Prices rose 0.1% compared with a year earlier. Consumer costs were unchanged in May and had fallen 0.2% in April, when compared to a year earlier. The last annual increase came in December.
When excluding volatile energy and food categories, core prices were up 0.2% last month and 1.8% from a year earlier.
From a year earlier, apparel prices are down 1.8%, home-furnishing costs declined 1.3% and toy prices plunged 6.2%. A stronger dollar has made the price of foreign goods relatively more affordable.
The annual gain in core prices would have been cut in half if it weren’t for a 3% increase in the cost of shelter that is being driven by increasing rents. That is because even though rents only represent 9% of the core consumer price measure, the Labor Department computes shelter costs for owned-homes by estimating what it would cost to rent comparable living spaces. This measure, called owner’s-equivalent rent, counts for 31% of the core.
(…) Commerce Department figures show that the rental vacancy rate in the first quarter, at 7.1%, was just off its lowest level in over 20 years. But new supply is coming.
(…) Friday’s report on housing starts from the Commerce Department showed that there were 512,000 multifamily housing units under construction in June—the most since 1986. Moreover, there are 20% more multifamily building permits issued in the first half of this year than in the first half of last year.
It takes time to get from permits to construction to completion, however. Meanwhile, an improving job market looks likely to continue driving household formation. So, new demand for rentals may outstrip new supply in the months ahead, sending rents higher and enticing more investors to put money into rental property. But supply will catch back up.
Eventually, like it always does.
The Federal Reserve Bank of Cleveland said Friday that underlying inflation is most likely stronger than more traditional price indexes indicate.
(…) the Cleveland Fed said its Median CPI index rose 2.3% over the same period.
The Median CPI is one of a small class of alternative inflation gauges that aim to provide an alternative read on price movements in the U.S. economy. The index tosses out the biggest price gainers and losers in a given month. Its creators say that gives a truer picture than the Labor Department’s CPI measure or its so-called core CPI, which excludes volatile energy and food prices, and was up 1.8% in the year ended in June. (…)
The Cleveland Fed’s Median CPI has been showing pretty steady annual gains for a while in the low 2% range.
It is pretty rare that the Cleveland Fed’s work on inflation gets any media attention, even much attention from economists for that matter. Yet, their work is important and instructive.
The median CPI, which has been rising at a 0.2% monthly clip for a while (+2.4% annual rate), accelerated to +0.3% in June and is now up 2.3% YoY. Meanwhile, the conventional core CPI has also been rising by 0.2% monthly on average since January. Core inflation, CPI-based, is thus in the 2.0-2.5% range in the U.S.. This is happening even though core goods inflation is negative (-0.4% YoY in June) thanks to the strong greenback.
Interestingly, core PCE remains in the 1.0-1.5% range. Is the Fed, focused on core PCE, underestimating inflation?
The Economist wrote a piece on the differences between CPI and PCE inflation 2 years ago that is still very relevant today:
The two indexes frequently diverge because they are constructed differently. While the weights in the CPI basket change only every few years, the PCE’s change each month, better capturing consumers’ tendency to shift from more expensive commodities and outlets to cheaper ones. The CPI’s weights are also determined by what consumers say they spend, whereas the PCE index is based on what they actually spend, or what is spent on their behalf, such as the employer’s portion of health insurance, and what the federal government spends on Medicare. As a result the CPI assigns much more weight to rent and housing and much less to health care. PCE inflation over time typically runs about 0.3% below CPI inflation, but the current divergence, at 0.7%, is the largest in more than a decade, according to Goldman Sachs.
The reason appears to be the divergent behavior of rent and health care. Rent inflation has been relatively firm lately, reflecting strong demand by households who no longer qualify for mortgages or lost their home to foreclosure. Rents have an outsized impact on the CPI because they are used to determine the cost of owner-occupied as well as rental housing. Meanwhile, as has been widely discussed, medical inflation has eased notably in recent years. No one is sure why; the Obama Administration credits cost controls implemented under the Affordable Care Act. The weak economy, which has forced employers and employees to curb consumption and forced providers to control costs better, is almost certainly a factor, too.
This means that to the extent CPI inflation overstates what consumers spend on housing and understates what they spend on health, it is overstating the cost of living. To be sure, workers do not see all the benefit of lower health inflation since their employers and the federal government pay most of the cost . But over time this ought to translate into higher take-home pay as money that would have otherwise gone to benefits goes to wages instead. It’s a helpful reminder of how much consumers stand to benefit from any reforms that reduce health care costs. (Mechanically, this is only true if price inflation falls by more than wage inflation, i.e. if it’s due to narrower profit margins or increased efficiency, not reduced volume of services, or lower wages to health care workers). Similarly, higher rents only affect the small portion of the population now trying to rent an apartment. The majority of people living in their own home, or about to buy one, are still benefiting from low home prices in most markets and rock bottom mortgage rates.
