U.S. Consumer Spending Rose Slightly in July Consumer spending inched up 0.1% in July as inflation remained near a four-decade high.
(…) Though growth in overall personal incomes cooled in July, wages and salaries accelerated on the month. A tight job market is putting more money in workers’ pockets, which could help sustain their ability to spend, economists say.
Wage growth is also contributing to elevated inflation. The personal-consumption expenditures price index, the Federal Reserve’s preferred inflation gauge, rose 6.3% in July from a year earlier. That was down from a 6.8% annual gain in June, a four-decade high. (…)
In real terms, Americans are spending no more: +0.2% MoM in July (+2.2% YoY) after +0.1% in total from April to June. Last 4 months: +0.9% annualized.
Services are not taking over from goods: they both rose 0.2% MoM in July.
However, spending on goods is not collapsing, at least just yet. Actually, real durable goods rose 1.5% MoM in July after +0.8% in June. They are up 3.5% YoY, slightly better than services’ +3.3%.
The generally tight relationship between income and expenditures disappeared during the pandemic, but it will resume and the current negative 4.4% gap between income and spending will close.
With negative real income growth this year, the closing of that gap will need to come from increased frugality unless Americans keep reducing their savings.
The personal savings rate (blue below) was unchanged at 5.0% in July, seemingly having found a floor. The savings rate averaged 5.6% in Q1 and 5.1% in Q2. It was 7.4% in Q4’19. Since 1960, the savings rate has very rarely declined below 5.0%.
Real disposable income rose 0.3% MoM in July thanks to stable prices that month. But real income is down 3.1% annualized year-to-date. On a YoY basis, it is down 3.7%.
Economists use real, inflation adjusted, dollars to assess consumer trends. But consumers live their lives with nominal dollars. In July, total expenditures were up 8.7% YoY while disposable income was up only 2.3%. Since March, income rose 5.6% a.r. (+2.4% a.r. in July). Assuming that disposable income grows at the same March-July pace (+0.46%/m), it will be up 4.0% YoY next December, at best keeping pace with inflation.
The core price index rose by 4.6% YoY in June, down from 4.8% in June. On a MoM basis, core prices rose 0.1% in July, after +0.6% in June and +0.3% in each of the prior four months. The annualized pace hovers around 4.0%.
Services prices rose 0.1% MoM following +0.7% in June (4.6% YoY).
Clearly, with such weak fundamentals, the fate of the consumer economy (~70% of GDP) rests on the elusive savings rate and on inflation. Good luck with these 2 forecasts.
Even more so given the Fed’s resolve to “moderate” demand in order to slow inflation while
- two major commodity suppliers are at war,
- businesses hastily diversify and complexify their supply channels,
- Europe deals with a severe energy crisis and
- the labor market has become very rigid with the balance of power clearly shifted to labor.
In his Jackson Hole comments, Mr. Powell acknowledged the challenge of taming inflation largely fueled by global supply constraints, but he was very clear:
Our responsibility to deliver price stability is unconditional. It is true that the current high inflation is a global phenomenon, and that many economies around the world face inflation as high or higher than seen here in the United States. It is also true, in my view, that the current high inflation in the United States is the product of strong demand and constrained supply, and that the Fed’s tools work principally on aggregate demand.
None of this diminishes the Federal Reserve’s responsibility to carry out our assigned task of achieving price stability. There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.
- Powell: Fed Must Show Resolve in Inflation Fight Fed Chairman Jerome Powell’s speech at a symposium of central bankers pushed back against expectations by some that the Fed might quickly retreat from raising rates next year. “We will keep at it until we are confident the job is done,” he said.
Some key points:
–The Fed isn’t convinced yet that inflation has peaked. “While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down,” Mr. Powell said.
–The Fed doesn’t see itself stopping its rate hikes anytime soon. The Federal Open Market Committee estimates the federal funds rate will settle at a range of 2.25 to 2.5 percent in the longer run. But “with inflation running far above 2 percent and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause,” Mr. Powell said.
–The Fed is wary of the risk of stopping interest-rate increases prematurely. “We must keep at it until the job is done,” Mr. Powell said. He points out that, historically, the labor market has tended to take a greater hit when the Fed hasn’t acted forcefully and swiftly enough to contain inflation. “Our aim is to avoid that outcome by acting with resolve now,” he said.
Typically, Jackson Hole speeches were 30-35 minutes mainly about “intellectual economics”. Friday, Mr. Powell took all of 8 minutes to simply, bluntly, tell investors he’s not about to pivot and say it in so many ways that nobody could doubt him. His opening was: “Today, my remarks will be shorter, my focus narrower, and my message more direct.”
