Despite lower taxes and higher share prices, U.S. corporate profits are showing signs of receding. No less august an observer as The Economist published an article with the provocative headline, “Profits are down in America Inc: Is it time to worry?” and dropping the phrase “earnings recession”.
The story refers to two separate indicators of business optimism — one tracking large corporates and Wall Street and the other tracking small and medium businesses — that had surged over recent years but are now regressing to the mean. Three reasons for the muted optimism are offered: the trade conflict with China, rising labor costs and a cyclical downturn in the vital tech sector.
But muted optimism is not the same as pessimism. So the article cites Morgan Stanley for more reasons to stoke anxiety: inventory buildups, declines in metals and mining profits and the advanced age of the current expansion are just a few. The kicker, though, is the bulge in corporate debt which “is nearly where it was before the subprime bubble burst in 2008.”
Still, as earnings season plows ahead, the possibility is emerging that the 175-year-old journal got it wrong this time.
“Companies appear to have set themselves up for the worst by warning investors of softer profit growth this quarter, but they may have gone too far, as they often do, and earnings are topping forecasts,” CNBC reports. “The earnings season began this week, with 43 S&P 500 companies reporting as of Wednesday morning, and a whopping 84% beating analysts’ estimates.”
Even so, stocks lost ground last week, with a surprise spike in Persian Gulf tensions Friday overriding any chance of a last-hours rally. The S&P 500 and Nasdaq both dropped more than 1% each, to 2,976.61 and 8,146.49 respectively, while the Dow lost 0.6% ending at 27,154.20. Through the course of the week, all three indexes attained then backed off from all-time highs. New York Fed President John Williams contributed to the whipsaw effect by making comments about the potential need for the central bank to make immediate, dramatic expansionary moves. This excited investors, but their interest abated when Williams’s office clarified that he was speaking as an academician and not as an FOMC member.
U.S. government debt yields declined for the week on the same news. Treasury purchasing led to a temporary positive spread between 3-month Treasury bill yield and the 10-year Treasury note yield. This spread had been inverted — a recessionary signal. The 10-year Treasury note, ended the week with a 2.05% yield, while that of the 30-year Treasury bond had risen to 2.578%.
2-year swap rates reversed direction and are higher than the 2-year U.S. Treasury note (positive spread) while the rest of the yield curve remains at a negative spread. At last read, the 10-year USD swap rate traded at 2.348%.
Gold prices gained over the weekend on Middle East tensions, although the strengthening dollar provided some countercurrent. Spot gold was up 0.2% at $1,427.26 per ounce in early London trading Monday.
Meantime, the same dynamics caused West Texas Intermediate crude futures to rise 47 cents, or 0.8%, to $56.10 a barrel.
This might be old news, but today’s decade-spanning economic expansion is the longest-lived since current measurements and definitions have been in place. It is almost as if no one remembers what a contractionary signal is supposed to look like. Just this past Friday, the 3-month T-Bill and the 10-Year Treasury temporarily reversed its inversion. And mere days after business leaders revealed reservations in their optimism, data showed that consumers were confident enough to buy big-ticket items at a scale that could fuel the boom for months to come. Ongoing trade wars, a heightened risk of an oil war, a looming crash-out Brexit, leading economic indicators pointing downward, a stalled North American trade pact and a hot-and-cold-running manufacturing sector are being treated by the market as so much background noise. Meanwhile, the Fed, to the delight of stockholders and chagrin of macroeconomists, is signaling its first rate cut since the recovery’s early days. In the coming days, we will discover if the Fed chooses to follow through on those signals. The USD LIBOR market is already reflecting a nearly 25bps rate cut. Should the Fed provide such a stimulus — which is likely considering this week’s second-quarter GDP estimate is expected to show a slowdown in growth — we will then find out soon enough if that was the correct course of action.
I. U.S. Economic Data/Markets
- The Conference Board Leading Economic Index declined 0.3% in June to 111.5. This follows no change in May and a 0.1 percent increase in April.
- Consumer sentiment attained its highest peak in 15 years in May. University of Michigan’s preliminary report shows the index rose to 102.4, up from 97.2 in April and far exceeding economists’ expectations of 97.5.
- Retail sales exceeded expectations in June, rising 0.4% over the previous month. Purchases of motor vehicles led the way. Economists polled by Reuters forecasted 0.1% growth. Core retail sales rose 0.7%.
