FLASH PMIs

Eurozone recovery slows as new orders fall for first time in four months

The eurozone’s economic recovery suffered a setback at the end of the second quarter of the year, according to provisional PMI® survey data. New orders decreased for the first time in four months, feeding through to softer expansions in business activity and employment. Meanwhile, business confidence dipped to the lowest since February. Rates of input cost and output price inflation eased to six- and eight-month lows respectively.

The slowdown in growth of business activity seen in June was reflective of a softer expansion in the service sector and a more pronounced decrease in manufacturing production, which fell to the largest degree in the year-to-date.

Looking geographically across the euro area, Germany recorded a slight increase in activity in June, while the rest of the eurozone continued to record solid expansion, albeit with the pace of growth easing to a four-month low. Less positively, France posted a decrease in output for the second month running.

The seasonally adjusted HCOB Flash Eurozone Composite PMI Output Index, based on approximately 85% of usual survey responses and compiled by S&P Global, dropped to 50.8 in June from 52.2 in May. Although the latest reading signalled a fourth consecutive monthly increase in business activity and thus suggested that GDP will continue to expand in the second quarter, the latest rise in output was only slight and the weakest since March to signal a loss of growth momentum as the first half of the year draws to a close. Nevertheless, the average index reading over the second quarter was the highest for a year.

Growth was again limited to the service sector, where activity increased for the fifth month running. The latest rise was solid, but the softest since March. Meanwhile, the recent improving picture in the manufacturing sector was reversed in June as production decreased at a marked pace that was the sharpest since the end of 2023. Manufacturing output has now fallen in 15 consecutive months.

Central to the slower expansion in overall business activity across the euro area in June was a renewed fall in new orders, which decreased for the first time in four months. The pace of decline was only slight, however. A marked reduction in manufacturing new orders outweighed a slight increase in services new business. Demand weakness in export markets was particularly prevalent as new export orders decreased much more quickly than total new business. The decline in new business from abroad (including intra eurozone trade) was the sharpest since February amid falls across both monitored sectors.

The eurozone’s largest economy, Germany, posted a third successive monthly increase in business activity, but the rate of expansion slowed and was only marginal amid a renewed fall in new orders. France, meanwhile, saw output decrease at the quickest pace since February. The rest of the eurozone recorded a further solid rise in activity, despite the rate of growth easing to a four-month low.

In tandem with a slower expansion in business activity, the rate of job creation also eased in the euro area during June. Employment rose for the sixth month running, but at only a slight pace that was the weakest since March. Staffing levels were raised solidly in the service sector, while a similarly-sized fall was recorded in manufacturing. With new orders returning to contraction territory, output was supported by work on outstanding business. As a result, backlogs of work continued to be depleted solidly, with the latest reduction the most marked since February.

The deepening downturn in the manufacturing sector resulted in more pronounced reductions in purchasing activity and holdings of both purchases and finished goods in June. Most notably, the depletion in post-production inventories was the sharpest in almost three years. Falling demand for inputs meant for spare capacity in supply chains, and lead times on the delivery of purchased items shortened for the fifth consecutive month. The latest improvement in supplier performance was solid, but the least marked since February.

The rate of input cost inflation eased for the second month running in June and was the slowest in the year-to-date. Input prices continued to rise sharply, however, with the latest increase still slightly stronger than the pre-pandemic average. For the first time in 16 months, input costs rose across both the manufacturing and service sectors as manufacturers posted a renewed increase in their cost burdens, albeit one that was only slight. In services, the pace of input cost inflation eased to a 38-month low.

In line with the picture for input costs, the pace of output price inflation also eased in June and was at an eight-month low. Selling prices in the service sector continued to rise solidly, albeit to the least extent in just over three years. Meanwhile, manufacturers lowered their selling prices slightly. The reduction was the joint-slowest in the current 14-month sequence of falling charges, equal with that seen in May 2023. Selling prices increased at slower rates in France and the rest of the eurozone, but at a faster pace in Germany.

After having hit a 27-month high in May, business confidence waned in June amid the fall in new orders. Optimism was the lowest in four months, but still broadly in line with the series average. Sentiment dipped in both the manufacturing and service sectors, with services optimism dropping to the lowest since January.

