In brief
- The U.S. economy is giving mixed signals: Services spending is robust and industrial production has improved but the housing market remains weak.
- Payroll growth is slowing and the unemployment rate is rising, yet wage growth is still a bit too warm. Overall, the data suggests a gradually cooling labor market.
- June’s CPI data was cooler than expected, raising the likelihood that the Federal Reserve will ease rates by September.
- Heightened earnings expectations, driven by projections for year-over-year margin expansion, have made this earnings season more challenging than prior quarters.
- Our constructive outlook for the economy and monetary policy leaves us overweight equities and credit, and modestly underweight duration, in our multi-asset portfolios.
The U.S. economy is navigating a complex but promising phase, with recent data releases reflecting a nuanced yet optimistic outlook. U.S. economic data released in the past few weeks has generally aligned with the softer activity and labor market data observed recently. The icing on the cake was the June CPI report, showing the stickier components finally started to ease. This leaves September as a live meeting for the Federal Reserve with markets assigning about a 95% probability to the Federal Open Markets Committee starting to reduce rates.
Retail sales have been better than expected and spending on services remains robust, indicating resilient consumer behavior. Industrial production saw a significant uptick in June and preliminary PMI data suggests that this positive momentum likely continued. The housing market faces challenges from higher interest rates and limited supply. Yet the overall economic trajectory appears poised to align with long-term growth trends in the second half of 2024.
In this context, we are confident that the Federal Reserve will begin easing monetary policy, creating a more favorable environment for risk assets.
Retail, housing and jobs: A nuanced picture
June retail sales exceeded expectations, leading estimates for 2Q real consumer spending higher as a result. The report should ease concerns about a sudden downshift in consumer spending. June’s total nominal retail sales and food services spending were unchanged (due to declines in motor vehicles and gas stations) but spending excluding these categories surged by a robust 0.8% month-over-month (m/m). The control category (excluding auto, gas, building materials and food services) increased 0.9% m/m. Meanwhile, both May and April retail sales data were revised higher. Furthermore, alongside the promising consumer prints, a rise in corporate spending, on capital goods and building materials, suggests that business fixed investment may accelerate.
Housing, on the other hand, remains under pressure. Housing starts and permits surpassed expectations in June, rising 3.0% and 3.4%, respectively. The improvement was driven primarily by the volatile multifamily segment; single-family components declined. This rebound in multifamily construction is likely due to rising inventories of single-family homes. Despite the June uptick in starts and permits, however, both were significantly down for the second quarter. Total housing starts dropped 16% quarter-over-quarter (seasonally adjusted average rate) and permits fell 22%, signaling a near-term drag on residential investment.
The June employment data presents a nuanced picture of the U.S. labor market, marked by both strengths and areas of concern. Payroll growth is decelerating and the unemployment rate is inching higher, yet wage growth remains somewhat elevated. High-frequency employment indicators, such as initial and continuing jobless claims, are trending upward, consistent with a gradually cooling labor market.
Nonfarm payrolls exceeded expectations, driven primarily by government employment, while private payrolls came in below estimates. The unemployment rate rose modestly in June, to 4.1%, considered a "good" increase because it was due to labor force expansion (Exhibit 1). Temporary help service jobs saw a notable decline but overall employment in the services sectors, such as leisure and hospitality, continued to grow, albeit at a slower pace. Average hourly earnings increased slightly and weekly hours decreased slightly.
An expansion in labor force participation has driven the unemployment rate higher
Exhibit 1: Labor force participation rate (%)
Source: Bureau of Labor Statistics, Haver Analytics, J.P. Morgan Asset Management Multi-Asset Solutions; data as of July 22, 2024.
Interrupting the broader cooling trend in labor demand, the May Job Openings and Labor Turnover Survey (JOLTS) showed a rise in job openings. Yet hiring rates also ticked up and the quits rate remained stable, suggesting modest downward pressure on wage growth. Furthermore, although jobless claims have settled into a higher range compared to earlier this year, they are still comparable to last summer's levels.
