FLASH PMIs

Eurozone business activity ticks lower amid falling demand

The seasonally adjusted HCOB Flash Eurozone Composite PMI Output Index, based on approximately 85% of usual survey responses and compiled by S&P Global, posted 49.7 in October, broadly in line with the reading of 49.6 in September. The latest figures suggested that business activity in the euro area decreased marginally for the second successive month.

Manufacturing production remained in a sustained downturn, falling for the nineteenth month running in October and at a marked pace. The rate of contraction softened slightly from that seen in September, however. On the other hand, the eurozone’s service sector remained in positive territory, registering a slight increase in business activity during the month. That said, the pace of expansion eased to an eight-month low as new orders decreased for the second consecutive month.

Overall, new orders were down for the fifth successive month and at a broadly similar pace to that seen in September. New business decreased across both manufacturing and services. While the contraction was sharper in manufacturing, the drop in services new orders was the steepest for nine months.

International demand also waned again in October. New export orders (which includes intra-eurozone trade) decreased at the joint-fastest pace so far this year, equal with that recorded in September.

With customer demand waning, firms in the euro area increasingly looked to scale back their workforce numbers in October. Employment decreased for the third month running, and at the fastest pace since the end of 2020. While the reduction in staffing levels was centred on manufacturers, the service sector saw a near-stagnation of employment. For the first time since early-2021, service sector hiring has almost come to a halt.

The picture was particularly bleak in Germany, where jobs were cut to the largest degree since the opening wave of the COVID-19 pandemic in 2020. Employment decreased slightly in France, while the rest of the eurozone saw staffing levels rise modestly.

Despite the drop in workforce numbers, weak client demand meant that companies continued to deplete backlogs of work at the start of the final quarter of the year. Moreover, the latest solid reduction in outstanding business was the most marked since January.

The worsening demand environment continued to subdue business confidence, which dropped for the fifth consecutive month to the lowest for almost a year. Optimism was also below the series average. Sentiment waned in both the manufacturing and services sectors, but remained stronger in the latter.

Although input costs increased again in October, the pace of inflation eased further and was the lowest in just under four years. As was the case with business activity, there were marked differences in price changes between the two monitored sectors. Manufacturing input costs decreased for the second month running, and at the fastest pace since March. Meanwhile, services input prices continued to increase sharply, albeit at a rate that was softer than the series average.

Similarly, output prices rose at a modest pace that was the slowest since February 2021, as a rise in services charges just outweighed a fall in manufacturing selling prices. Companies in Germany kept their output prices broadly stable, with the fractional pace of inflation the slowest since January 2021. Charges in France rose slightly following no change in the previous month, while the rest of the eurozone posted a modest increase in selling prices.

The retrenchment seen in the manufacturing sector during the month was not limited to output and employment, as firms scaled back their purchasing activity and stocks of both purchases and finished goods in October. Meanwhile, suppliers’ delivery times lengthened for the second month running. Although modest, the deterioration in supplier performance was the most marked since January.

Japan: Output declines for first time in four months

• Japan’s private sector in contraction with both manufacturing and services declining.
• New orders decreased in both manufacturing and services.
• New orders from abroad fell at the quickest pace since February 2023.

Bank of Canada Cuts Policy Rate by Half-Point With Return of Low Inflation Central bank says the bigger cut was possible given inflation returning to its 2% target and forecast to stay there through 2026

The central bank lowered the target for the overnight to 3.75% from 4.25%, marking the fourth consecutive rate reduction. Gov. Tiff Macklem said further rate cuts could be expected, so long as the economy evolves as forecast. (…)

“We took a bigger step today because inflation is now back to the 2% target,” Macklem said at a press conference Wednesday morning. “Price pressures are no longer broad-based.” Coupled with other indicators, “this suggests we are back to low inflation,” he added. (…)

Canada’s unemployment rate has climbed to 6.5% because companies are unable to absorb all the newcomers, via immigration, who have entered the workforce. The Bank of Canada said the share of firms reporting labor shortages has dropped below the historical average.

The central bank sharply revised downward its growth forecast for the third quarter, to 1.5% annualized from its earlier call for 2.8%. It expects growth of 2% in the fourth quarter. Overall, it anticipates growth of 1.2% in 2024, followed by 2%-plus growth in 2025 and 2026.

“It’s a pretty good-looking story—lower inflation, lower interest rates and a pickup in growth,” Macklem said.

Bond Markets Fear the ‘Known Unknown’ of a GOP Sweep They deeply dislike the prospect of unchecked Trump corporate tax cuts driving up deficits, even if stocks are likely to benefit.

