Weekly Summary: May 30 – June 3, 2022
- We suppose that we are in a “transition” period to slowing U.S. economic growth, slowing core inflation and the beginning of labor market tightness easing.
- Although many surveys have recently shown signs of labor market tightness easing, the nationwide Job Openings and Labor Turnover Survey (JOLTS), as well as initial and continuing unemployment insurance claims continue to reflect a very tight labor market. We still have a long road ahead before the labor market will be closer to a level of a demand-supply balance that the Fed would find “acceptable.”
- We maintain our view that the financial markets have been pricing in the increasing probability of a U.S. recession in the next twelve months.
- The much hoped for extension of last week’s U.S. equity rally got off to a “shaky” start this week, before strong gains on Thursday. Equities’ reactions to various headlines that are sometimes followed by quick reversals seem to reflect many uncertainties and lack of conviction. The world remains in a state of “Confusion.”
The Upshot: We will continue to monitor closely the current rally in U.S. equities. In our May 20 weekly commentary, we noted that on Thursday of that week (May 19) “we thought that U.S. equities were attempting to find a short-term bottom.” In retrospect, we were one day early as Friday, May 20 saw a very volatile day in U.S. equities before a strong positive reversal by the day’s close. The following week saw a very powerful rally. Coming into this week we were inclined to let this rally run its course with the understanding that we would be very quick to change our views if “appropriate.” The continuation of last week’s U.S. equity rally appeared very doubtful after Friday’s equity downturn subsequent to the better-than-expected Bureau of Labor Statistics (BLS) May U.S. employment report. We are maintaining our belief that this latest bottom will not prove to be a sustainable one. Given our assumptions, we continue to anticipate that global economic growth forecasts will be lowered and that headline inflation forecasts, which include energy and food, will be raised. We assume that upward revisions in inflation forecasts will primarily be due to higher energy and other commodity prices, mostly because the Russia-Ukraine war (war) persists. We believe that financial market volatility will continue for at least as long as this war endures. Therefore, we still favor diversified portfolios for long-term investors that consist of large-cap high quality stocks, as well as some commodity exposure. We will continue to look for opportunities to take advantage of market volatility.
World Remains “Confusing:”
The Temptations’ song “Ball of Confusion…” was released on May 7, 1970. The sentiment expressed in that song is just as applicable to the state of the world today as it was in 1970 – only the details have changed. “So, round and around and around we go; Where the world’s headed, nobody knows.” This rather accurately captures our own sentiment at present. The only thing that is relatively certain is that the world will continue to spin as life goes on somehow – “And the band played on.” Some things just seem to remain normal no matter what’s going on. Each generation typically feels that the particular time through which it lives appears especially “confusing.” But I have to admit that it is hard to imagine a time of more “confusion” than what we have now. We have highlighted this idea in many of our previous commentaries, particularly since Russia first invaded Ukraine on February 24. Ever since that date, the number of variables that could affect global inflation, economic growth, various countries, sectors, etc. has continued to increase. Accurate forecasting has become increasingly more difficult – “where the world’s headed, nobody knows.” We’re all just guessing now. The pandemic has verified an axiom that I have espoused for quite some time – the more complex a system, the more fragile it becomes. We all are very familiar now with the terms supply chain constraints and disruptions.
Last week’s commentary hopefully made clear our understanding that we could be in a period of transition from inflation as the primary concern of investors into one where slowing economic growth fears, stagflation fears and even recessionary fears will dominate. Most economic data released this week gives credence to this view, at least in terms of which direction the incoming data supports. We also suppose that this transition period will be characterized by very quick changes in consumer and business behaviors. But we have little doubt that the Fed’s focus will remain on reining in inflation and that it will maintain an aggressive monetary tightening stance. We think that the Fed must see at least a consistent pattern of slowing inflationary pressures before it would contemplate a “pivot” into a less aggressive stance.
China in a State of Flux
We are convinced that quick changes might be most dramatic in China. China’s policy responses to help stimulate economic growth even appear to be close to a trial-and-error state with open and publicly disclosed debate about the most effective policy measures. A prime example of such divergent opinions this week was the debate over whether cash payments should be made directly to Chinese consumers, much like what was done by the U.S. in the early stages of the pandemic. Premier Li Keqiang was the most outspoken critic of this policy suggestion. Li was also the most outspoken last week when he signaled the “clear urgency” of revitalizing China’s economy. Last week, Shanghai launched a 50-point plan aimed at revitalizing its economy after about two months of severe COVID-19 related lockdowns. These measures included fast tracking approvals of building projects, reducing some taxes for car buyers, allowing companies to delay insurance and rental payments, as well as subsidies for utility charges. Last week, Beijing disclosed its own 33 point plan to help revitalize the economy of all of China. This nationwide plan covered issues in trade, taxes, infrastructure and foreign policies, including assisting foreign firms operating in China. Evidently, this year China is maintaining its approach of targeting specific needs as it sees them.
