PMIs Reflect Robust Conditions in April, Underpinning Renewed Inflation Concerns: Apr. 21, 2023

This morning’s manufacturing and services data offered more surprises amidst mixed messages concerning the economy. At a time when investors are concerned about recession, inflation and the Federal Reserve, both the manufacturing and services sectors experienced sharp upticks in activity during April. Meanwhile, the equity market continues to maneuver like a rocking chair, back and forth between the S&P 500 ranges of 4100 and 4150.

The Flash Purchasing Managers’ Index (PMI) from S&P Global was a scorcher this morning, offering more confusion just a day after initial and continuing unemployment claims continued to reflect a slowing labor market. The services sector notched a 12-month high of 53.7, much higher than the 51.5 expected and achieving progress from last month’s 52.6 reading. Meanwhile, the manufacturing sector crawled out of contraction territory, reaching 50.4, a five-month high and the same level as October. The 50.4 level trounced expectations of 49 and was higher than last month’s 49.2.

Executives from both the goods and services sectors reported strong purchasing activity, robust hiring and elevated output. At the same time, however, cost pressures accelerated significantly, leading to renewed inflation concerns against the backdrop of a still hawkish Federal Reserve (Fed). Prices in both sectors rose at the fastest pace since September of last year. Taken together and consistent with our in-house inflation models and the Cleveland Fed’s inflation nowcast, April inflation is expected to be significantly hotter than March. 

Markets aren’t sure how to react to the recent confluence of conflicting economic information. Initially, the S&P 500 Index opened flat and drifted higher. Subsequently, it declined as much as 0.4% following the 9:45 am PMI release and is now roughly flat at 4130. The interest rate sensitive Nasdaq Index has fared similarly, nearly unchanged against the backdrop of some of the lowest volatility readings we’ve seen in over a year and change. The VIX was at 16.81 after aggressively breaking below an established intermediate term floor of around 20 since January of last year. Bonds yields are higher at the shortest end (1- and 2-month maturities) while the rest of the curve and the dollar are roughly unchanged. WTI crude oil is up 0.8% to $78.00 per barrel, propelled by hotter-than-expected economic data looking ahead to the summer driving season.

Despite the strong PMI readings today, earnings reports among cyclical companies this week have discussed weakening demand for products and services. They include the following:

• Transportation and logistics company JB Hunt is probably the strongest example. Its first quarter eps of $1.89 missed the Zacks consensus estimate of $2.04 and was significantly below the company’s year ago earnings per share (eps) of $2.29. Its revenue of $3.23 billion also fell short from a year ago with the company producing $3.48 billion in revenues in the first quarter of 2022. A decline in container imports at West Coast ports and overall weakness in trucking volume hurt the company’s results while JB Hunt’s management believes we are currently in a shipping recession. Earnings were also hurt by higher interest rates increasing the company’s interest expenses alongside a one-time loss for disposing of equipment.
• Provider of aluminum and aluminum oxide Alcoa also reported declining demand for its products. The company posted a loss of $231 million in net earnings or $1.30 per share, an improvement from the $395 million loss or $2.24 a share in the fourth quarter. The first quarter results, however, fell short of the $469 million in earnings, or $2.54 a share, in the year ago quarter. The company reported a decline in demand for its products, but said higher prices helped it increase revenues modestly from $2.66 billion to $2.67 billion quarter-over-quarter. 
• Tesla’s earnings report and subsequent actions provide additional insight into a weakening economy. It posted first-quarter profit of $2.5 billion, down from $3.3 billion in the first quarter of last year. Its diluted eps of $0.73 declined from last year’s $0.95 and missed the Zacks consensus estimate of $0.74. The sharp decline in earnings occurred despite Tesla’s year-over-year revenues increasing from $18.75 billion to $23.32 billion and the company setting a new record for automobile sales. Tesla had experienced underutilization of certain new factories and higher costs for commodities, logistics and warranties. It also generated lower revenue from environmental credits. During the quarter, Tesla made significant price cuts, which boosted its sales, but caused profits to drop significantly. During the earnings presentation, CEO Elon Musk said he believes the economy could include “stormy weather” during the next 12 months and that the company may make further price cuts to further stimulate demand, which caused its stock price to tank approximately 10%. However, last night, its website indicated that Tesla increased prices for certain models by $2,500, leading to a modest recovery of 0.5% for its shares this morning.

On a positive note, industrial real estate provider First Industrial Realty Trust posted strong results. Its net income was $0.59 per share, exceeding expectations calling for $0.57 per share and up from $0.53 a share a year ago. The company’s revenues were $149.4 million compared to the $143.6 million expected by analysts and higher than the $125.51 million in revenues in the first quarter of 2022. The company reported successfully increasing its rental rates on rollover leases and new leases while maintaining a high occupancy rate.

Against this backdrop, equities are pricey at nearly 19 times forward earnings when considering elevated yields on short term paper, as investors bet the house on a cutting Fed. 

As the Fed prepares to meet next month, investors are hiking their expectations of Fed rate increases this year, with 86% odds cementing a 25-basis point (bp) hike in May. On top of that, 27% odds now favor an additional 25 bp hike in June as traders revisit an inflation fighting Fed and forget about financial stability, for now. Still, however, market players are expecting cuts in the second half of the year, a sharp discrepancy from the commentary Fed speakers have provided supporting a higher-for-longer fed funds rate. Against this backdrop, equities are pricey at nearly 19 times forward earnings when considering elevated yields on short term paper, as investors bet the house on a cutting Fed.