(…) To explain why Treasury traders seem so anxious, look to the possibility of a Republican clean sweep of presidency, Senate and House of Representatives. With the improvement in Trump’s chances, and the dwindling odds on Democrats being able to keep control of the Senate, the chances of a sweep are now put at almost 50%.

That would allow much greater freedom of movement to make sweeping tax cuts, and thus arguably push up the deficit and bond yields. The traditional rule of thumb is that bond markets prefer political gridlock. (…)

There are other potential culprits, starting with China. Commodity prices have enjoyed a bounce as investors try to get a handle on just what the Chinese stimulus will entail. That in turn has pushed up inflation breakevens in the bond market:

(…) Over time, the bond yield is supposed to track nominal GDP growth, which is its highest since the 1980s (not that anyone would guess that from the election campaign):

The operative word is “nominal” of course. Inflation has ensured that the very robust growth since 2021 hasn’t translated into any equivalently strong rise in living standards. But it’s worth remembering that there’s real economic strength at present. That’s good news even if one of the side effects is rising interest rates.

Ed Yardeni:

The US presidential and congressional elections aren’t until November 5, but the Bond Vigilantes are voting early. The 10-year US Treasury bond yield has risen a whopping 63 basis points to 4.25% since the Fed’s September 17-18 meeting (chart). In exit polls, the Bond Vigilantes are saying they are voting against Fed Chair Jerome Powell’s dovish monetary policy because the economy is running hot, and the Fed’s premature 50bps rate cut 0n September 18 raises the risk that it will overheat. (…)

The Bond Vigilantes may also be voting against Washington, figuring that no matter which party wins the White House and the Congress, fiscal policies will bloat the already bloated federal government budget deficit and heat up inflation. The next administration will face net interest outlays of over $1 trillion on the ballooning federal debt. [Eating up 1.3% of GDP so far].

We are sticking with our 4.00%-4.50% range for the bond yield. We resisted raising our S&P 500 yearend target of 5800 when it rose above this level recently. We aren’t lowering it now that it is back at that level.

• The fiscal consolidation that never happened

The twice-yearly publication of the IMF’s World Economic Outlook is always a closely watched event, not only because it provides an in-depth analysis of recent macroeconomic trends, but also because it coincides with the updating of the Fund’s forecasts and databases. What caught our attention this time around was the Fund’s substantial reassessment of the evolution of the structural balance of general governments in the United States.

Recall that in its April report, the IMF had projected a significant improvement on this front in 2024 in its April report, which would have meant a sizeable drag on growth from fiscal policy. And while some consolidation would have made sense after a pandemic period characterized by huge deficits, the IMF’s forecast turned out to be way off the mark. Instead of holding back growth this year, today’s Hot Chart shows that public administrations are poised to contribute slightly to it.

This lack of fiscal discipline is certainly one of the main reasons that explain why U.S. growth has held up so well so far and why inflation remains slightly above the central bank’s target. But it is also beginning to raise questions about the Fed’s ability to cut interest
rates as much as investors expected a few months ago.

The expansionary fiscal programs proposed by the two presidential candidates are also helping to fuel these doubts. It remains to be seen whether there will be a significant gap between the candidates’ proposals and what they will be able to get through Congress once elected, but the risk of U.S. monetary policy diverging from that of other advanced economies has certainly increased recently.

Goldman Sees Risk of 10% Drop in Euro If Trump Wins US Election Bank keeps $1.10 year-end forecast, sees parity as possibility

Goldman Sachs Group Inc. said the euro could drop as much as 10% versus the dollar if Donald Trump and the Republicans win next month’s US elections and enact high global tariffs and generous domestic tax cuts.

The bank already believes that an outperforming US economy and relatively high rates will keep the dollar strong, and it sees a risk that strength in the greenback could last even longer than its forecasts if next month’s vote results in “much higher” tariffs. It also said the yuan could fall 12% under that scenario.

Investors have been ploughing into the dollar ahead of the presidential vote on Nov. 5, emboldened by solid US earnings and growing speculation that the Federal Reserve will be less aggressive in cutting interest rates. While Goldman’s base case is still for the euro and the yuan to rebound from current levels by the end of the year, it says a slump in both currencies can’t be ruled out depending on the outcome of the vote. (…)

While the race remains close, strategists see a Trump victory and Republican sweep of Congress adding to its rally, as Trump has threatened to slap tariffs on China, Mexico and other countries, which would likely crank up inflation and keep US rates high. (…)

Cahill said that the euro could depreciate “closer to 10%” if Washington slaps 20% tariffs on China and 10% levies on other countries. That scenario would push the euro down below parity to around 0.97, a level last seen in late 2022. But for now, Goldman is sticking with its forecast for the euro to end the year at $1.10, and rise to $1.15 in 12 months’ time.