The June survey data presented a mixed but cautiously optimistic picture. The flash U.S. June Composite PMI exceeded expectations, at 55.1, driven by a rise in the services component. The manufacturing PMI also saw a modest increase, to 51.7, as new orders and employment rose, although output and prices declined.
The ISM manufacturing index sent a different signal, declining on weakness in production and output. Importantly, however, both reports indicated some positive momentum with an increase in new orders and easing prices.
In the services sector, reports diverged: The ISM index dropped to 48.8, the lowest since 2020, whereas the S&P PMI rose to 55.3, a two-year high. The ISM business activity and new orders indices saw significant declines but the PMI showed improved new business activity and employment.
How do you get stronger earnings with weaker growth?
But what does a backdrop of moving toward more trend-like growth mean for profits? Interestingly, the significantly heightened expectations seen in the second quarter of 2024 present the greatest challenge since 2021 to surpassing consensus EPS growth estimates. However, earnings revision ratios and pre-announcements do not indicate a significant risk of negative EPS surprises. And negative preannouncements are lower than in the last two quarters.
Importantly, we think more reasonable Magnificent 6 earnings growth projections make 8% EPS growth achievable. Earnings growth in Q2 looks set to be driven primarily by the Mag 6 companies, with a broadening of this growth to other companies expected in the second half of the year. The risk that margins could surprise to the downside is lower for the Mag 6 than the S&P 500’s other 494 companies. Year-over-year (y/y) margins are projected to expand moderately in Q2 and more robustly in the second half, with core operating margins expected to increase by 64 basis points y/y in Q2. That leaves them on track to return to pre-COVID highs by the end of the year.
At writing time, the Q2 earnings season had kicked off with reports from the largest U.S. banks, which have generally showed strong capital markets activity but still sluggish loan growth. More broadly, S&P 500 operating EPS is currently tracking USD 58.24, representing 6.2% y/y growth. Pro forma EPS is tracking at USD 59.20, indicating 8.6% y/y growth, and seven of 11 sectors are expecting positive pro forma earnings growth in Q2. The most significant source of earnings growth, in Q2 and the coming quarters, is expected to be the Communication Services and Technology sectors. Ongoing cost-cutting efforts by many of the other 493 S&P Index companies are improving earnings, bolstered by favorable base effects.
While growth stocks are expected to continue their robust profit growth, pro forma earnings are set to contract in the Energy, Materials and Industrials sectors. In Financials, sluggish loan growth will likely drag on net interest income, but improvement in the Insurance and Capital Markets business segments should support earnings growth. Healthcare shares are expected to post earnings growth of 18.0% y/y as the sector recovers from 2023’s earnings recession. Within the consumer sectors, businesses that have embraced Americans’ rising price sensitivity look positioned to generate the best results.
Asset class implications
We expect that a broadening of earnings growth beyond the Magnificent 6 should support opportunities in the more value-oriented parts of the U.S. equity market. Furthermore, while small cap equities are performing better, we consider this more of a tactical, rather than structural, opportunity. The market has consistently rewarded earnings this cycle, leaving us to “follow the profits” when evaluating opportunities in U.S. equities. Given our constructive outlook on the economy and monetary policy, we are overweight equities and credit, and modestly underweight duration, in our multi-asset portfolios.
