“Something Just Like This”

Something Just Like This NewEdge Wealth Weekly Summary
December 9, 2022

Weekly Summary: December 5 – 9

 

Key Observations:

  1. We hope that Federal Reserve (Fed) chair Powell’s new risk management approach is on display at next week’s Fed meeting. We “want something just like this.” We view this new approach as diminishing the probability of the Fed “over-tightening.” We continue to expect the Fed to raise the federal funds rate by 50 basis points (bps) at next week’s meeting.
  2. We maintain that the general trends of a slowing U.S. economy, along with signs of dissipating inflation trends that we have highlighted in many of our commentaries, were evident again this week. The most prominent outlier to these trends was the stronger than expected November ISM Services PMI. We have chosen to discount the importance of this outlier.
  3. We were encouraged by the upward revisions to Q3 U.S. labor productivity and by the downward revisions to unit labor costs. We believe that a similar pattern will become evident in wage gains trends. We were not dismayed by the stronger than expected U.S. Producer Price Index (PPI) for November, given the slowing trends over time. The financial markets’ muted initial reaction to the PPI data seemed to confirm our assessment. The USD and interest rates remained well contained. The 2-10-year Treasury yield become less inverted as the 10-year Treasury yield rose relative to the 2-year Treasury yield. The 10-30-year Treasury yield also become less inverted relative to its prior peaks reached this week before Friday.
  4. The dramatic slowdown in China’s November trade data could be construed as an indication of slowing global economic growth. But the supply chain constraints due to China’s zero COVID-19 policies that hurt China’s ability to produce make this conclusion less certain. A much smaller decrease in U.S. exports growth is somewhat supportive of this notion. We hope that China’s recently announced attempts to ease COVID-related restrictions will help spur global economic growth. However, we expect this process to be rather “messy” that could be characterized by “fits and starts.”

The Upshot: Our general investment approach remains the same as depicted in last week’s commentary. We maintain our preference for big cap quality stocks with good balance sheets, relatively stable cash flows and stable margins. Volatility across sectors continues to be supportive of a diversified portfolio for long term investors. As the Fed’s “quantitative tightening” (QT – contraction of the Fed’s balance sheet) progresses on a pre-determined course, we expect liquidity to contract in financial markets, including in U.S. Treasuries. We have been highlighting this for quite some time. In our opinion, less liquidity should lead to more volatility. Most investors seem to ignore the QT of the Fed’s tightening monetary policies.

We maintain our concern, as expressed first in our November 18 commentary, that we foresee a more challenging trading environment by early next year. “During 2022, our principal concern revolved around inflation trends and the extent of the Fed’s monetary tightening. We now anticipate entering a period in the not-too-distant -future of concerns over inflation and the Fed’s monetary tightening policies on the one hand, and escalating concerns over the extent of economic slowdowns and the effect that a slowdown will have on margins and earnings.” We maintain our belief that U.S. inflation could dissipate in a more rapid manner than many expect. A flexible mindset will be a key to navigating financial markets.

 

Powell’s New Risk Management Approach

Our last weekly commentary highlighted Fed chairman Powell’s new “balancing of risk” approach to determine the pace of further hikes in the federal funds rate, and to determine how long to hold rates at a “sufficiently restrictive” level to achieve the Fed’s 2% targeted rate of inflation. We were pleased considerably by this new approach because we surmised that this approach would lessen somewhat the probability of the Fed “over-tightening” to achieve its goals. It was as if Powell was trying to answer at least two primary questions on the minds of many investors and analysts as expressed in the song “Something Just Like This” by Coldplay and the Chainsmokers. “Where d’you wanna go? How much you wanna risk?” How high will the Fed push the federal funds rate? How much does the Fed want to risk a recession by over-tightening? We “want something just like this.” We believe that Powell struck the “proper” balance for the Fed’s monetary policy in the near-to-medium term.