This poses an interesting dilemma for the Federal Reserve. It considers the PCE index superior to the CPI as a measure of the cost of living, and so focuses on it in forecasts and policy decisions. (…)
One theory is that the recent slowdown in health care costs is because
insurance companies have delayed implementing the full price pass-throughs so far. But that has not prevented, and in fact the law has forced, corporations to factor in the new costs. As a result in the US there is a curious split: on one hand unit labor costs are soaring, and just experienced the biggest 6 month surge since 2007 and, on the other, wages of non-supervisory workers which amount to over 80% of the population are near recessionary levels, and below half the Fed’s preferred wage inflation level of 4.5%.
This means that as a result of Obamacare, labor costs for corporations are already through the roof, and since every spare dollar allocated to SG&A is allotted to paying for Obama’s “Affordable” Care Act, there is virtually nothing left over for wage growth.
Whatever, the fact is that medical care costs have been accelerating lately, rising at a 2.8% annualized rate during the last 3 months and 3.4% during the last six. Maybe the medical disinflationary period is over. If so, the gap between core PCE and core CPI could close rapidly, providing more justification for rate normalization sooner than later, and maybe faster than slower.
Over and above inflation’s impact on the economy and monetary policy, it has a meaningful effect on equity valuation. It is rather interesting to see that many pundits are now incorporating low inflation rates in their analysis justifying high earnings multiples. Even some CAPE advocates are trying to adjust it for low inflation in order to explain why CAPE has been wrong since 2009.
The Rule of 20 best captures the effect of inflation on equity valuation. Rising inflation negatively impacts multiples (fair P/E = 20 minus inflation). Equities can rise along with inflation if earnings rise at a faster rate, which is not the case currently. Actually, earnings are declining 3-4% YoY and rising a slow 2.5% if Energy is excluded.
S&P currently expects Q2’15 EPS to come in at $28.53 (+$0.11 vs June 1) which would bring trailing EPS to $110.69 after the quarter is over. With core CPI at 1.8%, fair P/E is 18.2x which results in a fair level of 2015 for the S&P 500 Index, 5% below current levels.
U.S. equities have reached overvaluation levels unseen since October 2007, right when inflation threatens to rise (with the Fed’s blessing), right when interest rates are about to rise and right when earnings are stalling at best. Investors sentiment is becoming a key variable to gauge. Unfortunately, it can change as rapidly as Florida weather in July. Ask the Chinese about that!
Apartment Demand Drives Home Construction Starts jump 9.8% as multifamily sector paces market
Housing starts rose 9.8% from a month earlier to a seasonally adjusted annual rate of 1.17 million in June, the Commerce Department said Friday.
The gain was driven entirely by construction of multifamily housing units, mostly rental apartments, which rose 29.4%. Starts on single-family units, which represent almost two-thirds of the market, dropped 0.9%.
New construction of buildings with more than five units jumped 28.6% in June, hitting its highest level since 1987.
But the spike likely has more to do with a surge of activity in New York City last month right before tax incentives for multifamily developments were scheduled to expire.
New applications for building permits, a bellwether for construction in coming months, increased 7.4% to 1.34 million.
(…) rental-apartment vacancies remain near multiyear lows, and lease rates have risen by 10% in the past three years to the highest monthly average ($1,194) since research firm Reis Inc. began tracking the figures in 1980.
Housing trends are far from being uniform across the country, suggesting that conditions are still not ripe for a strong fundamental upswing (charts above and table from Haver Analytics):
Bidding Wars Return to Home Market Bidding wars, a hallmark of last decade’s housing boom, are back in a number of metro areas as too many buyers go after too few homes.
But while the earlier wars reflected enthusiasm fueled by easy-money mortgages, the current froth stems from a market short of homes for sale.
The reasons for the scant supply are myriad, including a much-slower-than-expected recovery in home construction. Yet an equally significant problem is that millions of people aren’t listing their homes for sale because they suspect they can’t qualify for a new mortgage, can’t afford the costs associated with a sale or fear that they won’t prevail in the scrum for the few houses available.
At the end of May, there were 2.3 million existing U.S. homes for sale, enough supply to last 5.1 months at the current sales pace. That is below the six to seven months of supply that the National Association of Realtors says is needed for a balanced market.
