The recent economic readings show the service sector of the economy and labor market supporting economic growth while small business optimism and CEO confidence signal an improving outlook from business.
Meanwhile, we are just about through earnings season with earnings once again coming in better than expected while stock market internals are consistent with a healthy uptrend. All of this is discussed below.
Service Sector Continues to Lead
While manufacturing conditions remain sluggish after a massive inventory rebuild earlier in the pandemic recovery, the much larger service sector continues to support economic growth, albeit at a moderating pace. The ISM Services PMI (a timely business survey) fell 1.2 points in July to 52.7 but is still well above the break-even level of 50, consistent with continued expansion in the overall economy.
Order backlogs rebounded into positive territory for the first time in five months, a positive sign for demand. The net number of services industries reporting growth ticked down to 10 from 12 in the previous month, still indicating strong breadth and also consistent with continued expansion for the economy.
Labor Market Remains Tight
While the July employment report showed slower growth with nonfarm payrolls expanding by a less-than-expected 187,000, the unemployment rate fell to 3.5% from 3.6% which remains historically low. Aggregate payrolls, which combine hours, payrolls, and wages, eased to 5.7% y/y. This was the slowest growth rate since March 2021, but still markedly higher than pre-pandemic. It supports continued growth in personal income and spending, albeit at a slower pace than earlier in this cycle, raising the odds of a soft landing for the economy.
Small Business Optimism
The NFIB Small Business Optimism Index increased for the third consecutive month in July, to its highest level since November 2022, and above the consensus estimate. While it is still well below its pre-pandemic peak and historical average, the improvement in recent months suggests budding optimism about the economic outlook. The index is up 2.2% from a year ago, the strongest y/y momentum since December 2021, and is historically consistent with growth accelerating for the broader economy. Lower inflation is playing an important role in better small business optimism.
CEO Confidence Improves
The Conference Board’s CEO Confidence Index rose to its best level since the first quarter of 2022. The increase in CEO confidence reflects markedly better current and expected conditions both for the overall economy and for CEOs’ own industries. Fewer executives than in the previous survey (84% vs. 93% before) expect a recession in the next 12-18 months. Most believe a potential contraction would be brief and shallow, with limited spillover globally.
Earnings Season Better Than Expected
Second quarter earnings season is almost complete with 89% of the S&P 500 market capitalization reported. Given the positive economic surprises throughout the second quarter and the muted outlook from most companies to start the year, it’s not surprising that earnings are beating estimates with 75% of companies topping expectations. Earnings are now expected to be down 4% in the second quarter after starting earnings season with expectations of minus 8%. This negative growth is primarily driven by weak earnings in Energy and Materials which faced tough comparisons after last year’s spike in commodity prices due to the Ukraine crisis.
Stock Market Internals Encouraging
We remain encouraged by the market’s cyclical leadership with most industries in an up-trend and the majority of stocks above their 200-day moving average. Most major indexes have rallied more than 20% off their October lows and are reaching new 52-week highs.
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