He must have learned something from his last post-FOMC presser which triggered a 2.6% afternoon jump in equities after many considered this “a pivotal moment”.
Pivoters finally got the right message. Volcker redux. Risk off!
The question now is where will they stop?
Stan Druckenmiller says that “Once inflation goes above 5%, it has never come back down without the Fed Funds Rate exceeding the CPI.”
Others argue that Fed Funds rates need to be 0.5-1.0% above core PCE inflation to really be restrictive. This currently means FF rates between 4.5% and 5.0%.
However, BlackRock doubts that the political climate and populism will allow a new Volcker to emerge.
Central banks are rushing to raise rates to contain inflation that’s rooted in production constraints. They are not acknowledging the stark trade-off: crush economic growth or live with inflation. The Federal Reserve, for one, is likely to choke off the restart of economic activity -and only change course when the damage emerges. We see this driving high macro and market volatility, with short economic cycles.
Equities would suffer if rate hikes trigger a growth downturn. If policymakers tolerate more inflation, bond prices would fall. Either way, the macro backdrop is no longer conducive for a sustained bull market in both stocks and bonds, we believe. We see higher risk premia across the board and think portfolio allocations will need to become more granular and nimble.
(…) For all the noise about containing inflation, we see policymakers ultimately living with some of it. We remain overweight equities and underweight government bonds in long-term portfolios. We expect investors to demand more compensation to hold long-term bonds in this new regime. We see a near-term risk of growth stalling and reduce equities to a tactical underweight. We prefer to take risk in credit because we see contained default risk. (…)
There is a loud chorus of critics who claim the inflation threat was there for everyone to see: if only central banks had raised rates earlier, we wouldn’t be in this mess. Rather than pushing back on this narrative, central banks have resorted to sounding ever tougher on inflation. They appear to solve for the politics of inflation, not the economics. (…)
All this implies that policy trade-offs are now much harder. Central banks are likely to veer between favoring growth over inflation, and vice versa. This will result in persistently higher inflation and shorter economic cycles, in our view. The end result: higher risk premia across the board. (…)
What are the implications?
•We expect higher risk premia for both equities and bonds.
•This regime is not necessarily one for “buying the dip.” Policy will not quickly step in to stem sharp asset price declines.
•A traditional 60/40 portfolio of stocks and bonds, hedges and risk models based on historical relationships won’t work anymore, we think.
•We believe views should get more granular at the sector level or below. For example, indebted companies may do well if their debt burden is alleviated by persistently higher inflation.
•It is even more important to recognize and overcome behavioral biases, such as inertia, when making big portfolio decisions.
•Market views will have to change more quickly on both tactical and strategic horizons, we believe.
Columbia University Professor Adam Tooze previews the pressures the Fed will face:
The first [Jackson Hole] meeting attended by a Fed chair was in 1982, when Paul Volcker, lured to Jackson Hole by the fly-fishing, clashed with his Keynesian critics. Economist Edward Kane delivered a blistering critique of Fed policy backed up by amusing adverts being run at the time by America’s banks.
As the conference history goes on to note:
Although attendees would later note Kane’s presentation as being especially brutal and unfair towards both Volcker and the Fed, he was certainly not the only Fed critic in the room. James Tobin, a Nobel Prize-winning economist from Yale University, said during one of the symposium’s discussions that the Fed should have less autonomy.
Monetary policy goals, he said, should be set in coordination with the government’s fiscal policy decisions. “After all, monetary policy decisions are the most momentous economic decisions the federal government makes,” Tobin said. “It seems anomalous to me that when the budget is planned and eventually voted, the process is completely detached from the gentle and amateurish surveillance the Congress exercises over monetary policy.” In case there was any question about Tobin’s views, the following Sunday, The Washington Post published a lengthy article by Tobin titled “Stop Volcker from Killing the Economy.”
History rhymes.
The Fed may well focus on core inflation, but the war-triggered energy crisis is impacting most economic players, all trying to pass trough their significant and enduring costs.
July headline CPI was unchanged while core CPI was up 0.3%, both significantly lower than June’s 1.3% and 0.7% respective gains.
But CPI-Energy declined 4.6% in the month so CPI ex-Energy rose 0.4% in July, 4.9% a.r., and is up 7.4% a.r. in the last 3 months and 6.6% YoY.
Oil prices turned back upwards since mid-August, underscoring the market tightness amid the complex geopolitical context. My educated guess is that the odds of seeing oil above $110 in the next year are higher than those of seeing it below $70, the 2021 yearend level. BlackRock last March:
- In a drive for energy security, the West is seeking to wean itself off Russian oil and gas –this presents a fresh supply shock in a world that was already shaped by supply.