Commenting on the flash PMI data, Dr. Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank, said:

“Is the recovery in the manufacturing sector ending before it began? Both we and the market consensus anticipated that the increase in the index in May would be followed by another rise in June, potentially setting the stage for an upward trend. However, rather than moving closer to expansionary territory, the HCOB Flash Eurozone Manufacturing PMI reading fell, dashing hopes for a recovery. This setback was compounded by the fact that new orders, which typically serve as a good indicator of near-term activity, fell at a much faster rate than in May. This rapid decline in new orders suggests that a recovery may be further off than initially expected.

(…) Using the preliminary HCOB Flash Eurozone Composite Output Index in a simple regression analysis, the GDP estimate for the second quarter indicates a slight downgrade but still points to positive growth of 0.2% compared to the first quarter.

“The ECB, which cut interest rates in June, may feel vindicated by prices data which signalled easing pressure in the Eurozone’s service sector. However, the HCOB PMI do not provide ammunition for another rate cut in July by the ECB. This is because, for the biggest Eurozone economy, Germany, service providers increased their selling prices at a sharper pace than in May. In addition, in the Eurozone manufacturing sector, which experienced deflation in output charges over the last 14 months, we may see a return of selling price inflation again as input prices in the region increased in June for the first time since February 2023.

“The worsening situation in both the services and manufacturing sectors in France might be tied to the results of the recent European Parliament election and President Emmanuel Macron’s announcement of snap elections on June 30. This unexpected turn of events has likely stirred up a lot of uncertainty about future economic policies, causing many companies to hit the brakes on new investments and orders. In any case, it is evident that France’s poor economic performance has significantly contributed to the deteriorating economic conditions in the Eurozone.”

UK Purchasing Managers Report Higher Inflation and Slower Growth

Japan: Business activity expansion stalls in June

• Japan Inflation Picks Up, Adding to Hopes for Rate Hikes by BOJ Consumer prices rose 2.8% from a year earlier in May, compared with the 2.5% increase in April

• Japan’s Services Activity Shrinks First Time in Almost Two Years

New US Home Construction Plunges to Slowest Pace Since June 2020

Housing starts decreased 5.5% to a 1.28 million annualized rate last month, according to government data released Thursday. The figure was below all but one estimate in a Bloomberg survey of economists.

Building permits, which point to future construction, fell 3.8% to a 1.39 million annual rate, also the weakest since June 2020. The declines in starts and permits were broad across multifamily and single-family units. Authorized permits for single-family homes dropped for a fourth straight month to the slowest pace in a year. (…)

The number of multifamily projects already under construction dropped to the lowest since September 2022, while those of one-family units were the weakest this year.

Canada Prepares Potential Tariffs on Chinese EVs After US and EU Moves

(…) Ontario Premier Doug Ford accused China of taking advantage of low labor standards and dirty energy to make inexpensive EVs. He called on Trudeau’s government to at least match the Biden tariffs. “Unless we act fast, we risk Ontario and Canadian jobs,” he said on the social media platform X.

The value of Chinese electric vehicles imported by Canada surged to C$2.2 billion ($1.6 billion) last year, from less than C$100 million in 2022, according to data from Statistics Canada. The number of cars arriving from China at the port of Vancouver jumped more than fivefold after Tesla Inc. started shipping Model Y vehicles there from its Shanghai factory.

However, the Canadian government’s main concern isn’t Tesla, but the prospect of cheap cars made by Chinese automakers eventually flooding the market. (…)

“China has an intentional, state-directed policy of overcapacity,” Katherine Cuplinskas, Freeland’s press secretary, said in an email. “Protecting Canadian jobs, manufacturing, and our free trade relationships is essential.”

Canadian auto industry groups have called on Canada to impose stiff tariffs. They’ve warned that Canada can’t afford to be offside with the US on this issue, given the upcoming review of the United States-Mexico-Canada free trade agreement. The US and Canada have tightly integrated auto supply chains, with parts and finished vehicles flowing across the border in huge quantities. The vast majority of Canada’s auto production is exported to the US.

