March 3rd, 2023
The fourth time was the charm for the S&P 500, which posted its first winning week since late January. After oscillating between positive and negative territory for much of the week, Friday’s economic reports were viewed favorably by investors, who focused more heavily on what the data suggested for the economy’s resiliency than what it could ultimately mean for higher rates. The ISM Services and Manufacturing indexes showed business accelerating slightly in February as new orders grew. Traders were quick to highlight indicators showing growing underlying demand, which pushed economically sensitive sectors higher on the week. Materials, industrials, and energy sectors led the way with gains of 3.42%, 1.66%, and 1.56%, respectively. Overseas data painted a similar picture with China’s PMI showing strong factory activity now that manufacturers are finally getting back to stride following their lockdown. With China back online, feedstock is now beginning to flow to other global manufacturers, allowing them to tackle their own backlogs and accelerate activity. The week managed to successfully close on a high note where the S&P 500 added 1.90%, of which 1.61% was added on Friday alone.
New Orders Improve Business Outlook
Business conditions improved slightly in February even as inflation remained a problem. The ISM Services Index held steady at 55.1, down only notionally from January’s reading of 55.2. Numbers above 50 indicate expansion while those below signal contraction. Within the index, however, new orders increased by 2.2 points, resulting in a solid 62.6 reading in February. To fill these orders, businesses were busy adding staff in February with the gauge that measures employment rising 4 points to 54. Aside from a brief dip in December, the services sector has consistently benefitted from a Covid tail effect as consumers have revisited missed and delayed experiences. Consequently, the services index has hovered in the 54-56 range for the better part of the last year. The manufacturing sector, however, has suffered from a combination of reduced demand, higher input costs, and higher consumer financing costs, which has resulted in the ISM manufacturer’s index declining month-over-month since August. That was true until February. For the month, the ISM Manufacturing Index managed to squeak out a 0.3 point increase, rising to 47.7 from 47.4 in January. A small victory, but a victory nonetheless at least as far as markets were concerned. Although the sector is still well in contraction territory, the gauge for new orders rose 4.5 points from the previous month to 47. An interesting sidenote is that the survey indicated new order rates could have been even stronger were it not for buyer and supplier disagreements regarding price levels and delivery lead times. The demand was essentially there despite terms not aligning. The odd part with investors’ response to the survey was that they completely dismissed the inflation reading. The prices index rose 6.8 points to 51.3, ending a four-month trend of lower prices. Overall, it was an overly optimistic interpretation to a fairly innocuous set of reports.
China Manufacturing and Services Activity Continues to Rebound
China’s manufacturing activity rebounded solidly in February, rising to 52.6 from 50.1 in January. That’s its highest reading since April 2012 when it hit 53.5. Non-manufacturing activity also grew further to 56.3 from January’s reading of 54.4. The moves higher were driven by businesses resuming more normal operations as the country dropped Covid restrictions. In the manufacturing sector, furniture manufacturing, metal products, and electrical machinery equipment saw the biggest improvements, with production and new orders all above 60. Manufacturing activity also got a strong bounce in new export orders which rose for the first time since April 2021. On the services side, business activity continued to accelerate, rising 1.6 points to 55.6. New orders also rose during the month, up 3.3 points to 55.8 points. While the market may have applauded the increased activity and an easing in the supply chain, the knock on effect from a reinvigorated Chinese industrial base may be an uptick in inflation as backlogged orders begin to get filled.
It is difficult to draw any profound conclusions in a week that essentially came down to a single day’s performance. It was encouraging to see the PMIs inflect slightly – particularly in U.S. manufacturing which has been in a consistent skid for the past 6 months. The modest recovery in those readings is perhaps evidence that, this far into the rate tightening cycle, buoyancy still exists in the economy. That observation may ease concerns over a deteriorating spiral knowing that additional rate hikes still lie ahead. That may be comforting, but that “buoyancy” is the very thing the Fed has identified as a problem and it is what the market has been grappling with since February as the inflation data started strengthening. The fact that the manufacturer’s ISM price sub-index didn’t spook markets more is entirely perplexing. Fed governors spoke on Thursday and again on Friday. Their message remains the same. While they may be done with 50 bps hikes, a series of 25 bps hikes is still planned. Furthermore, the tone is increasingly hawkish which makes sense since they proclaim their actions will follow the data. With the Fed’s next FOMC meeting still a few weeks off, however, investors were content to trade on sentiment more so than fundamentals on Friday. We will see if that sentiment holds with next week’s jobs report on tap.
The Week Ahead
All eyes will be on the labor market with big reports on nonfarm payrolls and the Job Openings and Labor Turnover Survey (JOLTS). Traders will also pour over the latest international trade reports for consumer spending patterns.
Spending, Debt, and Delinquencies
As reported in Probity’s market commentary last week and mentioned above, record high inflation and rising interest rates have not suppressed consumers’ desire to spend, and consumers appear willing to leverage themselves to do so. We wanted to do a deeper dive into the data this week since what is happening in the economy appears to be defying expectations among economists and the Fed, and it’s pretty fascinating.
A recent report by the Federal Reserve Bank of New York showed that credit card debt in America has reached record highs. The Quarterly Report on Household Debt and Credit released last month by the New York Fed’s Center for Microeconomic Data found that in the fourth quarter of 2022, total outstanding credit card debt held by Americans reached $986 billion. This marked a $61 billion increase over the previous quarter and the largest quarterly increase in 20 years. For comparison, the pre-pandemic high was $927 billion in the fourth quarter of 2019. The New York Fed’s report showed that household debt rose by $394 billion last quarter, or 2.4%, to $16.90 trillion in the fourth quarter of 2022 which is $2.75 trillion higher than just before the COVID-19 pandemic began.
Economists and retailers would typically expect January to be a soft month for retailers on the heels of holiday shopping, yet retail sales were up 2.3% from December 2022 to January 2023, and up 3.9% above last year. Total sales for November 2022 through January 2023 were up 6.1% from the same period a year ago. Spending on goods in particular rose 2.8% month-to-month. Food services and drinking places were up 25.2% from January 2022, while general merchandise stores were up 4.5% from last year.
We noted in our commentary last week that consumer spending is an indication that consumers are feeling confident in the jobs market: the labor market remains unusually tight with the unemployment rate in January reaching the lowest level since 1969. The pressure of historically high inflation and rising interest rates don’t seem to be discouraging consumers as one might expect. Higher consumption has been supported to some degree by a 0.60% increase in monthly personal income, up from the prior month’s 0.30% rise. While wages have been rising, the recent pace of wage increases has been slowing, and pay boosts are not keeping up with inflation.
The Fed’s report shows that not only are credit card balances rising at record levels, but credit card delinquencies are also on the rise. The share of current debt becoming delinquent increased across nearly all debt types, with credit cards and auto loans showing delinquency transparency rates of 0.6 and 0.4 percentage points, respectively. At the end of 2022, 18.3 million borrowers were behind on a credit card, according to New York Fed researchers. That compares to 15.8 million at the end of 2019. This shows that the current economic environment does appear to be testing some borrower’s ability to repay their debts but doesn’t seem to be enough to curtail spending and cool the economy.