Various tariffs on Chinese products could send the yuan to 7.4 per dollar, its weakest according to data compiled by Bloomberg going back to 2010. An analysis of the former president’s trade policy between 2018 and 2019 shows the Chinese currency depreciated 0.7% versus the dollar for each $10 billion in implied tariff revenue, the bank said.

In a scenario under which Trump imposes 60% blanket tariffs on Chinese imports, the yuan could drop to 8 per dollar, he added. (…)

U.S. Economy Again Leads the World, IMF Says International Monetary Fund upgrades U.S. growth outlook as strong investment boosts productivity

(…) In what has become something of a trend, the IMF upgraded the outlook for both U.S. and global growth, though more for the former.

The IMF projects U.S. gross domestic product to expand 2.5% in the fourth quarter from a year earlier—half a percentage point higher than a July forecast, which itself was an upgrade from a January estimate. U.S. output rose 3.2% in 2023.

That would be the fastest among the Group of Seven major advanced economies.

Global output is now projected to grow 3.3% this year, a smidgen above the prior estimate. Focusing just on wealthy nations, the U.S. is increasingly ahead. Advanced economies as a whole are expected to expand 1.9% this year after growing 1.7% last year.

For 2025, the IMF projects the U.S. to grow 1.9%, versus 1.7% for all advanced economies and 3.1% for the global economy.

China, the world’s second-largest economy, is expected to post 4.5% growth this year—a slight downgrade from a prior estimate—and 4.7% in 2025, after expanding 5.4% last year. The euro area’s economy is expected to grow 1.2% this year and 1.3% next year, after expanding 0.2% last year.

The IMF attributed the latest boost in the U.S. outlook to higher nonresidential investment and stronger consumer spending, which is being supported by rising real, or inflation-adjusted, wages. Real wages tend to rise when productivity grows, because companies that become more efficient can pay their workers more.

Investor money has flooded the U.S. in recent years, while big legislative packages funded green energy and infrastructure. Meanwhile, abundant domestic supplies largely insulated U.S. companies from energy shortages and price shocks.

Economists say that has all led to a surge in investment in the U.S., which boosts productivity—or output per hour worked. Productivity is the main ingredient for higher long-term growth and living standards. (…)

According to the IMF, U.S. gross fixed capital formation—a broad measure of investment—will rise 4.5% this year from 2023, more than triple the rate for all advanced economies. From 2016-2025, the IMF estimates U.S. investment will have grown an average 3.3% a year, versus 2.3% for all advanced economies.

By comparison, investment spending is projected to fall 2.7% this year in Germany, previously the juggernaut of Europe, after falling 1.2% last year.

This is a big shift. In the prior decade, from 2006-2015, U.S. investment spending grew an average 1.2% a year, roughly in line with the advanced-economy average. (…)

The abundance of energy supplies helped to keep a lid on prices in the U.S. after Russia’s invasion of Ukraine, while other countries, particularly those in Europe that relied heavily on Russia, have been hit hard by high energy prices. European Union companies are still paying two to three times more for electricity than U.S. firms, and four to five times more for natural gas, according to a September report from the European Commission. (…)

The IMF said in a September blog post that productivity gains by big U.S. companies are a primary reason why the U.S. and Europe have diverged in recent years.  (…)

Lost Decade Ahead For Stocks With Only 3% Annual Returns? (Ed Yardeni)

We’ve been asked to comment on yesterday’s grim forecast by economists at Goldman Sachs that the S&P 500 will produce annualized returns of only 3% (before accounting for inflation) over the next 10 years. They reckon that the range of possible outcomes includes -1% at the low end and +7% nominal returns at the high end.

In our opinion, even Goldman’s optimistic scenario might not be optimistic enough. That’s because we believe that the US economy is in a “Roaring 2020s” productivity growth boom with real GDP currently rising 3.0% y/y and inflation moderating to 2.0%. If the productivity growth boom continues through the end of the decade and into the 2030s, as we expect, the S&P 500’s average annual return should at least match the 6%-7% achieved since the early 1990s. It should be more like 11% including reinvested dividends.

It’s hard to imagine that the total return of the S&P 500 would be only 3% in the future given the returns just from the compounding of reinvested dividends.