However, Trudeau has moved carefully, given the possibility of Chinese trade retaliation. Some environmental groups argue that it’s most important to keep EV costs low to encourage higher consumer adoption. (…)

China’s EV Makers Got $231 Billion Aid Over 15 Years, Study Says

Slightly more than half the total amount of support was in the form of sales tax exemptions, according to the research from Scott Kennedy, a China specialist at the Center for Strategic and International Studies. The rest is made up of nationally approved buyer rebates, government funding for infrastructure such as charging stations, government procurement of EVs as well as R&D support programs, he wrote in a blog post. (…)

On a per-vehicle basis, support has fallen from $13,860 in 2018 to just under $4,600 in 2023, or less than the $7,500 credit available to US buyers of qualifying vehicles under the Inflation Reduction Act, according to the post. Sales-tax exemptions were worth almost $40 billion last year, with this jumping from under $10 billion in 2020 due to the rapid increase in sales of EVs. (…)

There is much more in the CSIS post than what Bloomberg reported:

(…) These estimates reflect the combination of five kinds of support: nationally approved buyer rebates, exemption from the 10% sales tax, government funding for infrastructure (primarily charging poles), R&D programs for EV makers, and government procurement of EVs. The buyer’s rebate and sales tax exemption have accounted for the vast majority of support for the industry (see Figure 2). That said, because of the high cost and desire to winnow the field of producers, the central government reduced the buyer’s rebate in 2022 and eliminated it beginning in 2023. (…)

There are at least two different ways to interpret the data on industrial policy support for EV makers. China’s trading partners could point to 15 years of sustained regulatory and financial support for domestic producers, which has fundamentally altered the playing field to make it much harder for others to compete in China or anywhere else where Chinese EVs are sold.

By contrast, defenders of China could point out that the data show that subsidies as a percentage of total sales have declined substantially, from over 40% in the early years to only 11.5% in 2023, which reflects a pattern in line with heavier support for infant industries, then a gradual reduction as they mature. In addition, they could note that the average support per vehicle has fallen from $13,860 in 2018 to just under $4,600 in 2023, which is less than the $7,500 credit that goes to buyers of qualifying vehicles as part of the U.S.’s Inflation Reduction Act.

(…) despite the extensive government support and expansion of sales, very few Chinese EV producers and battery makers are profitable. In a well-functioning market economy, firms would more carefully gauge their investment in new capacity, and the emergence of such a sharp gap between supply and demand would likely result in industry consolidation, with some mergers and acquisitions, and other poorly performing companies leaving the market entirely.

(…) My guess, though, is that the endurance of these subsidies is unlikely part of an intentional plot for global domination of this industry and instead a byproduct of China’s inefficient industrial policy system in which support typically extends too long and is spread overly widely, a pathology visible in both tradable and non-tradable industries. (…)

BTW, China does not have a monopoly on inefficient industrial policies:

Source: @Marlin_Capital via The Daily Shot

Chinese automakers retain grip over Southeast Asia’s booming electric car market

Electric vehicle sales are surging in Southeast Asia, led by China’s BYD and Vietnam’s VinFast , eating into the internal combustion engine car market dominated by Japanese and Korean firms, Counterpoint Research said on Friday.

EV sales in the region more than doubled in the January to March quarter from a year before, according to the research firm. Sales of ICE cars, meanwhile, slid by 7%.

“As Japanese and Korean automakers, who dominate conventional vehicle sales, lag in EV adoption, Chinese OEMs (original equipment manufacturers) are stepping in to fill the gap,” said Counterpoint analyst Abhik Mukherjee.

“Over 70% of EV sales in the region are from Chinese brands, led by BYD,” he said. In the first quarter of last year, 75% of all EVs sold in Southeast Asia were made by Chinese car makers.

Thailand, Southeast Asia’s second largest economy where Chinese car makers have committed more than $1.44 billion to set up new EV production facilities, is leading the charge.

The regional auto manufacturing hub where Japan’s Toyota Motor and Honda Motor have a major presence accounted for 55% of all Southeast Asia’s EV sales in the first quarter, with the segment growing 44% compared to last year.

“Vietnam saw an even more impressive growth, with BEV (battery electric vehicle) sales increasing by more than 400%, contributing to nearly 17% of regional sales,” the research firm said.

Across the region, China’s top-selling EV maker BYD maintained pole position, cornering 47% of the regional market leader, followed by Vietnam’s VinFast.

BYD has had early success in Southeast Asia, which is still a small EV market compared to other regions, on the back of distribution partnerships with large local conglomerates.

