Economic Strength Continues to Surprise: Jan. 18, 2024

Markets are mixed this morning with stocks seeking to recover from their recent stumbles. Yields are slightly higher though as economic data continues to surprise to the upside. Labor market and real estate sector data this morning arrived much hotter than anticipated on the heels of a scorching-hot retail sales report yesterday.

Labor Market Continues to Defy Expectations

Indicating sustained strength in the labor market, both initial and continuing unemployment claims have declined for the third consecutive week. Initial claims totaled 187,000 for the seven-day period ended January 13—the lowest level in 16 months and substantially below the expected 207,000. Claims also declined significantly from the previous week’s 203,000. Continuing claims for the week ended January 6 also decreased to 1.806 million, surpassing the median estimate of 1.845 million and the prior week’s 1.832 million. The four-week moving averages for both indicators decreased to 203,250 and 1.848 million from 208,000 and 1.862 million in the previous report.

Construction Activity Remains Weak

Despite persistent weakness in construction activity last month driven by mortgage rates approaching 7%, which poses a significant obstacle for potential homebuyers, but both housing starts and building permits surpassed expectations. Building permits reached a pace of 1.495 million seasonally adjusted annualized units (SAAU) in the last month, exceeding the projected 1.48 million and the reported 1.467 million for November. However, housing starts experienced a decline, dropping to 1.46 million SAAU in December from 1.525 million in November. This decline, though, was milder than anticipated by economists, who expected a figure closer to 1.426 million.

The increase in the pace of building permits was relatively evenly distributed between single and multi-family properties, with the former growing by 1.7% month over month (m/m) and the latter rising by 1.4% m/m. Across regions, most areas saw increased activity as follows:

• Northeast, 20.2%
• South, 8.4%
• Midwest, 4.7%

However, the West reported a decline of 16.3% during the same period.

A drop in housing starts was primarily driven by the single-family segment, which declined by 8.6% m/m. The smaller multi-family segment helped offset some of this weakness, gaining 7.5% during the month. In contrast to building permits, the West was the only regional gainer in the report, showing a m/m increase of 4.7%. The Northeast, Midwest, and South weighed on results, with the pace of construction activity decreasing by 16.9%, 8.8%, and 5.1% m/m, respectively.

Investors Scoop Up Tech Ahead of Big Earnings Next Week

Currently, most stock indices are experiencing a rebound, led by the Nasdaq Composite Index, which has surged by a notable 1%, outperforming other major US indices. The S&P 500 and Russell 2000 indices show more modest gains of 0.3% and 0.2%, while the Dow Jones Industrial Average is down by 0.2%. Sector wise, there is negative breadth, with most sectors in decline, except for technology, industrials, communication services and consumer discretionary, which are up by 1.5%, 0.6%, 0.5%, and 0.4%, respectively. On the flip side, the defensive health care, utilities, and consumer staples sectors are the laggards, experiencing declines of 1.1%, 0.9%, and 0.6%.

In the fixed-income market, the yield curve is showing a slight shift toward a bear-steepening formation. The 2-year Treasury remains roughly unchanged at 4.35%, while the 10-year Treasury yield is moving higher, up by 2 basis points (bps) to 4.12%. The dollar is strengthening, supported by higher rates and relatively robust economic performance. The greenback’s index has risen by 17 bps to 103.55, gaining against the euro, franc, and pound sterling, but depreciating against the yen, yuan, Aussie, and Canadian dollars.

Crude oil is trading higher despite a reported surge in US inventories. Traders are focusing on bullish demand forecasts from OPEC + and IEA, as well as potential supply disruptions arising from the Middle East conflict. WTI crude is up by 0.6%, or $0.40, reaching $73.07 per barrel.

Optimism About AI Grows

Recent earnings reports include optimism regarding the growth of artificial intelligence but also caution that the economy is likely to weaken. Additionally, demand for energy infrastructure is growing as the U.S. increases its exports of natural gas. Other industrial areas, however, are continuing to weaken, but in some industries, inventory levels have been reduced. Consider the following highlights:

• Taiwan Semiconductor Manufacturing Co., or TSMC, posted y/y fourth quarter declines in earnings and profits but beat expectations while reporting that the inventory glut of semiconductors is easing, and artificial intelligence is supporting demand for its products. It cautioned, however, that the economy is likely to weaken. For the fourth quarter, TSMC produced NT$ 238.71 billion in earnings, which exceeded the analyst consensus estimate of NT$ 225.22 billion despite declining from NT$ 295.04 billion in the year ago quarter. Its quarterly revenue of NT$ 625.52 billion declined from NT$ 625.532 billion in the year ago. TSMC attributed the decline to an inventory glut but said customers have been decreasing their stock, which should support demand in the coming months. Additionally, after many companies spent last year evaluating AI, they are ready to implement the technology, which will support demand for the company’s new generation of computing chips.

• Kinder Morgan is an energy infrastructure company with various assets, including more than 82,000 miles of pipelines, produced net income of $594 million in the fourth quarter, down from $670 million in the year-ago quarter. After adjusting for one-time expenses, the company’s earnings of $633 million declined from $708 million y/y. Earnings, adjusted for non-recurring costs, were $0.28 cents per share and missed the consensus expectation of $0.31. Kinder Morgan attributed the earnings decline to higher interest expenses and a decline in commodity prices. Milder weather during the quarter also hurt the financial performance of the company’s natural gas pipeline segment. Its product pipeline segment, which transports crude oil and refined products, experienced slightly better results y/y partially due to new capital products. Additionally, increased lease rates for its storage facilities, strong utilization and higher charter rates for its tankers resulted in its terminals segment earnings increasing y/y. Additionally, increasing exports of liquefied natural gas is expected to support demand for the company’s services.

• H.B. Fuller, which makes adhesives and other chemicals for a variety of industries, generated $45 million in profits for the fourth quarter ended December 2, up 5% from the $48.3 million in the year-ago quarter.  Its earnings per share (EPS) after adjusting for non-recurring costs was $1.32, which surpassed the analyst consensus expectation of $1.29. Its $902.9 million in revenue missed the analyst consensus expectation of $927 million and declined from $958.2 million in the year-ago quarter, a result, in part, of customers destocking. Despite the decline in revenues, the company’s previous restructuring helped reduce expenses and contributed to the y/y earnings increase. After a year in which customers aggressively destocked, H.B. Fuller anticipates that its 2024 organic revenue will climb as much as 3% as it believes demand will increase. 

Another Day, Another Head-Fake

I view today’s upward equity movement as a head-fake, primarily supported by technology stocks ahead of the sector’s major earnings announcements starting next week. Sustained gains in the stock market would necessitate exceptional earnings performances from the tech sector and a decrease in yields. However, this seems challenging given deteriorating global macroeconomic conditions and the recent streak of strong US economic data.

Looking ahead, significant insights into monetary policy are anticipated at the upcoming Fed meeting scheduled for the last day of the month. Market participants are keen to gather information on the outlook for interest rate cuts and quantitative tightening. Furthermore, investors are assessing the fate of the Bank Term Funding Program, which is set to conclude in March, around the same time the central bank’s reverse repo facility is expected to run out of cash. These developments hold substantial implications for market liquidity, interest rates, stock prices, the economic outlook, regional bank health, lending activity and bank reserves.

On the fiscal front, there appears to be less excitement, with expectations of increased debt issuance. This aspect may be perceived as less novel or surprising in comparison to the more nuanced and impactful discussions surrounding monetary policy.