 

November ISM Services

The general trends of a slowing U.S. economy were evident again this week, along with signs of dissipating inflation trends that we have highlighted in many of our commentaries. However, there was one survey that we considered an outlier to this trend. The Institute for Supply Management (ISM) Services PMI for November was 56.5%, compared to expectations of 53.5% and an October reading of 54.4%. The business activity index was especially strong as it rose 9.0% to 64.7%. The employment index rose a more modest 2.4% to 51.5%. New orders edged down 0.5% to 56.0, as prices moderated somewhat. The new export index dropped 9.3% to 38.4%, its lowest reading since April 2020. As reflected in some of this data, there can be a great amount of variability month-to-month (m/m). The chair of ISM Services Business Survey Committee commented that “increased capacity and shorter lead times have resulted in a continued improvement in supply chain and logistics performance. A new fiscal period and the holiday season have contributed to stronger business activity and increased employment.”

 

U.S. October Factory Orders

U.S. factory orders also were stronger than expected in October. Factory orders increased 1.0% m/m in October versus an expected increase of 0.7% and a September increase of 0.3%.

 

U.S. November Services PMI

November S&P Global U.S. Services PMI (PMI Services) was also announced on Monday and depicted a contracting U.S. economy as reflected by the Services Business Activity Index falling from 47.8 in October to 46.2 in November. The fall in Services output was the second sharpest since May 2020. Both domestic and foreign demand declined in November. However, the decline in foreign demand was at the quickest pace in two and a half years. Softening demand helped ease input price inflation to its slowest pace since the end of 2020. Some companies even offered discounts to help spur additional sales. Backlogs contracted at the fastest pace since May 2020. The Chief Business Economist at S&P Global commented that the survey data provided a “timely signal that the health of the U.S. economy is deteriorating at a marked rate” … and that the data are also “broadly consistent with the U.S. economy contracting in the fourth quarter at an annualized rate of approximately 1%, with the decline gathering momentum as we head towards the end of the year.”

 

Reaction of U.S. Financial Markets

The U.S. financial markets appeared to ignore the more “ominous” U.S. PMI Services data, and focused on the better-than-expected ISM Services and factory data. This resulted in the predictable market reaction on Monday – higher interest rates, a higher U.S. Dollar (USD) and generally lower equity prices. USD and interest rates remained rather contained through Thursday, even as the two-to-10-year Treasury yield inverted to over 84 basis points (bps) on Wednesday. The 10-to-30-year Treasury yield curve finally inverted by more than 5 bps on Thursday. The better-than-expected revised U.S. productivity measures and lower-than-expected U.S. unit labor costs for Q3, as well as increased concerns over a U.S. recession, helped push USD and interest rates lower on Wednesday. Most CEO’s who participated in the Business Roundtable this week saw a high probability of U.S. recession risk over the upcoming year. USD weakened on Thursday as interest rates and equities rose, and high tech performed best on that day.

 

U.S. Q3 Labor Productivity and Unit Labor Costs

On Wednesday, the Bureau of Labor Statistics (BLS) reported revised figures for Q3 U.S. labor nonfarm productivity and unit labor costs. Productivity was revised up to an annualized increase of 0.8% from a preliminary estimate of 0.3% quarter-over-quarter (q/q), and rebounding from a 4.1% drop. This was the first quarter of labor productivity growth since Q4 2021. However, productivity fell 1.3% when compared to Q3 2021. As with most economic data since the pandemic began, the reliability of productivity data might be questioned to some extent given the large shifts in the composition of the workforce. Unit labor costs – the price of labor per single unit of output – was revised down to a 2.4% increase from a previously reported increase of 3.5%. When comparing Q3 2022 to Q3 2021, the revised measures of unit labor costs rose 5.3% from a previously reported increase of 6.1%. Lower unit labor costs translate into lower rates of wage growth, which is welcome news for the Fed in its efforts to rein in inflation.