- Russia is the world’s third largest energy producer, accounting for 10% of global oil supply and 17% of global gas supply.
- Russia is the EU’s largest supplier of oil, coal and gas: 27%, 47% and 41% of imports, respectively.
- It will make inflation more persistent, slow growth and stoke demand for non-Russian fossil fuels in the short term.
- Reducing reliance on Russian fossil fuels will mean Europe is dependent on greater output elsewhere in the short term, especially of natural gas.The supply of renewable energy can’t be ramped up quickly enough in response. Even with energy conservation measures and a delay to phasing out nuclear power, supply needs to come from the U.S. and elsewhere.
- We believe the switch away from Russian energy will raise inflation and dampen growth in the short term, while creating the need for greater supply of non-Russian fossil fuels.
In Europe, natural gas and electricity now cost the equivalent of $600 and $1000 respectively in oil barrel terms per Gavekal. Europe will thus seek to burn more coal and more oil.
But last week we learned that:
- According to Reuters, the German government has voiced concern over the sustainability of coal supply for power plants along the River Rhine in the autumn as low water levels continue to hinder river navigation and thus slow down coal stocking ahead of winter.
- In a letter sent to the United States’ leading refiners, U.S. Energy Secretary Jennifer Granholm has called upon U.S. refiners to hold back exports to Europe and South America and start building inventories, despite both the gasoline and diesel curves being firmly backwardated. (oilprice.com)
- Opec+ said it will likely reduce output if demand declines.
When once asked what he would do if he were Fed Chairman, Jim Grant immediately replied “resign!”.
Tough job!
With such low visibility on geopolitics, economics and central banks, investors would normally want to use a higher discount factor (lower P/Es).
My old Irish friend Patrick alerted me to this recent Bloomberg article reposted by Yahoo!finance :
BofA Quants Say a Winning Stock Signal Is Bad Omen for Bulls
Bank of America Corp.’s quant analysts say a US stock market indicator with a perfect track record has bad news for bulls: Equity prices haven’t bottomed out yet.
The measure looks at the S&P 500 Index’s trailing price-to-earnings ratio in combination with US consumer inflation. Every market trough since the 1950s saw the gauge fall below 20. But during the waves of selling that battered markets this year, it only got as low as 27.
“One signpost with a perfect track record is the Rule of 20,” Bank of America’s equity and quant strategists led by Savita Subramanian wrote in a note. They add that unless inflation goes to zero or the S&P 500 falls to 2500 points, an earnings surprise of 50% would be required to push the gauge low enough to signal a market bottom — something they said seems “unachievable.” (…)
The Rule of 20 valuation always cycles through its “20” median, reflecting cyclical trends in profits, inflation and investor psychology.
With current parameters (trailing EPS of $220.24 and core inflation of 5.9%), the S&P 500 would be at its R20 median P/E at 3100, 24% lower! With inflation at 4.0% and profits of $232, the 12-m forward number, the R20 median would be reached at 3700.
My June analysis (Desperately Seeking The Low) concluded with
- The worst case is 2700-2900 if a crisis or stagflation.
- Fair value is in the 3300-3500 range.
- Watch inflation and the Fed, particularly if the economy slows measurably this summer. Slower inflation might bring the doves back and a good buying opportunity along.
The S&P 500 bottomed out at 3636 when oil prices peaked out. Negative eco news then started to feed pivoters, urging shorts to cover during a slow summer. Pivot expectations jumped after the zero July CPI while most new data points, excluding employment, were on the weaker side. The 10-Y Ts peaked at 3.5% in June to slide all the way down to 2.6% on August 1 (now 3.0%)
Sensing irrational exuberance and seeing rising financial conditions negate his tightening efforts, Jay Powell had to get market expectations more in line with his own and the FOMC’s. Mission accomplished.
Fair value remains in the 3300-3500 range.
Meanwhile:
EARNINGS WATCH
Through Aug. 26, 486 companies in the S&P 500 Index have reported earnings for Q2 2022. Of these companies, 78.0% reported earnings above analyst expectations and 17.9% reported earnings below analyst expectations. In a typical quarter (since 1994), 66% of companies beat estimates and 20% miss estimates. Over the past four quarters, 81% of companies beat the estimates and 16% missed estimates.
In aggregate, companies are reporting earnings that are 5.5% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.1% and the average surprise factor over the prior four quarters of 9.5%.
Of these companies, 69.8% reported revenue above analyst expectations and 30.2% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 78% of companies beat the estimates and 22% missed estimates.
