Getting Back to Normal
On Wednesday, Jerome Powell, Chair of the US Federal Reserve, stated that the Fed was not considering a 50-basis point cut. Today, only two days later, the market is pricing in a 50-basis point cut, driven by the worst US Factory Orders since the pandemic. The employment numbers were extremely weak from both ADP and non-farm payrolls, while unemployment ticked up to 4.3%. The three major areas of concern are global manufacturing, China, and consumer spending.
Manufacturing Shrinking: Global manufacturing is under pressure, as evidenced by a raft of activity gauges this week. The US ISM index fell to an eight-month low, China's factory sector remains in contraction, and the eurozone PMI signals further deterioration in that region. The PMIs contained negative signals for demand, with factories commonly reporting declines in output and new orders (Reuters). Meanwhile, growth in major Asian trading economies, such as South Korea and Japan, is heavily influenced by AI-driven demand for chip and chip-related exports as household consumption remains a drag. Global EV manufacturing is slowing and being delayed in many jurisdictions as reality versus expectations finally sets in!
Weak China Economy: China's data, ranging from manufacturing and investment to retail sales, shows that momentum continues to slow, with credit growth at a record low and deflationary pressures lingering despite incremental easing over the past year (Bloomberg). Property rescue measures have fallen short after recent figures on investment, home prices, sales, and construction starts showed ongoing steep declines. China's economic weakness is also having regional impacts, with Asian factories experiencing slower manufacturing activity in July (Bloomberg). Remember, China led the world in growth for over three decades, and now they are leaning towards a ZERO-interest-rate policy to stimulate the economy.
Negative Consumer Takeaways from Corporate Commentary: Recent corporate results in the US and Europe appear to signal cracks in the consumer resilience narrative amid pressures from the cost of living and interest rates. Firms have made anecdotal observations of a credit card spending slowdown, declining restaurant traffic, a fall in purchases of big-ticket items, lower travel demand, and China-driven weakness in luxury retail (Bloomberg). Reuters discussed how tepid China consumer spending is increasingly affecting a wide range of multinational corporate earnings.
With the major indexes taking it on the chin this week, led by large tech companies — for example, Intel is experiencing its worst day since 1974, and Amazon is having its worst day since April 2022. On the flip side, gold has eclipsed the $2,500 USD mark, 10-year US Treasury bond yields have dropped from 4.4% to 3.8%, and 5-year bond yields have fallen from 4.05% to 3.65%. In Canada, our 5-year notes now yield 2.88%, down from 3.2% at the start of the week. This is significant because mortgage rates are based on these bonds, meaning variable and fixed-rate mortgages should see relief rather soon. Companies like BCE, Telus, TC Energy, Capital Power, and Hydro One are all higher for the week. As yields continue to drop, investors look for alternatives for income replacement, and companies like those mentioned have excellent dividend yields.
The big question is whether a soft landing or a more drastic economic downturn (hard landing) is coming. For the past two years, central banks globally have been fighting higher inflation, due to all the post-pandemic government spending, by using higher interest rates as the blunt tool to hammer inflation. All of a sudden, it appears they may have used that tool a bit too long, and we are slowing down fast. Depending on the damage and the following actions taken, the markets react differently. According to Bank of America, market performance following the first cuts of a new easing cycle into a soft economic landing found the S&P up ~10% six months later (three episodes since 1970), while the S&P was down ~3% six months after cutting into a hard landing (seven instances). Let’s hope that the Fed acts sooner rather than later and moves to cut rates and ease the money supply enough to work towards a soft landing.
One major demographic point that all the major business news outlets have ignored is the lack of population growth in the US. Even with massive immigration, US population growth is as anemic today as it was during the Great War. Since the decade after World War II, US population growth has been steadily declining, leading to slower economic growth. Unfortunately, with ZERO population growth, there is very little new demand created to benefit the economy as a whole. The only other method to spur growth is through productivity. With the explosion in AI, labour productivity is improving, but this will not be a long-term story. Once AI becomes widespread and is readily available to all consumers, it will become commoditized, creating pricing pressure. So, we are back to pre-COVID economic growth—annual growth will be around 2% to 2.5% annually among OECD countries, and inflation will finally settle into 2% to 3% annually.