• BYD Mexico Plant Will Create 10,000 Jobs, Executive Says

(…) A plant of that size would employ more people than facilities for some other carmakers in the country, like Audi. Volkswagen’s Puebla plant — the largest in the country — employs 6,100 assembly line workers and 5,000 supervisory employees, along with thousands of people that handle parts assembly.

The carmarker is on pace to sell 50,000 units in the country this year, Vallejo said. Last month, BYD launched its Shark hybrid truck in Mexico, just another sign of the country’s growing importance to the company.

• Nissan halts production at Changzhou plant as China woes persist

Nissan Motor has halted production at its Changzhou plant in China as it seeks to optimise its operations, the Japanese automaker said on Friday.

The Changzhou plant, jointly operated with Nissan’s local partner Dongfeng Motor was producing the Qashqai SUV with annual capacity of about 130,000 vehicles a year, a Nissan spokesperson said. (…)

The Japanese carmaker operates eight factories in China through its joint venture with Dongfeng, but like other Japanese manufacturers it has lost market share to fast-moving local rivals that are attracting drivers with an array of software-loaded electric vehicles priced at similar levels to cars powered by internal combustion engines.

Smaller rival Mitsubishi Motors decided last year to end production at its Chinese joint venture.

Huawei Mobile Devices Near a Billion as Apple Rivalry Heats Up Consumer chief says Harmony users have reached 900 million

There’re now some 900 million Huawei gadgets installed with its inhouse Harmony operating software, up significantly from just a few months ago, consumer business Chairman Richard Yu said. Sales of premium Huawei smartphones climbed 72% in the first five months of 2024, he told attendees at an annual developer forum Friday.

Those numbers illustrate the phenomenal growth Huawei’s phones have enjoyed since it unveiled the Mate 60 Pro, which contained a 7-nanometer processor that Washington officials didn’t think Chinese firms capable of developing. Business has boomed since, helping Huawei more than quintuple profit during the March quarter and take market share from Apple and Chinese rivals. (…)

That helped Harmony OS overtake Apple’s iOS in Chinese market share during the January-March period, according to Counterpoint Research. (…)

Huawei intends to release a successor to its marquee smartphone, the Mate 70, at the end of the year, Yu said. That’s likely to run on HarmonyOS Next, which will sever remaining ties to Google’s Android. (…)

It’s also making progress on the AI front with the Ascend GPU, part of a growing portfolio of chips that prompted Nvidia Corp. Chief Executive Jensen Huang to call Huawei a formidable rival.

Chinese firms including Huawei are developing local alternatives to the most powerful AI accelerators that the likes of Nvidia make, which Washington has barred from the country. That effort is considered key to Beijing’s broader ambitions of catching up with the US in AI and chipmaking.

On Friday, Yu said its Ascend processors are 1.1 times more effective in training AI models compared with mainstream offerings, though he stopped short of naming specific firms. His company has so far set up three AI data centers powered by Ascend chips in China, helping local firms develop and host artificial intelligence services.

TECHNICALS WATCH

‘Sellers Are Entering the Market’ With S&P Faltering Beyond Tech

• The momentum factor outperformance has been remarkable. (The Daily Shot)

US Retail Sales Barely Increase In Sign of Consumer Strain Value of purchases rose 0.1% in May after downward revisions

The value of retail purchases, unadjusted for inflation, increased 0.1% after an downwardly revised 0.2% drop in the prior month, Commerce Department data showed Tuesday. Excluding gasoline, sales rose 0.3%. (…)

The figures underscore a notable downshift in consumer spending after stronger readings earlier in the year. Economists expect a moderate pace of spending going forward as Americans exercise greater prudence given persistent inflation, a gradually cooling job market and emerging signs of financial stress. (…)

The retail report showed so-called control-group sales — which are used to calculate gross domestic product — climbed 0.4% in May. It fell 0.5% in the prior month, which was the most in about a year. The measure excludes food services, auto dealers, building materials stores and gasoline stations. (…)

Spending at restaurants and bars, the only service-sector category of Tuesday’s report, declined 0.4%, the most since January.

The challenge with retail sales is to properly assess real sales because there is no official deflator for that important series. My formula is (0.35 x CPI-Durables + 0.65 x CPI-Nondurables) which roughly reflects the actual sales breakdown.