But in more than one-third of the 300 largest metropolitan areas tracked by Realtor.com, homes listed for sale in June had been on the market for a median of less than two months. A low median figure indicates rapid turnover in inventory as demand for homes exceeds supply.
Those include big markets like San Francisco, with a median time on market of 27 days, and Dallas at 38 days, as well as smaller markets like Vallejo, Calif., at 26 days and Kennewick, Wash., at 36 days. (…)
Even though U.S. home prices are up 31% in the past five years, 15.4% of homes—an estimated 7.9 million—remained underwater in the first quarter, according to real estate website Zillow. The long term average is 3% to 5%, Zillow says. These owners can’t sell unless they have thousands, sometimes tens of thousands, of dollars on hand to pay the shortfall on their old mortgage and finance costs of selling and moving. (…)
Meanwhile, at least 2.6 million homes have been taken out of the market since 2008 after investors purchased them and converted them to rentals, according to Stephen Kim, a housing analyst at the U.S. unit of Barclays PLC. (…)
During times of weak inventory, home builders normally ramp up construction. But though construction picked up this spring, the national pace of building single-family homes in June amounted to just 49.7% of the annual average from 2001 to 2003, which the National Association of Home Builders considers the latest normal housing market. (…)
(…) Although economic forecasters are expecting a September lift off, this starting date is still not fully priced into Fed funds futures (see Tim Duy.) What really matters, however, is whether the Fed then embarks on a medium term tightening path that persistently surprises the markets in a hawkish direction.
That is what has happened in each of the three previous tightening cycles, which were periods when fixed income traders consistently lost money by taking long positions at the front end of the yield curve. The current market pricing for forward short rates, which remains far below the Fed’s “dots” for the next three years, suggests that there is a strong possibility that this accident could repeat itself in the coming tightening cycle.
For about three decades, it has generally paid for traders to assume that the Fed will deliver a path for short rates that is lower than that built into the forward curve for interest rates at any given time. Maybe that partly reflects the fact that a risk premium is normally priced into forward interest rate curves. But, in addition, interest rates have been on a long run downtrend, with the Fed repeatedly choosing to deliver easier monetary policy than the market has expected. “Never underestimate the dovishness of the Fed” has usually been a profitable motto for traders. (…)
The exceptions to this rule, however, have come when the Fed has embarked on a path to raise rates, in 1988-90, 1994, 1999-2000, and 2004-07. In those periods, the market did not believe that the Fed was really serious about tightening monetary policy, and lost money by betting on a dovish central bank. (…)
For a long while, Janet Yellen seemed sympathetic to this asymmetry of risks, but lately she seems to have shifted her stance. Her recent message has been clearly tilted towards a path for rate increases that is “early and gradual” rather than one that is “later and steep”.
Last week, she went as far as to say that “the economy cannot only tolerate but needs higher rates”. That is an unusually hawkish choice of words for a Fed Chairman who is usually viewed as a dove.
Ms Yellen has been supported in this shift by her main lieutenants, including Stanley Fischer, William Dudley and John Williams. (…)
But Ms Yellen outlined her underlying case much better in her important speech on the “normalisation” of interest rates on 27 March. She believes that rates are now well below “normal” while the economy is virtually at normal. Here, “normal” for rates is defined as the equilibrium real rate, which Ms Yellen expects to rise as economic “headwinds” diminish in the next few years.
As this blog has argued before, analysis of the Fed’s forecasts shows that it is this rise in the equilibrium real rate, rather than the projections for inflation and unemployment (which are both assumed to be “on target” by next year) that drives the upward path for rates in the medium term.
Ms Yellen continues to argue that the upward path will be “gradual”. In an illuminating interview with the FT on 28 June, William Dudley explained that he interprets this to mean that rates will rise by 25 basis points four times a year, or at alternate FOMC meetings. That would be about half the pace seen in the 2004-07 tightening cycle, but it would still be much faster than the pace currently built into the market forward rates.
Wiiliam Dudley also emphasised that the comment about gradualism should not be regarded as a “pledge”. It is just a central expectation, based on the Fed’s current forecasts for inflation and unemployment. If the economic outcome differs from the forecasts, then so too will the the paths for equilibrium and actual interest rates. That is what the Fed means when it says its actions will be “data determined”.
That uncertainty gives the markets just about enough reason to adopt a much lower path for forward short rates than shown in the Fed’s current view of the future. But, at this stage of the cycle, the markets have often been wrong about the Fed’s readiness to tighten policy, and they may well be making the same mistake again.
