Note: I am travelling (Pacific time zone) until August 10. Posting will be irregular and possibly limited by time and equipment constraints.
America’s Post-Covid Factory Boom Is Running Out of Steam Companies are laying off employees and cutting production to counter falling orders and rising inventories
More U.S. manufacturers are rethinking their plans as they brace for an extended slump in demand.
Higher interest rates, rising operating costs, a strengthening U.S. dollar and lower selling prices for commodities are dampening activity at factories across the country. Executives for the makers of long-lasting items such as cars, crop-harvesting combines and washing machines are projecting challenging business conditions for the remainder of the year.
Deere & Co., the world’s largest manufacturer of farm equipment by sales, has shed about 2,100 production workers since November, or 15% of its hourly workforce. Rival equipment maker Agco said in June it would cut 6% of its salaried workforce worldwide, or about 800 people, by the end of the year.
Recreational vehicle maker Polaris this week said it would adjust production to cut back on shipments to dealers. The disclosure came as it reported a 49% drop in quarterly income and noted that sales of its motorcycles, boats and off-road vehicles all dropped as consumers pulled back on discretionary purchases. (…)
Whirlpool said a soft housing market is holding down demand for its refrigerators, dish washers and other household appliances. MSC Industrial Direct, a distributor of tools and industrial supplies to manufacturers, said its average daily sales during its recently completed quarter decreased by 7% compared with a year earlier. (…)
Sluggish economies elsewhere in the world, including China, also are weighing on U.S. companies. Elevator and escalator maker Otis Worldwide slightly raised its profit outlook for the year but pared its sales forecast because of falling demand in China.
The rising value of the U.S. dollar relative to other countries’ currencies makes foreign-made goods cheaper to import, putting U.S. companies at a disadvantage against foreign competitors.
Sohel Sareshwala, president of Accu-Swiss, a California-based manufacturer of small precision parts for the semiconductor, biomedical and food industries, said U.S. tariffs drive inflation and keep domestic prices for stainless steel and other materials he uses higher than his foreign competitors’ material costs.
“The strong dollar, it does make a difference. Their cost for raw material also is significantly lower,” he said.
Is it the economy or specific industry or company problems? Many of these companies boosted prices during the pandemic. Plus tariffs. Sticker shocks coupled with high interest rates do impact demand. As shown below, overall consumer demand remains fairly solid, including discretionary goods.
On a YoY basis, initial claims for unemployment insurance are flat through July 20.
As to the recent rise in the unemployment rate, Goldman agrees with my own analysis:
The increase in the unemployment rate—now up 0.46pp from its cycle low on a three-month average basis—has revived concerns about downside risks to the US economy. After all, in US history even moderate increases in the unemployment rate have eventually grown into large increases accompanied by recessions.
But we are less worried this time [mainly because] the recent rise in the unemployment rate breaks with the historical pattern in one crucial respect—there has not been an increase in the layoff rate, which remains historically low. This is important because it means the economy is not experiencing the usual vicious circle in which job and income loss lead laid-off workers to reduce their spending, leading to further job loss.
The increase in the unemployment rate has instead come partly from a surge in labor supply driven by immigration, with which job growth has not quite kept up. But job growth is far from weak, and with final demand still growing at a robust pace, it appears set to remain fairly solid.
A Fed Rate Cut Is Finally Within View Central-bank officials meet in the coming week looking ahead to a September rate cut to maximize chances of a soft landing
While Federal Reserve officials aren’t likely to change interest rates in the coming week, their meeting will nonetheless be one of the most consequential in a while.
At each of their four meetings this year, interest-rate cuts have been a question for later. This time, though, inflation and labor-market developments should allow officials to signal a cut is very possible at their next meeting, in September. (…)
The Fed’s newfound readiness to cut rates reflects three factors: better news on inflation, signs that labor markets are cooling and a changing calculus of the dueling risks of allowing inflation to remain too high and of causing unnecessary economic weakness. (…)
With inflation resuming its progress and the labor market cooling, Fed officials face a shift in the trade-offs they often refer to as risk management, which boils down to which problem—somewhat elevated inflation or rising unemployment—they judge as harder to fix.
The Fed was late to raise interest rates two years ago in part because it had incorrectly judged inflation would subside rapidly. The Fed was able to correct that mistake, but to do so, had to rapidly raise rates from near zero in 2022 to around 5.3% in July 2023, the highest in more than two decades. One lesson: “When you’re too confident that your view is correct, you’re prone to mistakes,” said San Francisco Fed President Mary Daly.
The Fed doesn’t expect demand or hiring to weaken much in coming months, but if it is wrong, it probably won’t be able to cut rates quickly enough to forestall a recession. “If you’re behind on [cutting rates] when the labor market starts to falter, it’s really challenging to get that back on track. It is just not the same thing” as the belated start to rate increases two years ago, said Daly. (…)
McDonald’s Sales Fall in First Since 2020 as Traffic Drops
The chain’s comparable sales, a metric tracking restaurants open for over a year, fell 1% from the year prior. Each of McDonald’s geographic segments saw sales declines. In the US, the trend was driven by a decline in foot traffic that was partially offset by higher prices. (…)
CPI-Food-Away-From-Home is up 27% since the pandemic vs 19% for core-CPI. YoY in June: +4.1% vs +3.3% respectively. Margins or volume?
China Defends Manufacturing Push, Says World Needs More EVs Vice Finance Minister Liao says Chinese output helps world
China’s manufacturing capacity is helping the world fight climate change and contain inflation, said Vice Finance Minister Liao Min, pushing back against US Treasury Secretary Janet Yellen’s latest criticism of the nation’s industrial excess.
“For decades, China has been a force of disinflation for the world through its supply of manufactured products with good value for money,” Liao said in an exclusive interview in Rio de Janeiro, where he attended this week’s meeting of G-20 finance ministers and central bank governors.
“It is now also providing green goods for the world as countries try to achieve their carbon reduction goals by 2030,” he said. Global demand for new energy cars will be 45 million to 75 million units by then, far exceeding the world’s current supply capacity, he added, citing estimates by the International Energy Agency. (…)
While China pays attention to concerns of major economies about overcapacity, it too is concerned by trade threats like tariffs, Liao said.
“We should communicate in a candid manner with respect to rules of market economy and true facts,” he said, adding that China and the US will “continue to discuss the issue at the China-US Economic Working Group meetings.”
Liao was a key member of China’s team of trade-war negotiators facing off against US officials during Trump’s presidency. He traveled to the US as an aide to then Vice Premier Liu He and met Trump in the Oval Office. More recently, Liao greeted Yellen when she visited the country in April. (…)
Brazil’s Finance Minister Fernando Haddad said that while the response by some countries to China’s exports is an “understandable reaction,” it’s not sustainable in the long run.
Government subsidies are not the main reason that Chinese industries such as the renewable energy sector have gained competitive advantages over their peers, Liao said in the interview. More important factors are corporate investment in research and development spanning years, entrepreneurship and technological innovation, he said.
“China’s reform and opening-up experience over the past more than 40 years has told us not a single industry can become a globally competitive sector simply relying on government support,” he said.
He also argued that some countries were left behind in terms of developing EVs because they enjoy advantages in the conventional auto sector and therefore didn’t shift their focus onto the emerging industry. In contrast, China had to seek growth in new sectors like EVs due to a lack of advantages in the traditional car market.
Demand-supply disequilibrium is only natural for any market economy, partly because companies make their own investment decisions and they do so for the long run expecting to meet higher demand, Liao said. Market forces will show if they made the right and wrong decisions, he said.
Large flows of capital funds into new industries is also not rare, he said, citing previous investment frenzies into sectors like information technology, shale gas and biopharmaceuticals that resulted in “periodical” excess capacity in developed countries.
The current AI angst is a case in point. The race by cash-rich behemoths to create moats on Gen AI with better, faster and cheaper LLMs and killer apps will no doubt come with large casualties in 2-3 years when the chips are finally down (pun intended). At this point of the race, nobody knows who the winners will be. We should begin to see how AI will directly impact our lives when Apple (and likely others) releases its new iPhone this fall.
Meanwhile:
Earnings Derail Stock Rally Over Doubts on AI, Consumer Strength Concerns about AI rally, consumer health weigh on sentiment
The latest earnings reports are fanning two worries that were already gnawing away at the US stock market: That the euphoria about artificial intelligence had run too far and that — at some point — consumers spending will start to stall. (…)
The Nasdaq 100 Index slid 2.6% in its third straight weekly loss after Alphabet Inc.’s results stoked a broader concern about how long it will take for investments in artificial intelligence to pay off. At the same time, updates from Southwest Airlines Co., United Parcel Service Inc., Whirlpool Corp. stoked worries about a potential pullback by consumers.
That’s heightened the stakes as earnings continue to roll out next week, including those from the tech bellwethers Microsoft Corp., Meta Platforms Inc., Amazon.com Inc. and Apple Inc. (…)
To be sure, there have been plenty of bright spots in the earnings picture. About 69% of companies in the S&P 500 that have already posted their results reported higher per-share earnings than a year ago, data compiled by Bloomberg Intelligence as of Friday morning show. And banks surpassed the sell-side’s expectations, while a profit squeeze for industrial companies may be coming to an end.