Slump in Chinese Consumer Confidence
China’s lockdowns and the ever-present fear of further lockdowns has had a devastating effect on Chinese consumer confidence. On June 1, the South China Morning Post revealed that the April consumer confidence index in China descended to 86.7 from the March level of 113.2. The April level was the weakest since 1991, when this survey first began. The very pessimistic outlook recorded in April only added to the urgency for consumption stimulus policies.
Chicago Board’s U.S. Consumer Confidence Index
The Chicago Board released its consumer confidence index for May early this week. The Index was moderately lower compared to March, but slightly above expectations. Over the last few months, this survey has exhibited only modest changes, both up and down. However, it is noticeably lower since mid-2021. Both the present situations and expectations were lower in May. The Senior Director of the Economic Indicators at the Conference Board stated that “the decline in the Present Situation Index was driven solely by a perceived softening in labor market conditions.” The director further stated that “purchasing intentions for cars, homes, major appliances, and more all cooled – likely a reflection of rising rates and consumers pivoting from big ticket items to spending on services. Vacation plans have also softened due to rising prices.” Inflation remained “top of mind” for these consumers. More “downside risks to consumer spending [was expected] this year.” As we have highlighted in prior commentaries, consumer sentiment – as measured by the University of Michigan sentiment indicators – has indicated much lower levels of confidence that fell to 10-year lows. Most of this divergence is due to the Conference Board’s survey’s focus on perceptions of the labor markets.
Source: J.P. Morgan, US: Consumer confidence declines in May (5/31/22)
U.S. Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) for May
One of the most anticipated U.S. economic data releases this week was the ISM Manufacturing Index for May. The headline rose 0.7% month-over-month (m/m) to 56.1, versus an expected decline. The underlying components of this survey were somewhat mixed as the employment sub-component contracted and fell below 50. The employment index of 49.6 was the first reading below the 50 mark since November 2020. The chair of ISM Business Survey Committee characterized this survey as, “The U.S. manufacturing sector remains in a demand driven, supply chain constrained environment. Despite the Employment Index contracting in May, companies improved their progress on addressing moderate term labor shortages at all tiers of the supply chain.” For many participants in this survey, supply chain and price pressures remained their principal concerns. Many also noted an improvement in their ability to hire in May versus April. On June 1, J.P. Morgan (JPM) thought that this report showed the U.S. manufacturing sector losing momentum, in part due to the recent U.S. dollar (USD) appreciation.
Source: J.P Morgan, US: ISM manufacturing survey moves up in May (6/1/22)
China May PMIs
Early this week, China released its official May PMIs for both manufacturing and non-manufacturing sectors. Although both readings remained below 50, and thus were still in contraction territory, both managed very strong and unexpected rebounds. The drop in coronavirus cases and the easing of mobility restrictions helped the rebound in the services sector. Supply chain disruptions also appeared to diminish as the proportion of companies reporting “logistic blockages” dropped 8% versus April.
Selected U.S. Economic Data
On Thursday, final revisions were announced for U.S. Q1 labor costs and labor productivity. Both continued to disappoint. Unit labor costs were revised up to 8.2% year-over-year (y/y) from a prior estimate of 7.2% and also increased 1.0% to +12.6 % quarter-over-quarter at annualized rates. U.S. nonfarm productivity was revised up from -7.5% to a still disappointing -7.3% seasonally adjusted annualized rate. U.S. April new manufacturing orders also disappointed rising only 0.3% month-over-month (m/m) versus +0.6% expected, and declining from a revised March reading of 1.8%. Demand for factory goods remained strong, but supply chain issues continued to restrain production. The anticipated continued shift in consumer spending patterns to more services spending in lieu of goods purchases could present future risks to factory output.
Source: J.P. Morgan, US: Unit labor costs revised up (6/2/22)
Although many surveys have indicated a lessening of labor market tightness in the U.S., the latest unemployment insurance claims still indicated a very tight U.S. labor market. For the week that ended May 28, initial claims dropped 11,000 to 200,000 and for the week that ended May 21, continuing claims also declined by a more-than-expected 34,000 to 1.3109 million. The latest JOLTS that was reported this week showed that there were 11.4 million U.S. job openings on the last business day of April. This was 455,000 fewer than the revised level of 11.855 million reported for the prior month. Although the gap between job vacancies and available workers was narrowed from 5.6 million in March to 5.46 million in April, this was still one of the largest such gaps in U.S. history. While job openings and hiring rates decreased for establishments with 250-999 employees, job openings increased for companies employing between 1,000-4,999 employees. The hiring rates increased for companies employing up to nine employees, as well as for companies employing more than 5,000. The very disappointing April ADP report for private payrolls of +128,000 additional jobs also showed an advantage that large firms have in hiring over smaller firms. Firms that employed fewer than fifty employees showed a drop of 91,000 jobs.