 

Chart, line chart

Description automatically generated

 

Chart, line chart

Description automatically generated

Source: JP Morgan, US: Productivity revised up, unit labor costs revised down (12-7-2022)

 

QFR Report for Q3

The U.S. Census Bureau released its Quarterly Financial Report (QFR) for Q3 midweek. U.S. manufacturing corporations’ after-tax profits decreased from revised Q2 profits of $269.7 billion to $250.2 billion in Q3, and were marginally lower than the revised $252.4 billion for Q3 2021. Seasonally adjusted Q3 sales decreased $19.1 billion from Q2 sales and were $312.8 billion higher versus Q3 2021 sales. Profit margins were being compressed over this past year. The shrinking profit margins story was even worse for large U.S. retail trade corporations. After-tax Q3 profits were $21.0 billion for retail trade corporations versus $42.8 billion (revised) for Q2 and versus $46.6 billion for Q3 2021. Seasonally adjusted sales for Q3 and Q2 were “not statistically different” and Q3 sales were $69.5 billion higher than Q3 2021.

 

Chart, bar chart

Description automatically generated

Source: US Department of Commerce, Quarterly Financial Report: US Manufacturing, Mining, Wholesale Trade, and Elected Service Industries, Third Quarter 2022 (12-7-2022)

 

Chart, bar chart

Description automatically generated

Source: US Department of Commerce, Quarterly Financial Report: Large US Retail Trade Corporations, Third
Quarter 2022 (12-7-2022)

 

QSS Report for Q3

The U.S. Census Bureau released its Quarterly Selected Services (QSS) total revenue estimates on Thursday. U.S. Services revenues grew 2.2% from Q2 to Q3 and were 9.0% higher than in Q3 2021. Revised revenue growth in Q2 was 2.3% higher than in Q1 and 10.14% higher than in Q2 2021. Revenue growth in Services appeared to be slowing. These services revenues were revised lower from the initial revenue estimates and have caused J.P. Morgan (JPM) to lower its Q3 tracking estimate of GDP growth from 3.0% to 2.8%.

 

U.S. October Consumer Credit Growth

On Wednesday, the Fed reported October consumer credit growth. U.S. consumers continued to increase their borrowings as consumer credit rose $27.1 billion in October following an upwardly revised $25.8 billion rise in September, but less than the expected $28.3 billion October increase. The seasonally adjusted October increase was 6.9% y/y, compared to a 6.6% y/y increase in September. Revolving credit was 10.4% higher y/y and nonrevolving credit was 5.8% higher y/y. The former includes credit card debt and the latter includes auto loans and student debt. Neither measure includes mortgage loans, which is the largest category of consumer debt.

 

Weaker U.S. Housing Trends Continue

According to Freddie Mac, the rate on the average 30-year fixed rate mortgage dropped from 6.49% the prior week to 6.33% this week. According to Mortgage Bankers Association’s latest survey of applications, demand for mortgages dropped 1.9% from the prior week and “home purchase activity” dropped 3% from the prior week. Overall, purchase applications were 40% lower y/y. First-time buyers were notably absent. According to Realtor.com, 19.6% of homes for sale in November had their prices reduced versus only 9.2% one year ago. Redfin reported that a record 2% of homes for sale were delisted on average for the twelve weeks ending November 20 versus 1.6% last year.

The real estate platform RealPage reported that U.S. November rents fell for the third consecutive month. Asking rents fell 0.59% in November, which was the largest monthly drop since 2010. The 6.5% y/y increase in rents was the lowest since June 2021 and much lower than the 15.7% y/y peak reached in March.

 

Used Vehicle Prices Continue Lower

The Manheim Used Vehicle Value Index tracks prices of used vehicles sold at its U.S. wholesale auctions. This index was 0.3% lower m/m in November and 14.2% lower y/y. It was about 15.6% lower than its record high reached in January. The index dropped to 199.4 in November, which marked the first month since August 2021 that the index was lower than 200. The November drop was the sixth consecutive month of price declines.

