The LEI’s Hole Is Too Deep to Dig Out Of
The Leading Economic Index (LEI) decreased 0.6% in April, marking the largest monthly drop since October. The index is now only 1.3 percentage points above its pandemic-related trough hit exactly four years ago. The U.S. economy has evolved in many unexpected ways since then, and despite a generally strong macroeconomic backdrop, recession indicators are still flashing signs of weakness. While the upturn in the six-month annualized change in the LEI is historically consistent with an improving economy, it is emerging from a recession signal that did not come to fruition. (…)
The S&P 500 lost some steam last month, which flipped stock prices’ contribution to the LEI negative for the first time in six months. The softening in equity prices coincided with an upward drift in the 10-year Treasury yield, while short-term bond yields held mostly steady. Consequently, the yield curve unwound some of its deep inversion over the month, leading the interest rate spread to its smallest drag (-0.1pp) on the LEI since last November. Credit conditions remain accommodative, evident in the Leading Credit Index’s positive contribution.
Despite generally loose financial conditions, permit applications for residential construction weakened in April and orders of durable goods are barely positive. Until market participants have more clarity on the timing and magnitude of monetary policy easing, we suspect the LEI will continue to slip in the coming months.
Source: The Conference Board and Wells Fargo Economics
The normally expected recession never happened, presumably because the LEI is very goods-sensitive in a predominantly service economy. But goods consumption was very strong during and after the pandemic. Why the weak LEI?
Because most goods Americans consume are imported.
This chart shows that new manufacturing orders jumped 28% between January 2021 and mid-2022 and flattened thereafter but production never rose. This while imports of goods (black) increased 21% in volume.
The LEI is now flashing recovery. If this means that manufacturing is recovering (as suggested by PMIs), the economy may not be soft landing, may not be landing at all.
American manufacturers saw their capacity utilization decline from 80% at the end of 2022 to 76.8% while their real fixed investments in structures (black line below) skyrocketed 80%. Assume they are not stupid and merely taking advantage of large government subsidies, production will eventually emerge from those structures, boosting employment and GDP.
Note the recent gap above between manufacturing shipments (value) and production (volume): prices rose 25% since the pandemic and have not declined since even after the supply bottlenecks eased.
Is the USA really reindustrializing, helped by higher tariffs and other protectionist measures?
Announcing his new tariffs on steel, aluminum, semis, EVs and solar panels last week, President Biden wrote on X: “China is determined to dominate these industries. I’m determined to ensure America leads the world in them.”
This was tried on solar panels since 2009 (subsidies, remember Solyndra) and 2012 (tariffs). The U.S. now has 2.8% of the world market, China 76%.
During the past 10 years, the USD has broadly appreciated 30%, +20% against the renminbi.
Can the U.S. reindustrialize with a currency many say is 20-40% overvalued on a purchasing parity basis?
The U.S. Finally Has a Strategy to Compete With China. Will It Work? The strategy, which took seven years to come together, is a three-legged stool consisting of tariffs, security restrictions and tech subsidies.
The U.S. buys almost no electric vehicles, steel or semiconductors—all targets of the tariffs—from China. But, by adding to, rather than rescinding, tariffs imposed in 2018 by former President Donald Trump, it signals that the decoupling of the Chinese and U.S. economies is becoming irreversible.
More important, the tariffs are the final piece of an economic strategy for competing with China.
This strategy is a three-legged stool. The first consists of subsidies to build a viable technology manufacturing sector, from clean energy to semiconductors. The second is tariffs on Chinese imports that threaten those efforts. The third is restrictions on access to money, technology and know-how that could help China compete. A fourth leg, a unified economic front with allies, remains unrealized. (…)
This [the 2022 Chips Act] enabled the Commerce Department to announce some $29 billion in subsidies to the world’s leading chip makers in recent months.
They include TSMC, which now says it will build three fabs, up from one, in Arizona by 2030. If TSMC follows through, its customers such as Apple and Nvidia might one day both design and manufacture their chips in the U.S. instead of Asia.
The restrictions [on the sale of advanced chips and chip-making equipment to China] are a powerful incentive for tech companies to invest in the U.S. or its allies instead of China. The White House, for example, is engaged in a continuing investigation into the security risks of “connected cars,” which share driver data with the manufacturer. This may provide a pretext to block all Chinese EVs from the U.S. market, even if they are assembled in the U.S. or Mexico.
So the U.S. finally has a strategy for economic competition. Whether it succeeds remains to be seen.
For one thing, it’s late. China’s dominance in key markets has only grown since 2017. The world is now bracing for a “second China shock” of cheap manufactured exports overwhelming local producers.
For example, its share of global production of “legacy” chips used in cars, appliances and other basic applications has grown from 17% in 2015 to 31% in 2023. It is on track to hit 39% by 2027, according to research firm Rhodium Group.
