Monday, July 29, 2019

Economic And Company Data More Positive, But Headwinds Exist

One area of the economy in both the U.S. and abroad that has garnered heightened attention of late is the manufacturing sector. Based on business surveys it is clear trade and tariff issues are having a more significant impact on the manufacturing sector. As the below chart shows the Purchasing Managers Index for manufacturing has dipped below 50 in the Eurozone yet remains above 50 in the U.S. A reading below 50 indicates the manufacturing sector is contracting, but not necessarily a recessionary level reading. Recessionary readings generally are in the low 40's area. Although the U.S. manufacturing PMI is above 50, the sector has slowed since its mid 2018 level.

When evaluating the services side of the economy though, this area has held up fairy nicely. Both the Eurozone services PMI and the U.S. services PMI remain above 50. With the services sector representing nearly 80% of GDP in the U.S. and 70% globally, less of a headwind is felt on overall economic growth as a result of a slowing manufacturing sector.

We noted in our Summer 2019 Investor Letter that some of the recent data and Fed actions are resembling the mid 1990's period. And from a strictly economic data and company earnings perspective some of the data is similar to the 2015/2016 economic slowdown. In the mid-July Philly Fed Business Survey, the general conditions index spiked higher to 21.8 versus consensus of 4.5. Econoday notes,
"The general business conditions index surged 21.5 points in July to a far higher-than-expected 21.8 in a gain mirrored by similar swings higher for new orders, now at 18.9, and employment now at a whopping 30.0. Shipments are at 24.9, delivery times are stalling at 15.0, and inventories are on the rise at 8.1 -- all signs of very strong demand."
Notable in the below chart is the fact the Philly Fed Survey experiences a large drop before the recessionary periods that are shaded in grey. This type of drop is not seen currently.

Another strong report related to manufacturing is last week's durable goods orders report. The 2.0% increase exceeded the high end of the consensus range. Again, as noted by Econoday,
"Not even the 2.0% headline jump in June,...nor the 1.2% surge in ex-transportation orders that far exceeds the consensus range, take the spotlight in this report. It's a rare 1.9% jump in core capital goods orders that points to new confidence in the business outlook and the release of prior pent-up demand for new production equipment."

The first two charts in this post were taken from a very detailed post by Scott Grannis. His post contains a dozen or so charts on the economy and the Fed that is a worthwhile read and review. as he notes, and we agree, there is a lot of conflicting data making it difficult to get a clear reading on the economy and the market, especially with the economy having slowed. As Warren Buffet once said, “In the business world, the rearview mirror is always clearer than the windshield.”

However, we currently believe there are more positives than negatives at this point in time. An important positive is recent earnings reports. Refinitiv notes in the This Week in Earnings report, that 75.2% of S&P 500 companies have reported earnings above analysts expectations. This compares to the long term average of 65%. Before the Q2 earnings reporting season was underway, it appears analyst were too pessimistic on corporate earnings expectations. We believe earnings have bottomed here and look for double digit growth in 2020, all else being equal.

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