Markets Shrug Off Suggestion of Peak Growth
July 9th, 2021
Hot off a long Fourth of July weekend, market bulls were primed to take markets to new highs. They did just that on both Wednesday and Friday on enthusiasm that the U.S. economy is bouncing back strongly from Covid-19. Air travel hit a post-pandemic high during the five-day holiday weekend with the TSA reporting over 10.1 million passengers hitting the skies. That is equivalent to 83% of travel volume for the same period in 2019. Bullish sentiment moderated slightly on Thursday, however, as concerns grew that more transmissible Covid variants in countries with low vaccination rates could throw a wrench in the global economic recovery. The surge in cases has prompted several countries to re-introduce social distancing measures in an effort to head off the surge while they ramp up vaccinations. Concerns surrounding a slowing global recovery coincide with potential signs in the ISM reports indicating that the U.S. economy may have reached peak demand for goods and services. Traders also revisited June’s nonfarm payrolls report which was released late last week. Businesses added 850K to the payrolls, up from the previous month’s 559K. Thursday’s market swoon was only temporary once bulls digested Pfizer’s announcement that it would file for a Covid-19 booster to target the delta variant. Re-opening plays such as cruise lines and casinos as well as economically sensitive financial and industrial stocks posted healthy gains during the trading session, helping the S&P 500 end the week higher by 0.40% to a new record high of 4,369.55.
Job Market Gathers Steam
It was another strong print for nonfarm payrolls as 850,000 hires were made in June, beating expectations for 706,000 new hires. Despite the rise in payrolls, the unemployment rate ticked up to 5.90% from the previous month’s 5.80%. The upward tick coincides with more prime-age workers, or those between 25 and 54 years old, electing to seek new jobs. The hospitality industry led in job creation with 343,000 added to the payrolls. Education also notched gains with 269,000 new hires. Professional and business services and retail added a healthy 72,000 and 67,000, respectively. For home buyers, the bad news is that the construction industry shed 7,000 positions as supply shortages and soaring materials costs prompt builders to tap the brakes on boosting their payrolls despite strong demand for housing in general. June’s payroll report brings the total jobs recovery from the pandemic to 15.6 million. Still more work is needed on the jobs front, however, as the total employment level remains 7.13 million below where it was in February 2020.
Services and Manufacturing Sectors Cool for the Summer
Strong pent-up demand for services pushed the ISM Services index to a record high of 64 in May, but June’s report showed demand slipped slightly in June with the index falling to 60.1. This missed estimates of 63.3. Numbers above 50 indicate expansion, while numbers below indicate contraction. A shortage of labor, rising raw materials costs, and a slowdown in new orders pulled the topline figure down. Manufacturing also slipped in June with the ISM Manufacturing PMI falling to 60.6 from 61.2 in May. That’s the sector’s lowest reading since January. The sector has struggled to meet surging demand on a raw materials shortage which has driven up costs and a shortage of qualified labor. New orders also grew at a slower pace as fractured supply chains have depleted inventories at factories and business warehouses. Although the indexes have slipped from recent highs, they still remain firmly in expansion territory. Demand should continue to remain healthy as consumers increase their mobility this summer.
July experienced a slightly more volatile start but that is relative to what was a very calm June. We continue to sit near all-time highs for most equity markets and given that the S&P 500 is trading at a 23x estimated 12-month earnings multiple, bulls are definitely paying up on the hopes of squeezing out additional gains at a time when it looks like we are at peak activity. It will be months before we see the degree to which the marginal decline in demand will translate into a material impact on earnings. While we certainly don’t expect a sharp drop in macro demand, we accept that we are likely cresting not only because of the proclivity to spend following Covid may have maxed out but also because of individuals’ ability to spend may wane, given that more people will soon be back to more structured routines come fall. On Thursday, investors were briefly spooked by the suggestion we have hit our zenith, but the fact is there has not been a sustained period of pessimism in nearly 16 months to prevent the dip buyers from pushing the market right back up. We’d expect things to get more interesting once the data starts to actually shift and the Fed starts to change its tone as we progress into the latter part of the year.
The Week Ahead
Will consumer and producer prices prove too hot for consumers to handle? We’ll find out as consumer and producer prices as well as retail sales results are released next week.
Carpocolypse
The pandemic is affecting the car industry in unusual ways. New car sales are being impacted by a global shortage of semiconductor chips resulting in low supply of inventory and higher prices. The average new car price hit $41,000 in June, up 5% from a year ago, and the average used car price hit $26,500, up 27% from a year ago. Sales of automobiles dipped at the beginning of the pandemic and began rising again in the latter half of 2020. U.S. auto sales in 2020 were about 14.6 million, down by about 3 million from the previous year. In 2021, the forecast is for sales of about 15.7 million cars.
Rental car companies have been affected as well. Last year, rental companies sold off parts of their fleets when bookings were low to stay above water. This summer, demand for rental cars has skyrocketed, and rebuilding those fleets is taking time which has created a supply shortage that is driving up rental costs. In Hawaii, tourists have resorted to renting U-Hauls to avoid paying rental prices that are as much as $1,000 per day. Some have called the situation a “car rental apocalypse” as companies scramble to meet demand. Both Hertz and Enterprise expect excess demand to continue through the near future. RV rental company Outdoorsy witnessed a 1,500% surge in bookings from the lowest booking day amid the pandemic to the highest booking. Outdoorsy is the Airbnb of recreational vehicles. It’s an online marketplace where renters can book camper vans, trailers, and motorcoaches from RV owners. It gained popularity as a way for people to vacation and social distance during the pandemic.
For the first time, the average age of vehicles on the road in the U.S. has surpassed 12 years old. According to new research from IHS Markit, the average age of a car in the U.S. climbed two months to 12.1 years, up from 11.9 in 2020. A decade ago, the average age of a vehicle in the U.S. was 10.6 years according to IHS Markit, and in 2002, the average age was 9.6 years. Vehicles are becoming more durable and lasting longer, and older cars are holding their value. Analysts note that cars used to be ready to hit the scrapyard when they reached 100,000 miles, and now it’s not uncommon for cars to be driven up to two times that distance or more, particularly electric cars. This is due to advances in automotive technology, such as improved parts and materials, improved assembly, better electronics, the advent of fuel injection, and use of synthetic oil, to name a few.
2020 also saw a sudden increase in vehicle scrappage, which is vehicles leaving the road. The causes for vehicle scrappage are accidents, air bag deployment, wear and tear, damage from fire or water, and other factors that render vehicles too costly to repair. It may also encompass cars that were mothballed or stored due to the pandemic when owners opted not to renew registration. Scrappage saw its highest volume in two decades at over 15 million units, comprising 5.6% of vehicles in operation. Typically, an increase in the scrappage rate would be expected to decrease the average vehicle age mentioned above, but this has been a weird year for the car industry.
During the pandemic, Americans put fewer miles on their cars. Miles traveled declined more than 13% last year due to pandemic-induced lockdowns and people working from home. As offices re-open, vehicle owners who may have allowed registrations to lapse because they were working from home may renew those registrations. The high demand and high prices offered for older vehicles may motivate individuals to sell their current vehicle and trade up to something newer.
As journalist Jim Henry said, the auto industry is “pervasive, yet little understood.” The anomalies of the past two years, and their broad reaching effects, have really proven his point.
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