Biden announced last week that tariffs on such chips would double to 50% from 25%, which in theory should divert production away from China. But those chips typically enter the U.S. embedded in other products, untouched by tariffs.
And China’s capacity expansion is largely immune to tariffs because it is driven by self-sufficiency, not profit, said Jimmy Goodrich, senior adviser for strategic technology analysis to the Rand Corporation.
The economic strategy has also been distracted by politics. Like Trump before him, Biden is obsessed with steel and its importance to rust-belt swing states. He raised tariffs on the metal even though the U.S. already has plenty of domestic and allied alternatives to China. He didn’t raise tariffs on drones, which increasingly have national security roles, for which the U.S. really does depend on China.
Finally, despite lots of talking, the U.S. and its allies have struggled to form a united front for competing with China. While Biden officials suspended Trump’s tariffs on European Union steel and aluminum, a deal to rescind them altogether failed in part because the EU wouldn’t coordinate with the U.S. against Chinese steel. Fearful of falling behind the U.S. and China on EVs, the EU is busy teeing up its own subsidies and tariffs.
Such divisions could widen further should Trump return to office and carry through with this threat to hit all imports, including from allies, with tariffs. China finally faces determined economic pushback from the West, but it can take comfort that it isn’t unified.
UAW Loses Unionization Vote at Mercedes Plant in Alabama The United Auto Workers’ loss hurts its push to organize at many foreign-owned factories in the South.
Fifty-six percent of workers who cast ballots voted against joining the UAW, according to the National Labor Relations Board, which oversaw the election. More than 90% of the factory’s roughly 5,000 eligible workers voted.
The loss marks the first significant setback for the UAW’s fiery president, Shawn Fain, who has rejuvenated the 89-year-old labor group through his passionate rhetoric and a more combative stance with Detroit’s automakers since taking over 14 months ago. (…)
Fain’s team had been on a roll heading into this week’s vote. A decisive victory at a 4,300-worker Volkswagen plant in Tennessee last month was a breakthrough for the UAW, marking the first time the Detroit-based union successfully organized a foreign automaker in the South.
That win followed record contracts the UAW secured from General Motors, Ford Motor and Chrysler-parent Stellantis late last year, after a dramatic, six-week strike. Fain said Friday that the union’s success in Detroit led to changes at Mercedes, including a recent wage bump.
The UAW was trying to show its recent success at VW wasn’t a one-off as it targets factories and facilities owned by about a dozen car companies, from BMW and Toyota Motor to Tesla. The UAW is spending $40 million on the organization drive over the next two years, which includes some factories in the Midwest and West as well as the southern states. (…)
“We have the company’s ear, for the first time in a long time,” Howell said. “If our management doesn’t get it right, we can vote the union in a year from now.” (…)
EARNINGS WATCH
466 companies in the S&P 500 Index have reported earnings for Q1 2024. Of these companies, 77.5% reported earnings above analyst expectations and 16.3% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 79% of companies beat the estimates and 17% missed estimates.
In aggregate, companies are reporting earnings that are 8.2% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 7.0%.
Of these companies, 60.7% reported revenue above analyst expectations and 39.3% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 65% of companies beat the estimates and 35% missed estimates.
In aggregate, companies are reporting revenues that are 1.0% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.5%.
The estimated earnings growth rate for the S&P 500 for 24Q1 is 7.6%. If the energy sector is excluded, the growth rate improves to 10.7%.
The estimated earnings growth rate for the S&P 500 for 24Q2 is 10.5%. If the energy sector is excluded, the growth rate declines to 10.1%.
The estimated revenue growth rate for the S&P 500 for 24Q1 is 3.8%. If the energy sector is excluded, the growth rate improves to 4.5%.
The broad beat rates and surprise factors are just impressive.
Optimism reigns:
Trailing EPS are now $226.30, up 2.8% YoY. Forward EPS are now $252.93, up 12.6% YoY.
The Rule of 20 Fair Value line (yellow) chart uses trailing EPS and core inflation which has dropped from 6.6% in October 2022 to 3.6% currently, providing a 3 point boost to P/E ratios.
We need to watch the coming economic numbers, however:
Bloomberg’s data confirm the negative surprises on growth, amid higher than expected inflation.
So, slowing growth but rising inflation. For now, that means rising margins:
Goldman Sachs:
This quarter, the average earnings surprise has been 11% while the average sales surprise has been 1%, pointing to margins as the key driver of better than expected earnings. Amid an environment of rising input costs in 2021 and 2022 companies began to take action to protect their margins and bolster profitability.
While many firms pointed to their pricing power in previous years, firms this quarter have emphasized actions they have taken to manage expenses and keep costs under control. We expect the profitability of firms will remain in focus as long as uncertainty remains over the timing and magnitude of policy easing. The market is currently paying a historically large premium for high vs. low margin stocks and the valuation of our margin factor currently ranks in the 90th percentile going back to 1980.