Source: J.P. Morgan, US: JOLTS data stay strong despite move down in openings (6/1/22)
Dallas Fed Manufacturing Activity
The Dallas Fed announced that Texas factory activity expanded at a “robust” pace in May, with its production index rising from 10.8 to 18.8. But most other indicators of the Dallas manufacturing index appeared much less favorable. Both the new orders index and the growth rate of new orders fell to their lowest levels in about two years. The general business activity index fell to a negative reading for the first time since July 2020. The company outlook index went further into negative territory. Expectations regarding future manufacturing were generally less optimistic than April. Employment edged lower but remained elevated. Prices and wages continued to increase strongly in May.
Dallas Fed Services Activity
On Wednesday, the Dallas Fed announced its May services survey results. The revenue index, a key measure of the services sector, declined to its lowest level in four months. Labor market conditions also moderated as the growth in employment and hours worked declined m/m. The employment index fell to its lowest level since February 2021, as the level of uncertainty increased sharply to its highest level since July 2020. The future business activity index fell into negative territory for the first time in nearly two years. Price measures remained near record highs in May and wage growth accelerated slightly.
Fed’s Beige Book
The Fed’s Beige Book, which is a compilation of economic information from contacts in each of the twelve Federal Reserve Districts, “is intended to characterize the change in economic conditions since the last report.” The Beige Book is published eight times per year, and this latest issue reported some softening in retail sales as consumers faced higher prices. Residential real estate activity also weakened due to higher mortgage rates and elevated house prices. Contacts still “tended to cite labor market difficulties as their greatest challenge, followed by supply chain disruptions, rising interest rates, general inflation, Russia’s invasion of Ukraine and disruptions from covid cases.” The majority of Districts reported diminished future growth expectations and three Districts expressed concerns over recession possibilities. Some firms in most Districts reported hiring freezes or some other signs that labor market tightness had begun to ease. But worker shortages still accounted for many firms operating below capacity. The majority of Districts continued to report strong wage growth, some reported moderate wage growth and a few Districts reported a “leveling off” or even an edging lower of wage growth. Furthermore, most Districts reported very robust prices, particularly for input prices. Three Districts reported that prices received had moderated somewhat.
U.S. – Economic Growth, Labor Market Tightness, Inflation
In general, we deem the above data and other recent core inflation statistics to support our supposition that the U.S. economy is showing signs of weakening, that the labor market tightness has begun to dissipate and that core inflation is exhibiting some signs of weakening.
First Three Days Trading this Week
The first two trading days of this week got off to a rather “shaky” start in a failed attempt to extend last week’s very strong rally. Over these first two days, the S&P 500 declined 1.37% and energy was the only positive sector with a +0.09% gain. After oscillating between gains and losses on Thursday, U.S. equities closed with dramatic gains. These gains increased the hope of many investors that last week’s rally could be extended. After the third day of trading, the S&P 500 now showed a cumulative three-day gain of 0.45%. The top three sectors over those three days were Consumer Discretionary at +2.94%, Communication Services at +2.28%, and Info Tech at +1.38%. Energy was now sixth best at a negative 0.21%. Treasury yields also rose during this period. Even though equities were obviously volatile during these three days, the Cboe Volatility Index (VIX) measure of equity volatility was lower each day to close roughly in the mid-20’s area. The Merrill Lynch Option Volatility Estimate (MOVE) Index, which is a measure of Treasury market volatility rose for the first two trading days before falling back to roughly where it started this week.
Selected “Key” Announcements this Week
This week began with announcements of record or near-record levels of CPI inflation rates of many European countries. Europe also announced an embargo of 90% of Russian oil by year end. On Wednesday, Canada’s central bank (BOC) announced a 50 basis points (bps) hike on its key rate to 1.50%. The financial markets took notice of the very hawkish rhetoric that accompanied this hike. The BOC stated that “the Governing Council is prepared to act more forcefully if needed.” The BOC stated further that “inflation continues to broaden,” and that inflation “will likely move even higher in the near term.” The BOC believed also that the “risk of elevated inflation becoming entrenched has risen.” Wage growth was characterized as “picking up and broadening across sectors.” Although the BOC described global growth as “slowing,” it described Canada’s economic outlook as “solid.” The better-than-expected ISM headline PMI described above and also released on Wednesday, helped propel interest rates higher and equities lower. Finally, JPM’s CEO Jamie Dimon also chose Wednesday to postulate that JPM should “brace” itself for an economic “hurricane” that is “coming our way.” But the hurricane could be a minor one or a major one. It was only very recently that Mr. Dimon described the economy in a much more positive way when he only envisioned “storm clouds.”