 

U.S. Jobless Claims — Unemployment Insurance Claims

Initial claims for unemployment insurance benefits increased by 4,000 to an expected 230,000 claims for the week that ended December 3. Continuing claims for the week that ended November 26 increased by a greater-than-expected 62,000 to 1.67 million from the previous week’s revised 1.61 million. The latest three-week increase in continuing claims was the most since May 2020. Continuing claims rose for the eighth consecutive week and were the highest since the week that ended on February 5. We interpret the latest unemployment claims as signaling a modest cooling of the still-tight labor market.

 

Chart, line chart

Description automatically generated

 

Chart, line chart

Description automatically generated

Source: US Department of Labor, Unemployment Insurance Weekly Insurance Claims (12-8-2022)

 

Central Banks Hike Rates this Week

The Reserve Bank of Australia (RBA) raised its key rate 25 bps on Tuesday. The Bank of Canada (BOC) raised its key rate 50 bps on Wednesday, and commented that it was cautiously optimistic about inflation trends. The Reserve Bank of India (RBI) raised its key rate 35 bps to 6.25% on Wednesday as well, after three consecutive hikes of 50 bps between June and September.

 

China Trade Data Weakens in November

Chinese exports and imports fell sharply in November due to coronavirus related disruptions in China and weak global demand. China’s exports were 8.7% lower y/y compared to a 0.3% y/y drop in October. Supply side disruptions likely played a role in export weakness as well. Imports were 10.6% lower y/y compared to a drop of 0.7% y/y in October. Sequential declines were notable as exports were 7.0% lower m/m and imports were 3.1% lower m/m. Technology exports dropped 19.1% m/m. Other notable trade data included a drop in iron ore imports of 3.9% m/m and an increase in copper imports of 12.8% m/m. On December 7, JPM forecasted that the net export contribution to China’s GDP growth in 2023 would turn into a negative contribution of -0.1% versus an estimated positive 0.7% contribution in 2022.

 

Chart, line chart

Description automatically generated

 

A picture containing chart

Description automatically generated

 

Chart, line chart

Description automatically generated

 

Chart

Description automatically generated

 

Chart

Description automatically generated

Source: JP Morgan, China (12-7-2022)

 

U.S. Trade Deficit Widens in October

Global demand weakness was reflected to a much smaller extent in the October sequential decline in U.S. exports of 0.7% m/m to their lowest level since May. This was the second consecutive month of a decline in exports. But the U.S. trade deficit widened by a less than expected amount to a four-month high of $78.2 billion from an upwardly revised $74.1 billion in September due to an increase of 0.6% m/m in imports. The widened deficit reflected an increase goods deficit of $6.1 billion and a $2.1 billion increase in the U.S. services surplus.

 

Caixin Services PMI Continues to Contract in November

China’s Caixin Services PMI fell to 46.7 from 48.4 in October and was lower than the expected level of 48.0. Surveyed companies mentioned COVID-19 restrictions that impacted their operations and dampened demand. In contrast to the official trade data, new export orders rose to 50.2 from 47.1. The relaxation of international travel rules helped boost this component of services PMI. Staff that were unable to attend their workplaces led to a fall in the subindex of employment from 51.4 to 47.2 in November.

 

China’s Producer Prices Continue to Fall in November

Chinese producer prices fell 1.3% y/y in November, the same as in October. Factory gate prices were assumed to fall due to weakening domestic demand due to strict Covid-19 related restrictions and falling commodity prices. Producer prices increased 0.1% m/m in November and were 4.6% higher over the first eleven months of 2022. As we have highlighted in previous commentaries, Chinese producer prices are often a prelude to the U.S. Consumer Price Index (CPI). China’s CPI rose 1.6% on an annualized basis in November.