By this measure, retail prices declined 0.45% MoM in May which would mean that retail sales, up 0.09% MoM in nominal terms , were up 0.54% in real terms, a solid month after –0.36% in April.

On a YoY basis, nominal sales are up 2.3% while real sales are up 1.6%, down from 2.3% on average in the previous 12 months, but still respectable demand considering the pandemic splurge on goods.

Wells Fargo:

Overall, the May retail sales data are consistent with a consumer that is only gradually losing its swagger. Broader control group sales, which excludes autos, gasoline, building material and food services store sales and feeds directly into the BEA’s calculation of real goods spending in the national accounts, rose a stronger 0.4% in May.

Volatility is now part of the retail scene. Labor income is slowing, excess savings are depleted (in real terms), the savings rate is historically low and interest rates still very high. Luckily, goods import prices are depressed by Chinese overcapacity and the strong dollar and energy prices are quiet.

The bars below show how each of the steps down in average nominal control sales growth rates since mid-2021 was also accompanied by large declines in average goods inflation (black lines), from 11.3% in the first period to 0.1% in the most recent period. Goods have deflated, but demand remains solid.

In reality, goods consumption remains strong, fueled by labor income growth above 5.0%, slowing overall inflation and the continued impact of the wealth defect. It is ironic that, attempting to undo the wealth its own policies created, the Fed keeps adding to the “problem” as Apollo’s Torsten Slok illustrates:

As Goldman Sachs illustrates, Americans are not squeezed by debt and interest rates:

Nor is the economy highly vulnerable to slower consumer demand:

US Sales Managers Survey

Next week we will get S&P Global’s Flash PMI survey results for June. This is from World Economics’ Sales Managers survey:

The US Sales Managers Survey Results for June reflect a likely acceleration of GDP growth levels seen in previous months of this year. All growth-related Indexes suggest an expectation of continuing modest-to-rapid economic expansion.

Real GDP year-on-year growth in excess of 2% is likely to continue into the second half of 2024.

The evidence presented by the June Sales Managers Survey suggests that the Federal Reserve’s interest rate hikes have had at best a very modest restraining impact on economic activity levels to date. However, the Fed’s efforts at simultaneously cutting price inflation appear to be working less well. The Sales Managers Price Index continues to register relatively high monthly readings, suggesting that the dragon of Price Inflation has not yet been slain, and big cuts in interest rates are not likely to feature in the run up to the November election.

US Homebuilder Confidence Slides to Lowest Level This Year Measures of current sales, outlook and buyer traffic retreated

A measure of the sales outlook over the next six months dropped 4 points to 47 this month. That followed a 9-point decline in May that was the largest since October 2022. The prospective-buyer traffic gauge and the NAHB index of current sales both dropped to the lowest level this year. (…)

This month, 29% of builders reported cutting home prices, the largest share since January, according to the NAHB survey. The average price reduction held steady at 6% for the 12th straight month. The share using sales incentives increased to 61% from a May reading of 59%.

CBO Jacks Up US 2024 Budget Gap Forecast by 27% to Nearly $2 Trillion

The nonpartisan Congressional Budget Office ramped up its estimate for this year’s US budget deficit by 27% to almost $2 trillion, sounding a fresh alarm about an unprecedented trajectory for federal borrowing.

The CBO sees the deficit reaching $1.92 trillion in 2024, up from $1.69 trillion in 2023, according to updated projections<?XML:NAMESPACE PREFIX = “[default] http://www.w3.org/2000/svg” NS = “http://www.w3.org/2000/svg” /> released in Washington Tuesday. The new estimate is more than $400 billion larger than what the CBO anticipated in February — in part reflecting additional spending, including aid for Ukraine, enacted since then, along with Biden administration student-loan relief measures. (…)

As a share of gross domestic product, the US deficit is now seen widening, not shrinking, for the 2024 fiscal year, which runs through September. The ratio is estimated at 6.7%, compared with the February forecast of 5.3% and the 6.3% logged for 2023.

By comparison, European Union nations have a guideline of keeping shortfalls at 3% or less. The US averaged 3.7% over the past half-century, according to the CBO.

“Total deficits equal or exceed 5.5% of GDP in every year from 2024 to 2034,” in the new forecasts, the CBO said. “Since at least 1930, deficits have not remained that large for more than five years in a row.”

