Porterhouse Trumps T-Bone

Being headquartered in Texas nixes notions of anything but a carnivorous existence. The best beef comes with the territory, as it should given the Lone Star State boasts the largest cattle inventory in America. That said, not every cut is equal; a nuance distinguishes two of the worthiest. The T-Bone is easily identifiable as it’s named for the T-shaped bone that runs through its middle. It’s cut from the short loin of the steer and has two different steaks attached to the bone. On the larger side is the strip while the smaller side is the tenderloin, which can be cut into smaller steaks called filet mignon (the only thing Danielle orders, medium rare, au poivre with bearnaise on the side). The key difference between the T-Bone and its rival Porterhouse is that the latter has an audaciously larger portion of filet meat vis-à-vis the former. While T-Bones retain their popularity, the Porterhouse was immortalized in 1988’s The Great Outdoors with John Candy, who characteristically consumed the Old ‘96er, a 96-ounce hanging-over-the-plate behemoth.

Financial markets continue to sport a John Candy-esque appetite for pushing the Fed’s terminal rate ever higher. The Citi U.S. economic surprise index began the month of March nearly in line with where it closed February (orange line), the highest since Spring 2022. For what it’s worth, the biggest upside surprise emanating from yesterday’s February ISM manufacturing report was the Prices Index (51.3 versus 46.5 consensus) and not the headline of 47.7 versus the consensus’ 48.0. Adding to the bullish tone were upside surprises from China’s manufacturing PMIs.

Because forward-looking ISM New Orders didn’t have a critical mass of market expectations in Bloomberg’s survey to generate a consensus number, it didn’t qualify. However, the 4.5-point advance (light yellow bars) was the largest monthly uptick in 28 months, helping push expectations for the Fed’s terminal rate to 5.47%, up from 5.42% at Tuesday’s close and 4.92% on January 31st (purple line).

As excitable as the ISM data left the stock jock community, we couldn’t help but take note of the glaring disconnect between the ISM and S&P Global’s parallel manufacturing survey. ISM polls procurement professionals of large manufacturing (and many multinational) corporations, while its counterpart garners opinions from C-suite executives of industrial companies of all sizes. Over time, the two converge — the most recent run of New Orders from both flags weakening demand (light blue and pink lines).

It was the qualitative comments that were off.

ISM leaned on future optimism with sell-side gusto: “With Business Survey Committee panelists reporting softening new order rates over the previous nine months, the February composite index reading reflects companies continuing to slow outputs to better match demand for the first half of 2023 and prepare for growth in the second half of the year…Panelists’ companies continue to attempt to maintain head-count levels…in preparation for a stronger performance in the second half.”

Contrast that with S&P Global: “US manufacturing remained under intense pressure in February. Although the PMI rose slightly, it continues to signal the steepest downturn outside of pandemic lockdown months since 2009…The worry is that new order inflows continue to fall sharply as many companies report disappointing sales, linked in part to a sustained trend towards cost-saving inventory reduction and low levels of confidence at their customers, both at home and abroad. None of this points to a healthy economic situation.

Despite differing spins, ISM and S&P Global’s production indexes were on top of each other – ISM’s at 47.3 (red line) and S&P’s at 47.4 (blue line). The contractionary streaks extended to three months for ISM and four for S&P Global. Oversupply remains the culprit. ISM’s Customers’ Inventories ‘Too High’ held at 18.4 last month (depicted inverted, yellow line) vs. January’s 18.5, levels consistent with recession. For perspective, 2023’s first quarter-to-date average was the seventh highest on record; the pandemic aside, this level harkens back to 2001 and 2007-09 recessions.

The compression in demand and output feeds the deflationary narrative. S&P Global’s February Commodity Price & Supply Indicators report pointed to the least acute commodity shortages in 29 months (blue line). Meanwhile, manufacturers reported the degree of commodity price unchanged from January and among the lowest seen in 2 ½ years (teal line).

Emphasizing the U.S. inventory cycle narrative, Freightwaves reported the national dry van rejection rate fell further in February, below levels seen in July 2019. The freight experts expanded: “With loaded volume in the LA-Chicago, LA-Dallas, and LA-Atlanta lanes down 13%, 25% and 20%, respectively, it’s clear that the lower year-over-year import volumes at the Ports of LA and Long Beach are translating to less transloading activity from 40-foot’ containers into 53-foot containers. That trend seems likely to continue until retail inventory levels are drawn down to a critical level that encourages more overseas shipments.”

Superficial optimism from China’s better data must be contextualized. A reality check with QI friends at the China Beige Book (CBB) revealed the Middle Kingdom’s economy decelerated into February. Echoing the much-touted PMIs, the CBB confirmed that the factory sector perked up. But as we’ve warned, last month’s consumption surge sputtered after the Lunar New Year. As CBB summed up the reality: “Market anticipation of Chinese revenge spending proved premature.” Especially in light of the non-validation out of bellwether South Korea’s export and industrial data, the deflationary inventory cycle could T-Bone the crowded, fast-money shorts in U.S. Treasuries.

Posted in Daily Feather.