In aggregate, companies are reporting revenues that are 2.6% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.2% and the average surprise factor over the prior four quarters of 3.4%.
The estimated earnings growth rate for the S&P 500 for 22Q2 is 8.5%. If the energy sector is excluded, the growth rate declines to -2.2%.
The estimated earnings growth rate for the S&P 500 for 22Q3 is 5.3%. If the energy sector is excluded, the growth rate declines to -1.4%.
Corporate guidance looks ok so far in Q3 but much fewer companies have offered guidance than at the same time during Q2. Visibility and confidence are understandably low.
Global economy faces greatest challenge in decades, policymakers warn
- “Central banks cannot hope to smooth out all economic air pockets, and must instead focus first and foremost on keeping inflation low and stable. Monetary policy needs to meet the urgent challenge of dealing with the current inflation threat.” – Bank for International Settlements Head Agustin Carstens
- “Central banks must act decisively to bring inflation back to target and anchor inflation expectations..the pandemic and war suggest that temporary supply shocks may have broader and more persistent effects on inflation when an economy is very strong, or the shocks are very large. Under such conditions, central banks may need to react more aggressively to control inflation” – International Monetary Fund Deputy Managing Director Gita Gopinath
- “In this environment, central banks need to act forcefully. They need to lean with determination against the risk of people starting to doubt the long-term stability of our fiat currencies — In other words, central banks are likely to face a higher sacrifice ratio compared with the 1980s, even if prices were to respond more strongly to changes in domestic economic conditions, as the globalization of inflation makes it more difficult for central banks to control price pressures” – ECB Board Member Isabel Schnabel (The Transcript)
- Mohamed El-Erian in the FT criticizes the Fed’s and Powell’s “policy mistake that involves inadequate analysis, bad forecasts, poor communication and belated policy responses. (…) Indeed, this may well be the least credible Fed in the markets’ estimation since the 1970s.”
BNPL lender Affirm’s shares tumble after gloomy full-year revenue forecast
U.S. bond funds record biggest weekly outflow in eight weeks
Top Canadian Union Boss Pushes for Inflation-Beating Pay Hikes
Unifor, which represents 315,000 workers in more than 20 sectors, has about 400 collective agreements to be concluded this year. It wants to attract new members in growing industries like warehousing and electric vehicles, according to the union’s new president.
Average wages in Canada are rising at more than 5% a year, but workers’ purchasing power is still declining because of the highest inflation since the early 1980s. That issue is front and center in negotiations for unionized workers, Unifor President Lana Payne said.
“Inflation is top of mind and has spilled over into every collective bargaining table we have right now,” Payne, who became the first woman elected to the top job this month, said in an interview. “In some sectors, we’re getting historic collective agreements.” (…)
The largest public-sector union, meanwhile, is demanding a 4.5% pay increase per year in talks with Prime Minister Justin Trudeau’s government that have hit an impasse. So far this year, annual increases in major union wage settlements are averaging 3%, according to employment ministry data. (…)
Canada’s unionization rate is currently about 27%, compared to 10% in the US and 24% in the UK. (…)
Unifor is also trying to institute the cost-of-living-adjustment clauses into agreements, which would allow wages to increase as inflation rises, Payne said. The loss of those automatic adjustment requirements in contracts over the past few decades “almost coincided with real wage growth lagging behind for the majority of Canadian workers.” (…)
From a debacle in slow-mo to…
- China’s Property Slowdown Sends Bank Shares Tumbling Fears of a weakening economy hit a pair of once high-flying bank stocks
The Shanghai-listed shares of China Merchants Bank and Ping An Bank Co.—two of China’s biggest, most prominent privately run lenders—have fallen by 32% and 25%, respectively, since the start of 2022, wiping $68 billion off their combined stock market value.
The selloff is just the latest indication of the problems a slowdown in the property sector is having on the wider economy. A two-year deleveraging campaign has damaged Chinese property companies, bringing on a liquidity crunch that has led to defaults among developers, the suspension of ongoing building projects and a big drop in new home sales. It has also fueled a boycott among some home buyers who are refusing to repay their mortgages.
That is bad news for Chinese banks, but the impact for China Merchants Bank and Ping An Bank will be worse than for the biggest state-owned lenders, said Kenny Ng, a securities strategist at Everbright Securities International. Declines in real-estate asset values will slow their mortgage business and hurt the wealth management products that the two banks have sold to their clients, some of which have included exposure to property developers’ debt, he said. (…)
“Banks have enough liquidity, but consumers or investors don’t want to borrow from banks to spend or invest. This shows a lack of confidence.”