Tuesday’s projections continued to show the US heading for record levels of debt relative to GDP, and escalating interest costs — which for this year will exceed defense spending. Over the coming decade, the CBO sees US deficits totalling $22.1 trillion, up more than $2 trillion from February’s report. (…)

The office now expects a 2% increase in GDP in the fourth quarter of calendar 2024 over the same period of 2023 — up from February’s 1.5%.

Inflation, as measured by the Fed’s preferred PCE price gauge, is seen at 2.7%, compared with the 2.1% forecast in February. (…)

Fed policymakers are expected to start lowering rates next year, with their benchmark falling to 3% by late 2028, holding steady from there on, the CBO said. (…)

The outsize US deficits also come despite an acceleration in immigration that has helped to boost growth and revenues. The CBO sees the surge continuing through 2026. The office estimates that this dynamic lowers total deficits by some $900 billion over a decade.

CBO projections are based on current legislation. That includes an assumption that the $95 billion foreign-aid package enacted in April will now add $95 billion, plus inflation each year, in discretionary spending going forward.

It also includes an expectation for many of former President Donald Trump’s tax cuts to expire as scheduled at the end of next year. The CBO has separately estimated that extending those provisions could add $4.6 trillion more in red ink. (…)

But nobody cares … until they do …

The WSJ:

Neither Mr. Biden nor Donald Trump talks about the national debt, perhaps because they might then have to do something about it. But a moment of tax truth at least will arrive at the end of 2025 when most of the 2017 Trump individual tax cuts expire.

Mr. Biden’s plan is to raise taxes by $5 trillion or more, which would put the overall federal tax burden above 20% of GDP, which is close to the highest in peacetime. That still won’t finance Mr. Biden’s spending ambitions, which will continue to cost trillions in future years even if he loses the election.

Mr. Trump says he wants to renew and maybe expand the Trump tax cuts, and the best way to finance that is by repealing the Biden spending blowouts in the Inflation Reduction Act, student-loan write-offs and pandemic-era welfare expansions. Failing to take on that challenge means either a monumental tax increase or a debt panic down the road.

The WSJ omits Mr. Trump’s new idea: raise tariffs on imports, potentially even replacing the entire income tax system with tariffs.

IMMIGRATION ISSUES

• The foreign-born labor force has grown 11% since February 2020, and the native-born labor force has remained unchanged over the same period. (Torsten Slok)

Rather important when scare labor pushes wage rates upwards. Wells Fargo:

• Labor force growth has strengthened considerably in the past two years, due primarily to robust immigration flows and a post-pandemic rebound in the labor force participation rate (LFPR)
• Foreign-born nationals, who currently represent about 20% of the labor force, have accounted for more than one-half of its growth over the past two years.
• Looking forward, it does not seem likely that the labor force will continue to grow at the same robust rate that it has over the past two years. Although it is difficult to predict the path of immigration in coming years—yet-to-be-determined policy choices and economic conditions in the United States as well as in foreign countries will affect immigration flows—the aging of the population and marked drop in the U.S. fertility rate in recent years means that the “natural” growth rate of the workforce will slow.

Goldman Sachs attempts to predict:

• Net US immigration averaged around 1 million per year in the two decades prior to the pandemic. We estimate it surged to roughly 2.5 million last year, boosting labor force growth and GDP growth and helping to dampen wage pressures. This year, we expect net immigration of around 2 million, twice the trend rate.

• With immigration still a key focal point heading into the election and little prospect for legislative changes this year, our 2024 net immigration estimates assumed the Biden administration would tighten policy in this area.
• Next year, we expect that a second Biden administration would leave immigration policy mostly unchanged. A second Trump administration would likely tighten policy substantially further, but there is a wide distribution of potential outcomes.
• At the high end of the range, in which courts block major asylum changes and the impact of deportation is limited, net immigration might decline to around 1.5 million in 2025, still roughly double the 2017-2019 averages reported by CBO.
• At the low end of the potential range, in which a Trump White House mostly cuts off asylum claims and humanitarian parole, and implements a more substantial deportation program, net immigration would likely fall below the 2017-2019 average of 0.7 million per year and could approach zero temporarily. That said, it seems unlikely that net immigration would be negative on an annual basis even in that scenario.