- Auto sales increased 0.7% in June, but receipts at service stations fell 2.8% as fuel costs dipped.
- The Atlanta Fed estimates GDP increased at a 1.4% annualized rate in the second quarter, a significant slowdown from the first.
- The New York Fed’s Empire State manufacturing survey rebounded out of the negative territory. The 4.3 July reading is a 12.9-point month-over-month improvement. A reading above 0.0 indicates improving conditions in New York’s bellwether manufacturing sector.
- Industrial production was unchanged in June nationwide, as increases for both manufacturing and mining offset a decline for utilities. An increase of nearly 3% for motor vehicles and parts contributed significantly to the gain in factory production; excluding motor vehicles and parts, manufacturing output moved up 0.2 percent. Capacity utilization for the industrial sector decreased 0.2 percentage point in June to 77.9%.
- Mortgage applications decreased 1.1% week-over-week, according to the Mortgage Bankers Association, adjusting for the July 4 holiday.
- Housing starts decreased by 0.9% to a seasonally adjusted annual rate of 1.253 million units last month, according to the Commerce Department.
II. Trade
The European Union’s surplus with the U.S. grew to €62.1 billion ($69.8 billion) in Jan-May 2019 from €55.4 billion in the same period of 2018, according to Eurostat. With China, the EU’s trade deficit expanded to €76.7 billion from €69.2 billion.
III. Economics Outside the U.S.
- Chinese Economy
- China’s economic growth slumped to its slowest pace in nearly three decades as the world’s second-largest economy feels the effects of a prolonged trade war with the U.S. GDP grew at a 6.2% annualized rate in the second quarter, down from the previous quarter’s 6.4%. China should anticipate continued “downward pressure” through the remainder of 2019, according to the National Bureau of Statistics.
- Total government, corporate and private debt rose to 303% of GDP in the first quarter, according to the Washington-based Institute of International Finance, up from 297% a year earlier.
- Eurozone Economy
- Economic sentiment dropped to 103.3, its lowest point in nearly three years in June, according to the European Commission.
- Consumer prices increased by 1.3% year-over-year in June, according to Eurostat. Core inflation increased by 1.1%.
- Current account surplus rose to a seasonally adjusted €30 billion in May from €22 billion in April, according to the European Central Bank.
- U.K. Economy
- CPI was unchanged in June at 2.0% year-over-year, matching expectations. Core CPI growth accelerated slightly to 1.8%.
- The International Labour Organization unemployment rate for May held at 3.8%, according to a preliminary reading, while average annual weekly earnings ex-bonus rose 3.5%.
- Housing prices are likely to make moderate gains between now and 2025, according to PwC. This year’s projected 1% growth would be the slowest due to Brexit uncertainty. Assuming an orderly Brexit, though, annual increases of 4% on average are projected.
- Canadian Economy
- Retail sales inched downward 0.1% to C$51.5 billion ($39.4 billion) in May. Excluding auto-related sales, retail declined a full 1.0%. The food-and-beverage sector was hardest-hit, while gasoline sales improved dramatically.
- Sales at motor vehicle and parts dealers improved 0.5% in May.
- E-commerce sales were C$1.8 billion in May or 3.0% of total retail. Year-over-year, e-commerce increased by 21.8%.
- Japanese Economy
- Core inflation, which includes oil products but excludes fresh food prices, rose 0.6% in June from a year earlier, according to Bank of Japan. So-called core-core CPI, which excludes food and energy costs, increased by 0.5%.
Key data/events this week:
- Monday
- U.S. bankruptcy filings
- U.S. national activity index
- U.S. Richmond Fed manufacturing survey
- Canada wholesale trade
- Tuesday
- U.S. Redbook
- U.K. FPC minutes
- U.K. business optimism
- Eurozone consumer confidence
- Japan PMI
- Wednesday
- U.S. oil inventories
- Japan leading indicators
- Japan foreign investment
- Eurozone PMI
- Eurozone M3 money supply
- Thursday
- U.S. wholesale and retail inventories
- U.S. international trade in goods
- U.S. jobless claims
- U.S. durable goods
- Eurozone monetary policy
- Canada earnings, hours and employment
- Japan CPI
- Friday
- U.S. GDP
- Germany retail sales
- China industrial profits