China’s “big four” state-owned banks—Agricultural Bank of China, Bank of China, China Construction Bank Corp. and Industrial & Commercial Bank of China Ltd.—have done much better in the stock market this year, bucking a long-term trend. They have fallen by an average of 4.9% since the start of the year, versus a 17% decline for the CSI 300 index of the largest stocks listed in Shanghai or Shenzhen.
This is partly because the giant state-run lenders have lower exposure to the property sector. Real-estate companies represent just 4% to 5% of their total loans, while China Merchants Bank and Ping An Bank have 7.2% and 9.4%, respectively, of their lending tied up in property, according to Macquarie.
But another key reason is that as China’s economy struggles, state-owned banks can find more alternatives to offering loans to developers. They can shift their lending from mortgages to big infrastructure loans, which private commercial banks will find hard to follow, said Vincent Chan, a China strategist at Aletheia Capital. (…)
At the end of 2021, China Merchants Bank and Ping An Bank were trading at forward price-to-book ratios of 1.49 and 0.88, respectively. Those numbers had fallen to around 0.92 and 0.61 by Aug. 26, according to FactSet. That is still a substantial premium to the big four, which are all trading at below 0.50. (…)
China Huarong Asset Management Co. and China Cinda Asset Management Co., the nation’s two largest state-owned distressed debt funds, reported a slump in first-half profits as credit impairments surged on a deepening property crisis.
Net income for the first six months at Cinda dropped 33% to 4.51 billion yuan ($652 million), after impairment losses on assets jumped 85%, according to an exchange filing. Huarong, which is also due to report Monday, had expected to post a net loss of 18.88 billion yuan for the same period, compared with a profit of 158 million yuan a year ago.
China’s distressed-debt managers have been in turmoil as aggressive lending to embattled developers and unchecked expansion into other areas during the sector’s boom years has beset the $730 billion funds with heavy credit losses, sending their bonds tumbling. Beijing is now weighing a preliminary plan to restructure the sector that could see state-backed entities take over three of the firms, people familiar with the matter said.
China Great Wall Asset Management on Friday reported a net loss of 8.56 billion yuan for last year after postponing the disclosure deadline twice, citing souring asset quality and losses from fair value changes. That compared with 2.1 billion yuan of profit the year before.
Beijing-based Huarong, Cinda, Great Wall and China Orient Asset Management Co., were created to buy bad loans from banks in the aftermath of the late 1990s Asian financial crisis, when decades of government-directed lending to state companies had left China’s biggest lenders on the brink of insolvency. The so-called AMCs later expanded beyond their original mandate, creating a labyrinth of subsidiaries to engage in other financial businesses, including shadow lending.
They have lent money to the majority of the country’s top 50 developers over the years. Property accounts for about 44% of Cinda’s acquisition and restructuring businesses.
“Real estate enterprises present significant credit risks, and some local governments are faced with severe debt risks,” Cinda said in the statement. “The distressed entities and distressed assets will increase. AMCs shall give full play to their professional advantages, take the initiative to act, and actively participate in the prevention and defusing of major risks.”
Chinese authorities in the past year have ordered the AMCs to pare back non-core businesses and shed assets from securities to insurance to reduce risks and return to their original remit. More recently, they were pegged as potential white knights to the crumbling real estate sector, only to be found knee-deep in the troubles themselves. (…)
- China’s AgBank Says Overdue Loans From Mortgage Boycott Double AgBank’s non-performing loan ratio on real estate grew to 3.97% from 3.39% at the end of 2021. Smaller rival Bank of Communications Ltd. last week reported bad loans to real estate jumped 79%, while China Merchants Bank Co. has reported a doubling of its ratio of non-performing real estate loans.
- China regulators tell banks to ramp up lending – sources
China’s central bank has stepped up pressure on lenders with new instructions to grow loans, six bankers with knowledge of the matter said, as the world’s second-biggest economy faces an economic downturn and a plunge in borrowers’ confidence.
The informal message, issued via phone calls over recent months to commercial, rural and even foreign banks, was to lend more money to productive businesses and put less of it in financial investments, the banking sources said.
The calls, which the sources said came from the People’s Bank of China (PBOC) and in one case the China Banking and Insurance Regulatory Commission (CBIRC), are the latest in a series of official efforts to encourage money out of a financial system awash with cash and into lending that can drive real growth.
- China Sends Officials to Supervise Policy Rollout in Provinces The government highlighted the role of inspection teams last week when it announced a 19-point stimulus package of more than 1 trillion yuan ($145 billion) focused mainly on infrastructure spending. Policy oversight was needed to “accelerate the implementation of the measures,” the State Council said in a statement at the time.