Exhibit 2: Multi-Asset Solutions Asset Class Views
Asset Class | Opportunity Set | UW | N | OW | Change | Conviction | Description | |
---|---|---|---|---|---|---|---|---|
Main asset classes | Equities | Equities — Overweight | Neutral | Moderate | Global growth close to trend supports ongoing earnings growth, valuations a headwind even with easing cycle in play | |||
Duration | Duration — Neutral | Neutral | Not applicable | Rate cutting cycle limits upside for yields, but market may be pricing more rate cuts than realistic given solid pace of growth | ||||
Credit | Credit — Overweight | Neutral | Low | Trend-like growth and attractive all-in yields supportive to credit despite tight levels of credit spreads | ||||
Preference by asset class | Equities | U.S. large cap | U.S. large cap — Overweight | Neutral | High | High quality and strong EPS but valuations, esp. in tech, are a headwind; concentration risks mitigated by cash flow generation | ||
U.S. small cap | U.S. small cap — Overweight | ▲ | Not applicable | Outlook improving as recession risk is contained, but favor profitable firms with low leverage given elevated financing rates | ||||
Europe | Europe — Underweight | Neutral | Moderate | Ongoing weakness in global goods cycle and evidence of inventory overhang in key industries hold back EU equities | ||||
Japan | Japan — Overweight | Neutral | Low | Improving earnings yield and bottom up profitability point to upside, outflows suggest that overbought conditions from mid-year are behind us | ||||
UK | UK — Neutral | Neutral | Not applicable | Attractive valuations and higher free cash flows support UK equities, but defensive nature of UK index a near-term headwind | ||||
Australia | Australia — Underweight | Neutral | Moderate | ERRs continue to lag peers but valuations expensive; soft demand for base metals a headwind to mining sector | ||||
Canada | Canada — Neutral | Neutral | Not applicable | Economy has shown some resilience in face of higher rates, but business outlook weak and valuations unappealing | ||||
Hong Kong | Hong Kong — Overweight | ▲ | Low | Activity in China remains weak and is a headwind to earnings. but valuations and positioning are supportive and increased policy responses could provide a boost | ||||
EM | EM — Underweight | ▼ | Low | Earnings revisions very negative and flows not supportive in EM equities | ||||
Fixed Income | U.S. treasuries | U.S. treasuries — Underweight | ▼ | Low | Scope for fiscal stimulus and deregulation could improve U.S. growth and raise the equilibrium yield for USTs | |||
German Bunds | German Bunds — Neutral | Neutral | Not applicable | Potentially attractive as ECB looks set to cut rates at a decent clip, but with election risks in Feb 25 and yields already low may be at risk of volatility | ||||
JGB | JGB — Underweight | Neutral | Low | Further BoJ hikes coming in 2025 maintain upside risks to JGB yields but at current levels demand is likely to remain reasonable | ||||
UK Gilts | UK Gilts — Neutral | ▼ | Not applicable | Weak UK economy with scope for BoE to cut rates to offset worst impact of mortgage resets for UK consumers | ||||
Australia bonds | Australia bonds — Overweight | Neutral | Not applicable | Least priced in for rate cuts of the major bond markets, also postive carry is an attractive feature | ||||
Canada bonds | Canada bonds — Neutral | ▲ | Not applicable | Has rallied a lot alongside the U.S. so spreads are tight and it is also the market with the most punitive carry dynamics | ||||
BTPs | BTPs — Overweight | Neutral | Low | Lower ECB rates supportive to periphery bonds but near-term risks around election cycle in Europe could mean some volatility | ||||
Corporate Inv. Grade | Corporate Inv. Grade — Neutral | ▼ | Not applicable | Robust corporate health and demand for quality carry; spreads tight, but carry advantage over sovereigns persists | ||||
Corporate High Yield | Corporate High Yield — Overweight | Neutral | Low | Contained recession risks and improving quality in HY index supportive, spreads are tight but all-in yields are attractive | ||||
EMD Sovereign | EMD Sovereign — Neutral | Neutral | Not applicable | Favor U.S. high yield to EMD sovereign given more fragile tail credits exposure in EMD compared to U.S. HY | ||||
Currency | USD | USD — Overweight | Neutral | Moderate | Growth advantage of U.S. over RoW set to widen further, so even as Fed cutting cycle weighs on USD, growth differential is supportive | |||
EUR | EUR — Underweight | Neutral | Moderate | EUR undermined by weakness of growth in Europe and likely need for the ECB to become more aggressive in cutting rates | ||||
JPY | JPY — Neutral | ▼ | Not applicable | BoJ the only major central bank hiking rates, lends support to JPY as does solid domestic growth outlook | ||||
CHF | CHF — Underweight | Neutral | Moderate | FX interventions have been reduced, and SNB on clear easing path, CHF could end up as the lowest yielder of the majors |
The tick chart and views expressed in this note reflect the information and data available up to June 2024.