 

U.S. November PPI

The November headline U.S. Producer Price Index (PPI) rose by a greater than expected 0.3% m/m and 7.4% y/y. The 7.4% y/y increase was the smallest since May of last year. Headline expectations were for gains of 0.2% m/m and 7.2% y/y. October’s figures were revised up to 0.3% m/m (from 0.2%) and 8.1% y/y. Core PPI, ex-food and energy rose 0.4% m/m (most since June and higher than an expected increase of 0.2% m/m) and 6.2% y/y. The 6.2% y/y reading was the lowest in over a year but higher than the expected 5.9% y/y gain. Most of the 0.4% m/n gain in core PPI was attributable to services that also increased by 0.4% (versus a 0.1% increase in October) as the index for final demand goods rose only 0.1% after a 9.6% m/m increase in October. About one-third of the monthly gain in services prices was attributable to prices for securities brokerage and similar services, which increased by 11.3% m/m. There can be great variability in these monthly figures, so we will await the announcement of the U.S. November CPI data next week before making any assumptions. Overall, it appeared that PPI inflation continued to moderate. Headline monthly changes averaged 1.0% over the first half of this year and averaged 0.1% thereafter. The core PPI averaged 0.7% in monthly gains over the first half of this year and averaged 0.3% monthly gains thereafter. Interest rates rose, USD traded higher and equities were lower after the “hotter” than expected PPI data was announced. But we would characterize the financial markets’ initial response as rather muted.

 

Chart, line chart, histogram

Description automatically generated

 

Chart

Description automatically generated

 

Chart

Description automatically generated

 

Timeline

Description automatically generated

Source: JP Morgan, US: November PPI is firmer than expectations (12-9-2022)

 

University of Michigan Consumer Sentiment Index

The preliminary Index of Consumer Sentiment for December rose to 59.1 from 56.8 in November and surpassed the expected reading of 56.9. Current conditions rose3 from 58.8 to 60.2 and the expectations gauge increased to 58.4 from 55.6. Expectations were the highest since April. Year ahead inflation expectations dropped to 4.6% from 4.9%. This was the lowest reading since September 2021 and was likely influenced by lower gasoline prices. Longer run inflation expectations were steady at 3.0%. “Gains in the sentiment index were seen across multiple demographic groups with particularly large increases for higher income families and those with larger stock holdings supported by recent rises in financial markets.” Financial conditions do matter. One year business conditions “surged” 14% and long-term business conditions increased 6%.

 

Chart

Description automatically generated

Source: University of Michigan, Index of Consumer Sentiment

 

China “Reopening”

Chinese equities continued to react positively this week on any announcements in regard to the relaxation of China’s strict zero COVID-19 policies. Subsequent to the November 11 rollout of “20 measures,” which were meant to guide officials on the easing of COVID-19 related restricts, the Chinese government released another “10 measures” this week that were meant to pave the way from an eventual exit from its strict zero COVID policies. In conjunction with this announcement, Chinese health officials mentioned that “we are close to the moment to return to normalcy” but more medical preparations are still required. In general, we would characterize all of these “measures” as more targeted, specific and “scientific.” The Wall Street Journal reported on Thursday that Foxconn’s founder-director sent a letter to Chinese officials more than a month ago that maintaining a zero COVID policy would threaten China’s economy in the global supply chain. Foxconn is a major supplier for Apple. Some people were convinced that this appeal played a major role in convincing China’s leadership to relax COVID related restrictions. Another encouraging sign for China’s economic growth prospects was the more “pro-growth” tone that emerged from the December Politburo meeting chaired by Xi Jinping, when compared to the prior meeting. The Politburo is the major decision-making body of China’s Communist Party.

 

Bottom Line

For the time being, we are maintaining our basic investment approach as expressed in last week’s commentary. We continue to prefer high quality big cap stocks that offer good balance sheets, as well as relatively stable cash flows and profit margins. We expect volatility across virtually all financial markets.

We anticipate that China’s “reopening” could be a rather “messy” process characterized by “fits and starts.” To the extent that China will be able to “reopen,” global economic growth could accelerate, which would benefit many commodity prices such as base metals, sand perhaps most notably copper. Energy prices should be a beneficiary of China’s increased appetite as well. Increased commodity prices would probably exacerbate inflationary pressures. The expected easing of supply chain constraints as China reopens could counterbalance some inflationary pressures. Some industries will benefit while others will be helped. “Selective” investing could be ever more important. We believe that to the extent that China’s “reopening” could spur global economic growth relative to the U.S., that this could lead eventually to a more sustained weakening of USD.

