance returns to this market.” [Retail Trade]
• “Labor market remains tight, and wages have risen at an unprecedented rate. We are expecting a long-term effect on pricing of services.” [Transportation & Warehousing]
• “Overall business activity in the month has been strong. We are seeing increased orders and slight improvements in backlogs. The primary headwinds this month continue to be very expensive ocean freight rates, increasing business costs and increasing raw-materials costs. The top line is not outrunning expenses.” [Wholesale Trade]
• “Starting to see a lot of commodity-price increases for chemicals, acidizing and cementing. This is driven by product cost increases stemming from low production from plants.” [Mining]
• Commodities Up in Price: Beef (2); Chicken (2); Construction Materials (4); Copper Wire (3); Diesel (7); Electrical Components (5); Engineered Wood Products; Food (2); Freight (2); Fuel (6); Gasoline (7); Insulation; Labor (7); Labor —Temporary (6); Lobster Tails; Lodging; Lumber (6); Metal Products (2); Natural Gas; Oriented Strand Board (OSB) (7); Packaging Materials (2); Pallets (2); Paper; Personal Protective Equipment (PPE)*; Plastic; Plastic Products (2); Polyvinyl Chloride (PVC) Products (10); Pork Products; Poultry; Stainless Steel Products; Steel (10); Steel Products (6); Tires; and Wood Pallets.
• Commodities Down in Price: Exam Gloves; Gloves; Masks; Nitrile Gloves; and Personal Protective Equipment (PPE)*.
• Commodities in Short Supply: Chicken (2); Chlorine; Computer Hardware (2); Electrical Components (3); Electronic Components (3); Gloves (7); Labor (2); Labor — Contingent; Labor — Temporary (6); Lumber (3); Lumber Products (2); Needles and Syringes (7); Nitrile Gloves (13); Pipette (4); Plastic Products; Polyvinyl Chloride (PVC); Polyvinyl Chloride (PVC) Products (5); Resin-Based Products (2); Steel Products (7); Vehicles (2); and Wood.

Note: The number of consecutive months the commodity is listed is indicated after each item. *Indicates those commodities reported both up and down in price.

• Rising rents may not be transitory. The median U.S. rent climbed 9.2% in the first half, and surveys suggest renters are bracing for even more hikes. The run-up complicates the Fed’s view—shared by most investors—that the current spike in inflation will prove impermanent because higher rents are harder to reverse than prices for things like lumber and used cars. That’s not the kind of post-pandemic bump most renters were looking for. (Bloomberg)

Meanwhile, consumers seemed to keep spending through June…

…but mainly on services as demand for goods took a June dive:

(…) Heading into the hottest days of the summer, above-average temperatures and dry conditions in the forecast may roil crop production in areas already in the grips of a drought. The volatility in agricultural futures is linked to the uncertainty that growing regions will get the rain they need. (…)

Swaths of Minnesota, Iowa, Nebraska, Wisconsin and the Dakotas are experiencing droughts, according to the U.S. Drought Monitor. According to USDA data monitoring crop health, the dryness is particularly hurting wheat and soybean crops in those areas. (…)

Meanwhile, the USDA also reported that U.S. grains inventories are down to their lowest levels since 2015. Robust demand for U.S. grains on the world export markets means inventories are dwindling faster than predicted.

Potentially exacerbating a supply squeeze due to weather is how much U.S. grain exports China buys. The nation has been hands-off in recent weeks, leading some to question if it will cut its appetite for U.S. agriculture as it rebuilds its hog herd after devastation from African swine fever.

However, in separate reports issued last week, the USDA’s Foreign Agricultural Service said that China imported $7.7 billion of U.S. soybeans in the first quarter of 2021, the second-highest on record for the quarter. The FAS also forecast that China will remain strong importers of U.S. grains as higher domestic prices there make importing attractive. (…)

Toronto Home Sales Hit Lowest Point in a Year

Home sales in Canada’s largest city fell 9.1% in June from the month before to 8,885 transactions, the third consecutive monthly decline, according to data released Tuesday by the Toronto Regional Real Estate Board. Despite the declining number of sales the seasonally adjusted average price of a home remained virtually unchanged last month at C$1.06 million ($859,890), the data show. (…)

Vancouver, Canada’s priciest home market, showed a similar decline in June home sales from the previous month, though activity both there and in Toronto remains above where it was a year ago and elevated by historical standards. Toronto’s record start to the year caused that city’s real estate board to raise its forecast for average home prices in 2021 to C$1.07 million from the C$1.025 million it predicted in February. (…)

Also in Toronto, in a reversal of the pattern seen for much of the last year, annual growth in condominium sales in June outpaced the sales growth for all types of ground-based homes, suggesting interest may be returning for the denser housing types the pandemic put out of favor, but are often the first choice of immigrants newly arrived to the country. (…)

