Labor markets remain strong & inflation continues to trend in the right direction!
The U.S. economy continued to produce jobs in May, with nonfarm payrolls surging more than expected despite multiple macroeconomic and geopolitical headwinds. Payrolls in the public and private sectors increased by 339,000 for the month, well ahead of the 190,000 estimate. Despite the labor force participation rate remaining unchanged, the unemployment rate rose to 3.7% in May, slightly above the 3.5% estimate. The jobless rate was the highest since October 2022 but is still near its lowest level since 1969. Average hourly earnings, a key inflation indicator, rose 0.3% month-over-month (M/M), which was in line with expectations. On an annual basis, wages increased by 4.3%, which was 0.1% below the estimate. Finally, the broader U6 unemployment rate rose to 6.7%.
Inflation cooled in May to its lowest annual rate in more than two years, likely taking some pressure off the Federal Reserve to continue raising interest rates. CPI rose just 0.1% M/M in May or 4.0% year-over-year (Y/Y), which was its smallest increase since March 2021. Shelter prices were the biggest contributor to CPI growth, while used car prices rose 4.4%. Excluding volatile food and energy prices, the picture was not as optimistic, with core CPI rising 0.4% M/M or 5.3% Y/Y. A 3.6% decline in energy prices helped keep the CPI gain in check for the month, while food prices rose just 0.2%.
All signs point to the long-awaited Fed pause & pivot
The Fed has raised rates ten times since March 2022, and they finally paused rate hikes at their June meeting. The Fed remains data dependent and while they paused in June, Chairman Jerome Powell indicated that future rate hikes are likely. Although the economy appears resilient based on consumer spending trends and the employment picture, other factors like manufacturing point to underlying economic weakness.
Source: Bureau of Labor Statistics, CNBC
Worrisome signs in recent PMIs outside of positive price declines
The U.S. ISM non-manufacturing index decreased by 1.6 points to 50.3 in May, against consensus expectations for an increase, to its lowest level since May 2020. A figure less than 50 implies market contraction. The underlying components were slightly more positive: the prices paid component continued its sharp decline to its lowest since May 2020, signaling declining services inflation. The ISM Manufacturing PMI exhibited further weakness in May with the headline reading falling to 46.9 from 47.1 in April. While production and employment grew, new orders fell further into contraction territory at 42.6. The prices component also declined sharply.
Housing affordability continues to be an issue
30-year mortgage rates are rising again, helping push the average monthly mortgage payment in the U.S. to nearly $3,000. This is a significant increase from the average payment of $1,500 just a few years ago. The rising cost of housing is putting a strain on many families, which most economists expect to eventually dent consumer spending.
2023 has been all about mega-cap tech/growth stocks
The S&P 500 Index has returned 13% YTD through June 8, 2023, but the rally has masked muted returns for most stocks. The equal weighted S&P 500 has returned just 3% YTD. The five largest S&P 500 firms (Amazon, Apple, Google, Microsoft, and NVIDIA) have rallied 47% YTD and now comprise 24% of the S&P 500’s market cap. Excluding those five stocks, the remaining 495 stocks have returned just 5% over the same period. Strong performance from stocks other than this narrow group would be a positive sign for equity markets.
Source: Goldman Sachs, FactSet, data as of 6/8/23
AI/Tech should drive EPS rebound later this year
S&P 500 earnings fell only 2% in Q1 versus the –6.7% estimate at the start of the quarter. Analysts expect Q2 EPS to decline 6.4%, a figure that has been revised lower in recent months. Earnings are still forecast to grow 1.2% in 2023 which means that growth should return during the second half of the year. We continue to stress that U.S. companies are excellent at providing conservative guidance and beating reduced earnings expectations. Companies involved with AI have been the biggest winners YTD and that should continue. Amazon, Meta, Alphabet, and NVIDIA are expected to be the largest contributors to earnings growth for the S&P 500 in the second half of this year. These four companies have also seen some of the largest price gains thus far in 2023.
Eurozone falls into “technical” recession
The Eurozone HCOB Composite PMI fell to a three-month low of 53.3 in May versus the April’s 54.1 reading. Services continued to exhibit strength with a reading of 55.9, but manufacturing showed weakness with a 36-month low reading of 44.6. The composite PMI pointed to solid growth in the eurozone through Q2 of 2023. Eurozone GDP contracted 0.1% quarter-over-year (Q/Q) in Q123, marking the second consecutive quarter of contraction. Eurozone GDP is likely to grow in Q2, largely due to the strong services backdrop, but manufacturing weakness remains a clear drag on economic momentum.
Eurozone inflation remains stubbornly high while U.K. CPI accelerates higher
Eurozone inflation fell from 7.0% in April to 6.1% in May. Core inflation, closely-watched by the European Central Bank (ECB), eased to 5.3% from 5.6%. The decline in headline inflation resulted in the lowest reading since February 2022. The ECB’s benchmark rate has risen from -0.5% last year to 3.25% in May, its highest level since November 2008. In the U.K., core CPI accelerated to 6.8% Y/Y in April, above consensus expectations. While headline inflation moderated to 8.7% Y/Y, it still came in above market expectations. Core inflation in the U.K. should ease gradually, and additional rate increases from the Bank of England are expected.
Japan’s economy outperforms in Q1; China PMIs offer confusing picture & likely more stimulus
Japan’s economy emerged from recession and grew faster than expected in Q1 as a post-COVID consumption rebound offset global headwinds and improved hopes for a sustained recovery. Japan’s GDP grew at an annualized rate of 1.6%, well ahead of the 0.7% estimate. Private consumption and business spending both exceeded expectations in Q1.
In May, China’s factory activity unexpectedly switched from decline to growth. This was driven by improved production and demand, which helped struggling firms that had previously been hit by slumping profits. The Caixin/S&P Global manufacturing PMI rose to 50.9 in May from 49.5 in April, above the 50-point index mark that separates growth from contraction. The Caixin data contrasts with a deepening decline in activity shown in a government survey, which covers larger businesses and state-owned companies. The official manufacturing PMI fell to 48.8 in May from April’s 49.2, the lowest level since December, when China ended most of its COVID measures.
China’s service sector continued to show some strength based on the official services PMI that came in at 54.5 (down from 56.4 in April). Despite the decline, it was the 5th consecutive month in expansion territory after the country removed strict COVID restrictions.
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