Across S&P 500 firms, those within the Financials sector that have a higher level view of consumer have noted that they still see strength in consumer spending and consumer balance sheets.
Among consumer facing companies however, the tone is more cautious, with several companies noting that the consumer has become more discerning and have started to trade down to lower priced product offerings. Furthermore, companies themselves have begun to focus more on the affordability of their products and services.
Other pockets of consumer facing companies still noted signs of strong consumer demand however, such as cruise lines, airlines, and entertainment companies.
During the 1Q earnings season, 83% of Consumer Staples companies have posted positive earnings surprises, the highest share of earnings surprises among sectors and a reflection of a better than feared earnings season.
This helps:
SENTIMENT WATCH
Roaring Kitty Is the Poster Child for Meme-Obsessed Generation T Younger investors are much more willing to take risks than their elders.
(…) Regardless of lagging regulatory attempts to curb speculation, the fervor behind wild swings in recent years of cryptocurrencies and randomly selected micro stocks — which often have large short positions, making them vulnerable to squeezes — can’t be un-invented. The boom in US sports betting, along with spread betting and contracts-for-difference trading in the UK, are all symptomatic of the new world of finance. (…)
Insane volatility has had the reverse effect on Gen-Z and Millennials by encouraging them to take bigger risks, rather than fleeing from price swings like their parents. The younger gang favors more active trading in smaller sizes and across a wider set of products. Bitcoin’s price more than doubling since October is just the latest fuel driving younger investors. Back off boomers: Gen-T is doing things its own way. (…)
Younger investors are more open to investing using futures and in fractional shares, the research shows, and are 50% more active than their older counterparts, with nearly 60% making adjustments monthly. (…) One intriguing development is in “copy trading” — a style where followers mimic ‘leaders’ portfolios and track performance via a leaderboard. This is predominantly on the investment platform provider eToro Group Ltd. It’s attracted the interest of the UK’s Financial Conduct Authority.
(…) if your first “investment” was a fractional stake in newly resurgent bitcoin or a soaring Magnificent Seven stock, your mindset is bound to be influenced. And your ultra low-cost 24/7 online platform provider also offers derivatives, leverage and a raft of trading techniques that don’t involve classic value analysis — it truly is a different world than 93-year-old Warren Buffett’s.
There’s a flipside to this youthful experimentation. Instead of applying value filters like generations of chartered financial analysts, there’s a much higher propensity to stick with whatever’s hot on social media. (…)
Retail investing is a huge market with in excess of $20 trillion invested and over 100 million accounts globally. But it’s the online business where the biggest changes are happening, with more than 11 million US-based accounts trading online at least once a year. (…)
The top reason cited in Investment Trends research for opening an online account is the ability to speculate with small amounts of money. Numbers two and four are more familiar: managing pension savings, and finding higher returns than from cash savings. But reasons three and five are driven by Gen-T; the desire to learn new skills, and the availability of commission-free trading. (…)
The new age of investing was accelerated by the pandemic and social media, and will likely be further propelled by artificial intelligence. Adapt or die might prove to be a good maxim for long-only fund managers and older generations of investors alike.
BTW:
One of the Last Big Bears on Wall Street Turns Bullish on US Stocks Strategist hikes S&P 500 12-month target by 20% to 5,400
Morgan Stanley’s Michael Wilson now sees the S&P 500 rising 2% by June 2025, a major about turn from his view that the benchmark will tumble 15% by December.
The strategist — whose bearish 2023 outlook failed to materialize as markets kept rallying — finally gave in and boosted his target for the S&P 500 to 5,400 points from 4,500. That catapults his forecast from among the lowest on Wall Street to one that projects a fresh record for the index.
“In the US, we forecast robust EPS growth alongside modest multiple compression,” Wilson wrote in a note on Sunday with his Morgan Stanley colleagues, as they discussed the firm’s second-half views across various assets.
Generally, the bank expects a “sunny macro environment,” which will support risk assets in the second half of the year, although Wilson reiterated his view that broader outcomes for the economy are becoming hard to predict as data become more volatile. (…)
China Sells Record Sum of US Debt Amid Signs of Diversification Selling seen as diversification away from US dollar assets
China sold a record amount of Treasury and US agency bonds in the first quarter, highlighting the Asian nation’s move to diversify away from American assets as trade tensions persist.
Beijing offloaded a total of $53.3 billion of Treasuries and agency bonds combined in the first quarter, according to calculations based on the latest data from the US Department of the Treasury. Belgium, often seen as a custodian of China’s holdings, disposed of $22 billion of Treasuries during the period. (…)
With China selling dollar assets, its holdings of gold have risen in the nation’s official reserves. The share of the precious metal in the reserves climbed to 4.9% in April, the highest according to central bank data going back to 2015. (…)
Meanwhile: