Labor market remains solid as inflation continues to trend lower
Payroll growth decelerated in December but was still better than expected with 223,000 new jobs being added to the economy versus the market’s estimate for 200,000 jobs. The unemployment rate fell from 3.7% to 3.5%, and the broader U6 unemployment rate fell to its lowest reading ever at 6.5%. Wage growth was less than expected, an indication that inflation pressures could be weakening. Average hourly earnings rose 0.3% month-over-month (M/M) or 4.6% year-over-year (Y/Y). The respective estimates were for growth of 0.4% and 5%. After raising rates by another 50 basis points at its December meeting, the Fed now expects the terminal rate to be around 5.1%.
All eyes were on the December CPI report which showed headline inflation fell 0.1% M/M (the largest M/M decline since April 2020) while core inflation rose 0.3%. On an annual basis, headline CPI rose 6.5% and core inflation increased 5.7%. Gas prices, which fell 9.4% M/M or 1.5% Y/Y, were the major driver of the decline. Food and shelter costs rose in December but used car prices fell 2.5%. It is important to note that the metric for shelter costs is lagging and current data suggest rents are already declining. The Fed has raised rates 425 basis points since the start of their current cycle and another 25 bps is expected in February. Markets are pricing in a much lower terminal rate than the Fed.
Retail sales, durable goods orders and PMIs all exhibit weakness in December
U.S. retail sales declined by –1.1% in December after consumer fears of high inflation and a slowing economy made for a lackluster holiday shopping season. While December sales fell more than consensus expectations, November sales were also revised lower from –0.6% to –1.0% M/M. Retail sales during the holidays came in lighter than expected but still grew 6% Y/Y. Durable goods orders in the U.S. fell by 2.1% M/M in November, the sharpest decrease since April 2020 and much worse than the market forecast of a 0.6% decline. Excluding defense, orders were down -2.6%, though excluding transportation this figure moves up to +0.2%. Core capital orders excluding defense spending and aircraft (which combine to serve as a proxy for GDP business spending) were also +0.2%, higher than expected.
Source: Bureau of Labor Statistics, CNBC
The ISM Manufacturing PMI fell from 49.0 in November to 48.4 in December. Employment showed strength, but production, new orders, and prices all declined. The ISM Services PMI also fell sharply in December, dropping into contraction territory at 49.6 from 56.5 in November. New orders and production led the weaker than expected service sector activity. Survey respondents cited slowing order activity, persistent inflation, and higher labor costs that are pressuring margins.
Eurozone growth is treading water, Japan removes the lid on interest rates
The eurozone downturn extended into its sixth successive month in December, according to flash PMI data. The rate of decline of business activity moderated for a second month running amid a reduced rate of loss of orders, improving supply conditions, lower price pressures, and an uplift in business confidence. While any recession may be mild, the further fall in business activity in December signals the strong possibility of a downturn. Q4 data is tracking at a quarterly rate consistent with GDP of 0.0-0.2%.
Bank of Japan Gov. Haruhiko Kuroda shocked markets in late December by doubling a cap on ten-year JGB yields. The BOJ will now allow Japan’s ten-year bond yields to rise to around 0.5%, up from the previous limit of 0.25%. The central bank kept its ten-year yield target unchanged at around 0%, left its short-term interest rate at -0.1%, and said it would significantly increase its bond purchases to ¥9 trillion ($67.5 billion) per month compared with the currently planned ¥7.3 trillion. Many economists interpreted the move as laying the preliminary groundwork for exiting a decade of extraordinary stimulus policy. The surprise decision sent bond yields surging higher and the yen strengthened significantly versus other major currencies.
China’s GDP outpaces expectations in Q4, India continues to grow
China’s Q4 GDP report was better than expected, with 2.9% growth reported versus the estimate of 1.8%. For 2022, the Chinese economy grew 3%, slightly ahead of the 2.8% forecast. While beating downwardly revised expectations, Chinese GDP was well below the government’s 5.5% growth target. Economic data showed broad weakness in 2022, but readings such as retail sales, industrial production, and fixed asset investment were above forecasts in December. Growth has clearly slowed across China due to their zero COVID policy, but restrictions have been removed and the PBOC has provided significant stimulus. China will announce it 2023 growth target in March, and they should be concerned about slowing global growth and weak external demand.
Source: Wind, National Bureau of Statistics
India’s economy is posting the fastest growth among major economies putting it on track to become the world’s third largest before the end of the decade, according to financial forecasts from Morgan Stanley, the IMF, and S&P. India is expected to grow by nearly 7% in 2022 despite the economic turbulence created by Russia’s war in Ukraine. That momentum is likely to continue, helping it overtake Japan and Germany to become the world’s third-largest economy by 2028. India benefits from having a relatively shielded economy that tends to weather external turbulence better than others along with the need to maintain a high level of growth to raise a country of 1.4 billion people out of poverty.
Japan’s economy unexpectedly shrank for the first time in a year in Q3, stoking further uncertainty about the outlook as global recession risks, a weak yen, and higher import costs negatively impacted household consumption and business profits. Q3 GDP fell at annualized rate of 1.2% with private consumption growing 0.3% and corporate investment rising 1.5%. External factors were the driving factor behind the negative growth. While exports expanded 1.9% from the previous three months, imports grew by 5.2% as higher energy costs and the weak yen pushed up the prices of products coming to Japan. The steeper import bill led to a decline in net exports, dragging GDP lower.
World Bank slashes its 2023 global growth forecast
The World Bank revised its outlook for global GDP growth in 2023 from 3.0% to 1.7%. It now expects China to grow only 4.3% versus the previous estimate of 5.2%. U.S. GDP growth was slashed from 2.4% to 0.5%, European growth was lowered from 1.5% to 0.1%, and Japan’s GDP growth was revised down to 1.0% from 1.3%. The World Bank said that while tighter monetary policies from central banks around the world may have been necessary to tame inflation, they have contributed to a significant worsening of global financial conditions, and ultimately a substantial drag on economic activity.
2022 resilience has led to 2023 uncertainty over GDP growth, earnings, and valuations
As we enter the fourth quarter earnings reporting season, the estimated earnings decline for the S&P 500 is -3.9%. At the start of Q4 on 9/30/22, the estimated earnings growth rate was +3.5%. EPS has been revised sharply lower and 10 of 11 sectors have seen downward revisions. The energy sector is expected to report earnings growth of 61% in Q4; excluding energy, the S&P 500 earnings decline would be 8.2%. Declines are also forecast from the analyst community in the first two quarters of 2023, but 4.6% growth is projected for the full year. Several investment banks have negative top-down earnings forecasts for 2023. As examples, Goldman Sachs believes S&P 500 earnings will be flat Y/Y while Morgan Stanley’s Mike Wilson believes earnings could collapse 10-15% depending on the degree of slowdown/recession in the U.S. There is significant uncertainty surrounding economic growth and corporate earnings. Both were resilient in 2022, but any meaningful deterioration could lead to another downward rerating of equities.
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