Moreover, those that posted disappointing figures have generally not been severely punished, at least so far. Companies in the S&P 500 that have trailed projections on both earnings per share and sales have underperformed the broader S&P 500 Index by an average of 1.6% within a day of reporting, the least since 2017, according to data compiled by Bloomberg Intelligence. (…)
The Google parent reported sales and cloud revenue that beat expectations. At the same time, capital spending rose to $13.2 billion in the second quarter, exceeding Wall Street’s estimates.
“It really feels like we are moving from a ‘tell me’ story on AI to a ‘show me’ story,” said Ohsung Kwon, equity and quantitative strategist at Bank of America Corp. “We are basically at a point where we’re not seeing much evidence of AI monetization yet.”
With weeks still to go before major US retailers roll out their earnings, early reports have indicated consumers are continuing to feel the pinch of high interest rates and still elevated inflation, particularly in the low-income category. Second quarter EPS growth in both consumer staples and consumer discretionary sectors is sitting at the lowest level in two years. (…)
Maybe there is too much focus on low-income consumers. They are indeed pressured by high interest rates and food/rent inflation but employment remains solid (Indeed Job Postings rose 1.5% MoM in June), real wages are still rising and inflation on essentials is slowing (+3.9% YoY in June).
Consumer spending contributed 1.6% out of the 2.8% GDP growth in Q2. Spending on services has picked up while goods are not collapsing as widely expected.
Source: U.S. Department of Commerce and Wells Fargo Economics
Significantly, discretionary expenditures have accelerated lately.
Source: U.S. Department of Commerce and Wells Fargo Economics
June saw the lowest saving rate of the past 18 months. Statistically, the hand off in June means that even if spending were to flatline, real consumption expenditures would rise at a 1.1% annualized rate in Q3.
The Atlanta Fed GDPNow is at 2.8% for Q3 while the NY Fed’s staff estimate is at 2.7%.
EARNINGS WATCH
From LSEG IBES:
206 companies in the S&P 500 Index have reported earnings for Q2 2024. Of these companies, 78.6% reported earnings above analyst expectations and 15.0% 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 16% missed estimates.
In aggregate, companies are reporting earnings that are 4.4% 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 7.3%.
Of these companies, 58.3% reported revenue above analyst expectations and 41.7% 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, 62% of
companies beat the estimates and 38% 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 1.2%.
Factset calculates that S&P 500 companies with more than 50% of their revenues from foreign countries grew their earnings 21.8% in Q2 vs +4.0% for domestically focused companies. That in spite of fairly similar revenue growth rates and benign forex impact. Yet, the U.S. economy keeps meaningfully outperforming other economies.
IT and Communication Services companies are again the likely culprits as Factset shows:
More from LSEG IBES:
The estimated earnings growth rate for the S&P 500 for 24Q2 is 12.1%. If the energy sector is excluded, the growth rate improves to 13.1%.
The estimated revenue growth rate for the S&P 500 for 24Q2 is 4.8%. If the energy sector is excluded, the growth rate improves to 4.8%.
The estimated earnings growth rate for the S&P 500 for 24Q3 is 7.1%. If the energy sector is excluded, the growth rate improves to 8.3%.
Trailing EPS are now $231.10. Full year 2024e: $243.56. Forward EPS: $259.84. Full year 2025e: $279.65.
Expectations are very high. Revenues are seen accelerating sharply amid decelerating inflation while profit margins will go through the roof.
Ed Yardeni:
S&P 500 forward earnings (i.e., analysts’ consensus earnings expectations over the coming year) tends to do a good job of forecasting actual earnings when the economy is growing. S&P 500 forward earnings hit a new record high of $263 last week suggesting a solid gain in S&P 500 EPS during Q2, and boding well for Q3.
The weekly S&P 500 forward profit margin has climbed to its highest level since June 2022, nearing a new record high. We’re expecting realized margins to reach new record highs in the second half of the Roaring 2020s, beginning as early as 2025.
The S&P 500 forward P/E is relatively high at 20.6 currently. It is inflated by the 30.0 forward P/E of the MegaCap-8 (i.e., the Magnificent-7 plus Netflix) (chart). Excluding them, the S&P 492 are trading around 18.5. The S&P 400 MidCaps and S&P 600 SmallCaps are cheaper at 15.7 and 15.4. The problem with the S&P SMidCaps is that their earnings have been flat for the past couple of years. About 40% of the Russell 2000 universe currently are losing money.