China’s key plenum aims to fix decades-old tax revenue imbalance Long-touted changes to China’s tax system will focus on allowing local governments to retain more fiscal revenues

Measures that redistribute income from central authorities to municipalities, curbing an addiction to land sales laid bare by China’s property crisis, will top the agenda of a leadership gathering in July, known as the third plenum, they said. (…)

Policy advisers said the main changes are likely to revolve around how much revenue local governments retain, rather than adding or hiking taxes.

Municipalities currently get half of value-added tax revenue and 40% of personal income tax, while the central government gets most corporate income tax and all of what China calls a consumption tax, currently levied on producers and importers.

The advisers did not give figures on the future division of tax income between central and local governments.

But they said local governments may be allowed to keep most of the consumption tax – which accounts for almost a tenth of China’s total tax revenues – and more of the value-added tax – which accounts for more than a third.

Proposals also include Beijing taking over growing commitments on pensions and healthcare as the population ages.

The aim is to stop municipal debt accumulation by balancing revenues with expenditure, the advisers said.

“Local governments’ spending should be based on their fiscal capacity,” said a second adviser. “A mature society no longer needs to find special ways to build more infrastructure.” (…)

The International Monetary Fund calculates China’s tax-to-GDP ratio at 14%, versus a 23% average for the Group of Seven developed economies.

This makes social spending difficult to fund without raising taxes on capital or businesses. Taxing households more is a difficult proposition as China’s upper personal income tax band is among the world’s steepest, at 45%. (…)

Chinese media said policymakers may shift the point of charging the consumption tax to wholesalers and retailers.

This tax currently only applies to 15 types of goods, from alcohol and tobacco, to luxury cars, jewellery and yachts. Domestic demand for these items has limited impact on China’s productivity.

Goldman Sachs analysts say charging consumers shifts incentives for local officials from growing their manufacturing base to growing their consumer base. (…)

EARNINGS VS VALUATIONS

Ed Yardeni:

The rally in the S&P 500 Semiconductor industry has been both earnings-led and valuation-led. Its forward P/E is currently 35.5. During the previous decade, its multiple was always below 20.0 and usually around 15.0. Since early 2023, the industry’s forward earnings rose more than 100% as analysts turned more bullish on the prospects for this industry.

Earnings-led meltups should be more sustainable than valuation-led ones. The current meltup is a combination of both. Will that make it more sustainable than the meltup at the end of the 1990s? Not necessarily since the tech rally of the second half of the 1990s was also led by both rising earnings expectations and valuations. Back then, the Tech Bubble was followed by a Tech Wreck as both earnings expectations and forward P/Es dropped sharply.

That could happen again this time. However, we are counting on the stock market rally to broaden as the customers of tech companies use technology to boost their productivity. We also believe that the earnings expectations for tech are more realizable than they were in the late 1990s. That’s especially so since we aren’t expecting a recession any time soon.

Goldman Sachs also sees profit growth broadening amid “reasonable” equal-weight P/E multiples:

In Q2’24, only 3 sectors had better earnings growth than the S&P 500 ex-Energy. This is expected to rise to 4 in Q3, 6 in Q4, 5 in Q1’25 and all of 2025.

CHARGE!

From Fortune:

TDK Corporation’s new solid-state battery, with an energy density that’s 100 times greater than what now powers everything from hearing aids to smartwatches, is further proof that battery makers are on the front lines of innovation. Breakthroughs in one category often spur new developments in another, and the Japanese Apple supplier’s new all-ceramic product could spur innovation in other areas.

Batteries are the workhorse of the energy transformation. The speed of innovation reflects how much energy they can store, how quickly they charge, how much they cost to produce, their environmental impact, and how easily we can access the raw materials to make them. Where they are located also matters, of course, as the world’s biggest battery manufacturers, BYD and CATL, happen to be based in China. Both are expected to ship lithium-iron-phosphate (LFP) battery cells that charge from zero to 100% in 10 minutes this year, with CATL’s Shenxing Plus boasting it will give electric vehicles a range of more than 620 miles on a single charge.

In addition to being on the front lines of innovation, Chinese battery makers are also on the front lines of politics. Republicans in Congress have urged Biden to ban CATL imports, for example, arguing that it uses forced labor—a charge CATL denies. (CATL is working with automakers like Tesla and Ford.)