Robust labor market and sticky inflation continue to present major challenges for the Fed
The February employment report showed another strong and better than expected month of job growth. U.S. employers added 311,000 new jobs to the economy last month, well ahead of the 225,000 estimate. The unemployment rate rose to 3.6%, above the expectation for 3.4%. The labor force participation rate rose to 62.5%, its highest level since March 2020. A more encompassing unemployment measure that includes discouraged workers and those holding part-time jobs for economic reasons rose to 6.8%, from 6.6% in the prior month. There also was some good news on the inflation side, as average hourly earnings rose 4.6% year-over-year (Y/Y), below the 4.8% estimate. The monthly increase of 0.2% also was below the 0.4% estimate. It should be noted that most of the job gains came from lower wage sectors of the economy.
CPI inflation rose in February but was largely in-line with expectations. The Consumer Price Index increased 0.4% for the month, putting the annual inflation rate at 6% Excluding volatile food and energy prices, core CPI rose 0.5% in February and 5.5% on a 12-month basis. The components of CPI were mixed, with shelter costs up 0.8%, food costs up 0.4%, energy prices down 0.6% and used car prices down 2.8%. With interest rate volatility surging due to the collapse of Silicon Valley Bank, Fed Fund futures have declined. The Fed may hike rates by another 25 basis points in March, but future rate hikes are now in doubt. The market’s probabilities for future rate cuts and the ending terminal rate fell sharply after SVB’s collapse.
Mixed economic data signals continue
January’s durable goods orders report was mixed, with a headline decline of 4.5% but a gain of 0.8% when excluding the volatile commercial aircraft sector. Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in the calculation of GDP), rose 1.1% in January following declines in the last two months of 2022. While orders are still rising, they are shrinking when adjusted for inflation. Retail sales jumped 3% in January, smashing expectations. Retail sales have surged 6.4% Y/Y, in-line with the pace of inflation.
Source: Bureau of Labor Statistics, CNBC
February PMI data showed that manufacturing activity is contracting while the service sector is expanding. The ISM Manufacturing PMI rose slightly to 47.7 in February from 47.4 in January. New orders rebounded while production and employment weakened. The prices component surged back above 50, highlighting potential inflation pressures building once again. The ISM Services PMI was flat month-over-month (M/M) at 55.1 in February with growth in business activity, new orders, and employment. Robust service sector data continue to show the resilience of U.S. consumers.
Where will the E in P/E end up?
S&P 500 earnings fell 4.6% in the fourth quarter., and forward guidance from most companies had a negative bias. The numbers are even worse when excluding the energy sector. In 2023, the analyst community expects earnings to contract in Q1 and Q2 but begin to grow again during the second half of the year. For the year, earnings are forecast to grow 2.1% with revenue growth of 2.0%. According to FactSet, the S&P 500 had earnings of $219 in 2022 and that is forecast to grow to $223 in 2023 and $249 in 2024. Analysts/economists are very slow to revise earnings estimates and slowing economic growth likely means downward revisions. We also note that several banks have already published downward revisions for 2023 in the 10-20% range. There is still significant uncertainty around economic and earnings growth for 2023.
Global shipping costs have largely normalized following the COVID pandemic spike
Prior to the COVID pandemic, global shipping costs ranged from $2,000-$5,000 per 40-foot container. Shipping costs spiked higher following the reopening of the global economy and corresponding surge in demand. Over the past year, the supply/demand picture has changed, and shipping container prices have normalized back to pre-pandemic levels. Demand has weakened with the potential for a recession later in 2023, and inventory levels were quite high following the initial pandemic surge. UBS highlights U.S. to European shipping as remaining robust due to strong demand for European imports.
Japan grows in Q4 despite weak business spending
The Japanese economy advanced 0.6% on an annualized basis during the fourth quarter of 2022, below the market consensus of 2% growth and after a revised 1.0% contraction in the previous period. Private consumption increased 0.5% with the removal of some COVID restrictions and government spending increased at a faster pace in Q4 than the previous quarter. On the negative end was a 50-basis point contraction in business spending for the first time in three quarters. Like virtually everywhere else across the globe, rising inflation has been a growing issue in Japan. Private consumption did rebound in Q4, but the outlook will be key for how the BOJ implements potential future monetary policy changes.
Eurozone economy rebounds in February, but like the U.S., services outpaces manufacturing
Eurozone business activity growth accelerated to a nine-month high in February, reflecting an improved performance of the service sector and a return to growth of manufacturing output. The eurozone flash composite PMI rose from 50.3 in January to 52.3 in February. Eurozone services activity hit an eight-month high of 53.0, and eurozone manufacturing output hit a nine-month high of 50.4, but the official eurozone manufacturing PMI fell to a two-month low of 48.5. Business activity across the eurozone grew much faster than expected in February, thanks to resurgent service sector activity and a recovering manufacturing economy. February’s PMI is broadly consistent with GDP rising at a quarterly rate of just under 0.3%.
China sets conservative growth target for 2023 although reopening data shows strength
Although Moody’s expects GDP growth in China to decline over the medium-term, Moody’s did raise their growth outlook for 2023 and 2024 from 4% to 5%. They expect support from domestic consumption to fuel better-than-expected economic growth. This is somewhat in-line with the Chinese government’s 2023 GDP growth target that was just set at “around” 5%. The target is considered conservative given slowing global demand and indications for lower infrastructure spending. China’s long-term goal is to transition the economy to a more consumer led model.
China’s manufacturing sector hit its highest level of activity since April 2012. The official manufacturing PMI rose to 52.6 in February from 50.1 reported in January. China’s non-manufacturing PMI also grew further in February to 56.3 from January’s 54.4 reading, when China saw a sharp improvement backed by a recovery in services and construction activity. The broad-based improvements for both manufacturing and non-manufacturing PMIs in February reflect the solid momentum of the post-reopening recovery.
Source: S&P Global
India is a bright spot in the global economy
India’s Q4 GDP report showed growth of 4.4%, below the 5.2% reading from Q4 2021. Manufacturing and service sector data remain solid across the country and the government still maintains its 7% GDP growth estimate for its fiscal year ending March 31, 2023.
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