It’s early in the season but so far, so good as Factset reveals:
With 12% of the companies in the S&P 500 reporting actual results for Q2 to date [61 companies], slightly fewer companies are reporting actual EPS above estimates (72%) and actual sales above estimates (56%) compared to the 5-year averages. In aggregate, companies are reporting earnings that 4.0% above the estimates.
Due to companies beating earnings estimates in aggregate and upward revisions to estimates for companies yet to report, the blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for Q2 2015 is now -3.7%. This is a smaller decline than the estimate of- 4.5% at the end of the second quarter (June 30).
If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would jump to 2.6% from -3.7%.
In terms of revenues, 56% of companies have reported actual sales above estimated sales and 44% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is slightly below both the 1-year (57%) average and the 5-year average (57%). In aggregate, companies are reporting sales that are 0.9% above expectations. This surprise percentage is equal to the 1-year (+0.9%) average and above the 5-year (+0.7%) average.
Due to companies beating revenue estimates in aggregate and upward revisions to estimates for companies yet to report, the blended revenue decline for Q2 2015 is now -4.0. This is also a smaller decline than the estimate of -4.5% at the end of the second quarter (June 30).
If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would jump to 1.9% from -4.0%.
At this point in time, 8 companies in the index have issued EPS guidance for Q3 2015. Of these 8 companies, 7 have issued negative EPS guidance and 1 has issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the third quarter is 88% (7 out of 8). This percentage is above the 5-year average of 69%.
Persistent Dollar Strength Would Be Big Hit to U.S. Growth The dollar’s strength in recent months has been broadly recognized as a force weighing on U.S. growth. New research from the New York Fed seeks to determine how much impact a persistent rise in the dollar might have, and discovers it is significant.
Writing on the New York Fed website Friday, economists Mary Amiti and Tyler Bodine-Smith say a 10% appreciation in the dollar over the course of a three-month period slices half a percentage point off of the year’s total growth rate. If the rise in the dollar is maintained, it will take another 0.2 percentage point off growth the following year.
With the Fed estimating the economy’s long-run growth trend at around 2% to 2.3%, headwinds such as those described in the research can make a real difference.
The authors note the dollar has risen 12% since the middle of 2014. (…)
The bank said its model indicates a 10% rise in the dollar reduces export volume by 2.6%, which translates to a half percentage point lower net export contribution to gross domestic product. For a two-year period, the appreciation would shave 0.7 percentage point off the net export contribution to GDP.
Dollar Gains on Fed Rate ExpectationsFor Many Firms, China’s ‘New Normal’ Spells Doom Industrial city’s struggle illustrates how slower economic growth is squeezing manufacturers
(…) One of Beijing’s biggest fears is that mass closings of factories could bring social instability. The HSBC/Markit Purchasing Managers Index shows that factories have cut jobs for 20 consecutive months. May’s culling was the fastest since the global financial crisis. (…)
There are other signs of tough times. At the Zhenai wholesale and retail shopping complex, among Tengzhou’s largest, there are now so few customers that shop owners race down empty hallways on electric scooters.
In one store selling funeral shrouds, owner Song Changxiu said business is about the worst he has seen it in a quarter century. People aren’t dying less often, he said. Their survivors are buying cheap polyester rather than pure cotton.
Ringing Tenzhou are dozens of largely empty and partially-built residential towers bearing names like “Family in Harmony” and “Enjoy Life.” Marketing manager Zhu Qirei in the showroom of the “Peaceful World” development said she is pinning her hopes on locals returning from elsewhere and buying property. “I can’t say what this year will bring,” she said. (…)
A total of 576 companies were suspended on mainland exchanges as of the midday break on Monday, equivalent to 20 percent of total listings, and down from 635 at the close on Friday. The halted firms are valued at an average 243 times reported earnings, compared with 164 times for all companies traded in Shanghai and Shenzhen.
The ongoing suspensions are raising doubts about the sustainability of a rebound in Chinese stocks. The Shanghai Composite Index has climbed about 14 percent from its July 8 low, following a 32 percent plunge that helped erase almost $4 trillion of value. The number of companies with trading halts exceeded 1,400, or around 50 percent of listings, during the height of the rout as the government took increasingly extreme measures to shore up equities. (…)
The suspended companies have a combined value of 4 trillion yuan ($644 billion), equivalent to about 9 percent of China’s total market capitalization. The majority of halts were by shares listed on the Shenzhen Composite Index, the benchmark gauge for the smaller of China’s two exchanges. (…)
Interesting piece by Michael Johnston. Perniciously, such articles will likely undermine, and be used to undermine the credibility of doomsayers just when equity markets are nearing bubble levels.