EARNINGS WATCH

As we move into earnings season, companies are pretty bullish—even historically so. According to FactSet, the number of S&P 500 companies that have guided higher on earnings growth and EPS estimates is at a 12-year and 15-year high, respectively. Big beats on revenues, too, are widely expected.
The chart below, furnished by FactSet, gives a snapshot of that bullishness. (…)

“Analysts have not only increased EPS estimates for the second quarter, but also for the full year,” John Butters, FactSet senior equity analyst, writes in a July 2 research note. “The CY 2021 bottom-up EPS estimate… increased by 8.6% (to $191.31 from $176.13) during the second quarter (from March 31 to June 30). This increase marked the largest increase in the annual bottom-up EPS estimate for the index during the calendar second quarter since FactSet began tracking the annual bottom-up EPS estimate in 1996.” (Fortune)

COVID-19

• Delta variant drives Spain’s Covid-19 rate to highest in mainland Europe Infection rate almost tripled in past week, fuelled by sharp rise among under-30s
• Trump Country Rejects Vaccines Despite Growing Delta Threat

(…) Two Americas have emerged from the growing vaccination gap. In one, dominated by states that Biden won in the November election, most adults got their shots and daily life is rapidly returning to normal, with assurances from health officials that the worst is over. But in the other — overwhelmingly Trump country — fewer adults are vaccinated and health officials fear that the new, more transmissible delta variant, first observed in India, is driving a surge of cases, hospitalizations and deaths.

(…) a Gallup poll last week found that 57% of Republicans say the pandemic is over, compared with 4% of Democrats. (…)

The following charts are from Longview Economics Ltd. of London, [via John Authers] and compare cases and deaths in the delta outbreak with those during the wave that forced a closedown last fall:

The conclusion so far is that vaccination is doing what it’s supposed to. By immunizing those most vulnerable first, the British authorities seem to have ensured that this outbreak would largely only infect those most able to withstand it. So it is hard to see why this should be taken as such a major reason to doubt reopening and reflation. There is, potentially, reason from the British experience to fear what might happen if the delta variant reaches communities where the elderly largely haven’t been vaccinated, as is still the case in some American states. But for now that threat is largely hypothetical.

• British Airways and Virgin Atlantic are to trial fast-track lanes for fully-vaccinated passengers arriving at London’s Heathrow airport. The British government wants to stop requiring fully-vaccinated travelers to isolate when arriving from an “amber list” country such as the U.S. or Germany. BBC

Bitcoin Fraud Concerns Draw Scrutiny From Regulators Cryptocurrencies didn’t get much attention in Washington until recently. Now regulators are signaling they want more control over an asset that has pushed further into Wall Street activities without investor and consumer protections.

China Takes Didi Investors for a Ride American shareholders get an expensive lesson in Xi Jinping risk.

(…) Most of this counts as business as usual in China, as investors should have known. Didi’s prospectus disclosed that executives from Didi and at least 30 other internet companies in April were hauled in for a meeting with Beijing regulators, where they were told to conduct “self-inspections” for compliance with antitrust, tax and other laws. The company warned it could only assume its self-criticism, er, inspection had been sufficient.

Beijing’s habitual regulatory ambiguity might also explain why Didi pushed ahead with its offer even after regulators “suggested” it delay. The company decided to list absent a formal prohibition from Beijing, the Journal reports. Asking for forgiveness rather than permission often pays off in China’s vague, wink-and-nudge legal climate. As Didi noted elsewhere in its prospectus, the legality of most overseas listings of Chinese tech companies is an open question under Chinese laws that technically bar foreign ownership. Those listings have gone ahead anyway, and profitably so.

Didi’s plight reminds investors that what Beijing gives, it can easily take away—which is one of the risks for which bigger returns are supposed to compensate. This follows Beijing’s scuttling last year of what would have been a blockbuster initial public offer by Jack Ma’s Ant Financial in Shanghai and Hong Kong, apparently because Mr. Ma made the mistake of criticizing regulators in a speech.

President Xi Jinping is consolidating state control over the economy, so American investors in Chinese firms can expect more regulatory disruption. Those capital gains will come with capital political risks.

• Down $831 Billion, China Tech Firm Selloff May Be Far From Over

• China to Tighten Rules for Overseas Stock Listings China said it would tighten rules for companies seeking to sell shares abroad and strengthen oversight of overseas-listed companies, moves that follow scrutiny of Didi Global and could hinder attempts by homegrown firms to raise money in the U.S.

The Pizza Delivery Guy Will Be a Robot at Many Campuses This Fall