Let’s dig into some of the points made by Goldman:

(1) Earnings growth. S&P 500 earnings per share has grown roughly 6.5% per year for nearly a century. Assuming 6% growth over the coming decade (and removing dividends from the equation), valuations would need to be cut in half to produce just 3% annual returns.

(2) Valuation. Much of Goldman’s analysis is a story of high valuations. Conventional wisdom holds that higher starting valuations lead to lower future returns. With the Buffett Ratio (i.e., forward P/S) at a record high 2.9, and the S&P 500 forward P/E elevated at 22.0 times, we agree that valuations are stretched by historical standards.

(3) Profit margin. The forward P/E is relatively low compared to the forward P/S because the S&P 500 forward profit margin has been rising into record high territory and should continue to do so in our Roaring 2020s scenario.

(4) Inflation hedge. Goldman’s forecast does not consider that stocks are historically the best inflation hedge, as companies have embedded pricing power. Meanwhile, bonds suffer as interest rates rise to combat higher inflation.

(5) Market concentration. One of the biggest “worries” in Goldman’s analysis is that the market is highly concentrated. But while the Information Technology and Communication Services sectors are now about 40% of the overall S&P 500, around the same as the peak of the dotcom bubble, these are much more fundamentally sound companies.

These two sectors account for more than a third of the S&P 500’s forward earnings today versus less than a quarter in 2000. We also believe that all companies can be thought of as technology companies. Technology isn’t just a sector in the stock market, but an increasingly important source of higher productivity growth, lower unit labor costs inflation, and higher profit margins for all companies.

(6) Bottom line. In our view, a looming lost decade for US stocks is unlikely if earnings and dividends continue to grow at solid paces boosted by higher profit margins thanks to better technology-led productivity growth. The Roaring 2020s might lead to the Roaring 2030s.

• The Front Cover Curse

(…) The problem is that the latest issue of The Economist has a front cover story titled, “THE ENVY OF THE WORLD: America’s economy is bigger and better than ever.” The editors could have also titled the story, “US Hard Landing Forecast: Rest In Peace.” Front cover stories like this one have often been contrary indicators.

In 2016, Gregory Marks and Brent Donnelly, analysts at Citibank, looked at every cover story from The Economist going back to 1998, selecting those stories that covered “an emotional or hyperbolic portrayal of an asset class or market-related theme.” They selected 44 cover stories that had either an optimistic or a pessimistic point. They found that impactful covers with a strong visual bias proved after one year to be contrarian 68% of the time. That’s high enough to suggest that market watchers should keep the front-cover curse on their radar.

So be bullish, but stay alert. We will continue to help you do so.

Missing: Business Weeks’s front page.

The insider indicator

(…) While business leaders were busy last week offering reassuring earnings guidance, underneath the rosy outlook was a different trend: They were selling stock.

A gauge of insider sentiment, one that tallies the number of sellers versus buyers, is poised to hit the highest monthly reading in more than three years, data compiled by the Washington Service show.

The figures chime with various high-profile sales that have made headlines recently, including Warren Buffett’s unloading of Apple and Bank of America stock, and retreats by Nvidia insiders, including CEO Jensen Huang.

Granted, some of the exits no doubt have nothing to do with the business outlook, driven instead by the need for cash to buy a house or pay for kids’ tuition. And the stock rally has been mostly invulnerable for months amid Federal Reserve interest rate cuts and generally good tidings on the economy and earnings.

Still, the last time the insider indicator shot up, in July, it was a precursor to market pain, with the S&P 500 subsequently falling 8%.

With equities up nine of the last 10 weeks and benchmarks flirting with valuations rarely seen since the dot-com era, bulls may want to consider whether the people in charge know something they don’t.

The INK U.S. Sentiment Indicator represents companies with buy only transactions divided by companies with sell only transactions:

There is little change in overall US insider sentiment as we head into Q3 earnings season and the November 5th elections. There remain roughly four stocks with key insider selling for every one stock with key insider buying over the past 60 days. That depressed level signals broad market overvaluation, but absolute dollar amounts of insider selling remain within normal ranges.

As such, we would characterize the insider behaviour as cautious, seeking only to purchase stock in the open market when distinct opportunities arise.

Insider sales can be tricky. Better to concentrate on buys:

According to SentimenTrader’s Jason Goepfert, the number of insiders buying shares in their companies has recently fallen to levels last seen in September 2021. While insider buying isn’t an exact science, it has in the past been a reliable guide as to whether stocks are looking cheap or expensive.

Corporate executives among S&P 500 firms have some of the least open market purchases in 13 years.