 

 

Definitions

S&P Global Services PMI – The S&P Global US Services PMI is compiled by S&P Global from responses to questionnaires sent to a panel of around 400 service sector companies.

S&P Global Manufacturing PMI – The S&P Global US Manufacturing PMI is compiled by S&P Global from responses to questionnaires sent to purchasing managers in a panel of around 800 manufacturers.

Producer Price Index (PPI) – The producer price index (PPI), published by the Bureau of Labor Statistics (BLS), is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time. It is a measure of inflation based on input costs to producers.

Core Producer Price Index (PPI) – The core producer price index (PPI), published by the Bureau of Labor Statistics (BLS), is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time that excludes food and energy prices, which are the more volatile parts of inflation.

Inverted Yield Curve – An inverted yield curve describes the unusual drop of yields on longer-term debt below yields on short-term debt of the same credit quality. Sometimes referred to as a negative yield curve, the inverted curve has proven in the past to be a relatively reliable lead indicator of a recession.

China Reopening – A “reopening” in China means an easing of their zero-covid policy which includes a relaxation of travel rules and domestic travel.

Quantitative Tightening (QT) – Quantitative tightening refers to monetary policies that contract, or reduce, the Federal Reserve System’s balance sheet.

Federal Funds Rate – The term federal funds rate refers to the target interest rate set by the Federal Open Market Committee. This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.

Labor productivity – Labor productivity measures output per labor hour.

Unit Labor Cost (ULC) – Unit labor cost is how much a business pays its workers to produce one unit of output.

Quarterly Financial Report (QFR) – The Quarterly Financial Report (QFR) is a principal economic indicator conducted by the U.S. Census Bureau.

Quarterly Services Survey (QSS) – The QSS is a principal economic indicator series that produces, for selected service industries, quarterly estimates of total operating revenue and the percentage of revenue by class of customer (government, business, consumers, and individuals).

Business Roundtable (BRT) – The Business Roundtable is a nonprofit lobbyist association based in Washington, D.C. whose members are chief executive officers of major United States companies. Unlike the U.S. Chamber of Commerce, whose members are entire businesses, BRT members are exclusively CEOs.

Trade Deficit – A trade deficit occurs when a country’s imports exceed its exports during a given time period.

Trade Surplus – A trade surplus is the amount by which the value of a country’s exports exceeds the cost of its imports.

China Caixin Services Purchasing Managers Index – The Caixin PMI is a composite indicator designed to provide an overall view of activity in the services sector and acts as a leading indicator for the whole economy.

 

IMPORTANT DISCLOSURES

The views and opinions included in these materials belong to their author and do not necessarily reflect the views and opinions of NewEdge Capital Group, LLC.

This information is general in nature and has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy.

NewEdge and its affiliates do not render advice on legal, tax and/or tax accounting matters.  You should consult your personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.

The trademarks and service marks contained herein are the property of their respective owners. Unless otherwise specifically indicated, all information with respect to any third party not affiliated with NewEdge has been provided by, and is the sole responsibility of, such third party and has not been independently verified by NewEdge, its affiliates or any other independent third party. No representation is given with respect to its accuracy or completeness, and such information and opinions may change without notice.

Investing involves risk, including possible loss of principal.  Past performance is no guarantee of future results.

Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No assurance can be given that investment objectives or target returns will be achieved. Future returns may be higher or lower than the estimates presented herein.

An investment cannot be made directly in an index. Indices are unmanaged and have no fees or expenses. You can obtain information about many indices online at a variety of sources including:  https://www.sec.gov/fast-answers/answersindiceshtm.html or http://www.nasdaq.com/reference/index-descriptions.aspx.

All data is subject to change without notice.

© 2024 NewEdge Capital Group, LLC

Stay in Touch

You may also like…