USD Top Already in Place for 2022?
On Thursday morning, Microsoft cut its fiscal Q4 earnings and revenue guidance due to unfavorable foreign exchange rate movements. Microsoft’s stock traded close to 4% lower on this announcement before closing about 0.7% higher. It is well known that Microsoft, along with most large tech companies, has very large overseas operations which are negatively affected by a rising USD when they translate their foreign revenues and earnings back into USDs. DXY is a USD index of the U.S. dollar’s value relative to some of its key trading partners. DXY hit its peak this year on May 12 when it was over 9% higher for the year. During the day of June 2, DXY was only about 6% higher YTD. In our May 20 weekly commentary we stated that “we could be putting in a USD top …” Our confidence that we have seen a USD top for this year has only increased since then. Given USD’s recent trajectory, we found it rather odd that Microsoft would choose to make a special announcement on this topic. Many other U.S. companies with overseas operations obviously will be affected as well.
We assume continued volatility across virtually all financial markets for at least as long as the Russia-Ukraine war persists. We will continue to monitor closely the current rally in U.S. equities. Coming into this week we were inclined to let this rally run its course with the understanding that we would be very quick to change our views if “appropriate.” This was particularly true given the “shaky” start of U.S. equities this week. The continuation of last week’s rally appeared very doubtful after Friday’s equity downturn subsequent to the better-than-expected BLS May U.S. employment report. We maintain our belief that this will not be a sustainable “bottom.” Additionally, we view that analysts’ revisions of their margins and earnings might need to be adjusted lower as a prerequisite. We also continue to uphold our conviction that predictable margins should become increasingly important in evaluating appropriate investments.
Our fundamental investment approach remains the same as expressed in our recent commentaries. We maintain our preference for large-cap high quality stocks in a diversified portfolio with at least some commodity exposure.
The Job Openings and Labor Turnover Survey (JOLTS) – A monthly report by the Bureau of Labor Statistics (BLS) of the U.S. Department of Labor counting job vacancies and separations, including the number of workers voluntarily quitting employment.
U.S. Dollar Index (DXY) – The U.S. dollar index (DXY) is a measurement of the dollar’s value relative to six foreign currencies as measured by their exchange rates. Over half the index’s value is represented by the dollar’s value measured against the euro. The other five currencies include the Japanese yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc.
Beige Book – The Beige Book is a report produced and published by the Federal Reserve. The report, referred to formally as the Summary of Commentary on Current Economic Conditions, is a qualitative review of economic conditions. The Beige Book is published eight times each year before meetings held by the Federal Open Market Committee (FOMC) and is considered one of the most valuable tools at the committee’s disposal for making key decisions about the economy.
ISM Manufacturing Index (PMI) – The ISM manufacturing index, also known as the purchasing managers’ index (PMI), is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms. It is considered to be a key indicator of the state of the U.S. economy.
ISM Services PMI – The ISM Services PMI, also known as the ISM Non-Manufacturing Index, is an economic index based on surveys of more than 400 non-manufacturing firms’ purchasing and supply executives.
Chicago Board Consumer Confidence Index – This consumer confidence indicator provides an indication of future developments of households’ consumption and saving, based upon answers regarding their expected financial situation, their sentiment about the general economic situation, unemployment and capability of savings.
Michigan Consumer Sentiment Index – The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States conducted by the University of Michigan. The survey is based on telephone interviews that gather information on consumer expectations for the economy.
Labor Productivity – Labor productivity measures the hourly output of a country’s economy. Specifically, it charts the amount of real gross domestic product (GDP) produced by an hour of labor. Growth in labor productivity depends on three main factors: saving and investment in physical capital, new technology, and human capital.
Unit Labor Cost – Unit Labor Cost (ULC) is how much a business pays its workers to produce one unit of output. Businesses pay workers compensation that can include both wages and benefits, such as health insurance and retirement contributions.
Unemployment Insurance Claims – The term unemployment claim refers to the request for cash benefits made by an individual after they are laid off from their job. Claims are filed through state governments for temporary payments after people lose their jobs through no fault of their own.
The United States Department of Labor (DOL) tracks the number of weekly unemployment claims to report each week’s initial and continuing claims.
ADP National Employment Report – The ADP National Employment Report is a monthly report of economic data that tracks the level of nonfarm private employment in the U.S. It is published by Automatic Data Processing, a company that handles payroll for about a fifth of all privately-employed individuals in the U.S. The ADP National Employment Report is also known as the ADP Jobs Report or the ADP Employment Report.
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