Consumers Boosted Spending in August U.S. consumers are digging deeper into their wallets to cover rising costs of essentials such as rent and utilities as inflation spreads.
Another rather poor (biased) account from the WSJ:
Household spending rose by a solid 0.4% in August after dropping a revised 0.2% in July, the Commerce Department said Friday. The August increase was just 0.1% after accounting for inflation.
The personal-consumption expenditures price index rose 6.2% year-over-year in August, down from a 6.4% in July, according to Friday’s report. On a monthly basis the index rose 0.3%, up from a 0.1% decline the prior month.
But the core PCE-price index, which strips out volatile food and energy categories, accelerated on both an annual and monthly basis, rising 4.9% in August from a year ago, compared with a 4.7% increase in July, and 0.6% from the prior month.
Spending on services such as rent, utilities, transportation and healthcare picked up strongly in August, and goods spending declined for the second month in a row as gasoline prices fell. (…)
Revised figures on saving habits in recent months showed households’ financial buffers—boosted by stimulus and limited opportunities to spend earlier in the Covid-19 pandemic—have recently dropped more substantially as consumers dip into savings to pay for everyday items.
The personal saving rate was 3.5% in August for the second month in a row, up from a recent low of 3% in June. That was down from 9.5% a year ago and close to levels last seen during the 2007-2009 recession. (…)
In truth, there was nothing solid in this Income and Outlays report:
- Wages and Salaries rose 0.3% in August, half the average rate of the previous 6 months.
- Growth in nominal personal income slowed from 6.1% annualized in Q2 to 3.6% in July/August.
- Real disposable income has declined in 10 of the last 13 months. It is down 4.5% YoY and 0.9% below its pre-pandemic level. It is up only 0.7% annualized in the last 5 months.
- Unsurprisingly, real expenditures are slowing down rapidly: Q1: +3.2% a.r.; Q2: +1.7%; July/August: +0.2% a.r. using all available decimals. July was revised down from +0.2% to -0.1%.
- The savings rate was unchanged at 3.5% in August but up from 3.0% in June. It was 8.7% in Q4’19. Accounting for inflation, the level of personal savings is 63% lower than before the pandemic.
- Real expenditures on Goods continued to decline: -0.2% MoM in August. They are down 3.5% a.r. since February.
- This past week, CarMax Inc. shares sank after the used-car retailer flagged that high prices, paired with high broader inflation and rising interest rates, have slowed demand. The company’s profit fell 50% in its most recent quarter and its sales leveled off at 2% growth, both worse than analysts expected. “This points to some deterioration in per unit pricing and profitability in the coming quarters, as rising interest rates and economic conditions affect demand,” said Thomas King, president of the data and analytics division at J.D. Power. (WSJ)
- Real expenditures on Services are not taking the slack: they rose 0.2% MoM in August after 0.0% in July. They had increased 4.4% a.r. in Q1 and 3.8% in Q2.
- Last, but not least, core PCE inflation jumped 0.6% in August after being unchanged in July. It is up 4.9% YoY. Inflation on Goods was -0.3% MoM (+8.6% YoY) thanks to lower gas prices. Durable Goods prices were up 0.5% (+5.3% YoY) after declining 0.2% in July. The cost of Services rose 0.6% (+5.0% YoY).
Bank of America’s consumer spending in hardline categories per its credit card tracking through Sept. 24: “We observe a softening trend in most hardline categories on a YoY basis. (…) discretionary demand remained pressured.” (via @MikeZaccardi)
Americans’ propensity to spend is being severely challenged by rapidly slowing nominal income growth, inflation and real personal savings at the 2008 level. Good luck during the holidays season.
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Higher Rates Will Put the Kibosh on Consumption Growth There was nothing in Friday’s report to give pause to the Fed’s plans to keep pushing rates higher. Futures market implied odds of Fed policy makers raising rates by another three-quarters of a point at their meeting in early November, rather than a half point, increased after Friday’s report. (…)
- Goldman Sachs’ baseline forecast calls for the Fed to deliver a 75bp rate hike in November, a 50bp hike in December, and a 25bp hike in February, for a peak rate of 4.5-4.75%. GS has 4 scenarios: “In a non-recession outcome, we see the Fed as most likely to follow roughly our baseline path (30% subjective odds), but we also see a meaningful risk of an upside scenario in which the Fed hikes more than we expect (20%). In a recession outcome, we see the Fed as most likely to cut substantially (30%), but we could imagine more limited cuts if inflation proved stickier in a downturn than we would expect (20%).”
Home Builders Offer to Sell Homes in Bulk at Discount to Investors As mortgage rates hit a 15-year high and individual buyers back away, builders look to unload both planned and completed homes
(…) There were 14% more homes under construction this August than there were a year ago when the sales market was more robust, according to U.S. Census Bureau figures. Major home builders, including Lennar Corp. and KB Home, have reported walking away from contracts to buy thousands of lots for future building projects. (…)
Dean Myerow, co-founder of Fort Lauderdale, Fla., rental owner and developer Southern Waters Capital, said he is in contract to buy 20 new homes a month from a builder in Florida. The builder’s retail business has dried up in recent months amid higher interest rates, Mr. Myerow said. He estimated the discount to retail he will receive on the homes is between 15% and 20%.
“We think rental rates will remain very strong,” he said. (…)
Buying homes in bulk next to each other instead of scattered is easier to manage, investors said. (…)
OPEC+ to Weigh Production Cut to Bolster Oil Prices The group is considering an output reduction of 1 million barrels a day, its biggest cut since the pandemic began, as the economic slowdown hurts demand.
- Oil Output Cut Will Underwhelm Without a Big Change An OPEC+ output cut will be diluted by its members’ chronic underperformance — unless baselines are changed or Saudi Arabia acts alone.
(…) OPEC+ can’t keep things as they are and retain credibility. The amount the group pumps and its theoretical target have become increasingly estranged from each other over the course of the year, with output lagging behind the planned volume by more than 3.5 million barrels a day in August, according to figures compiled by Bloomberg.
That big gap is going to dilute the effects of any cut decided on Wednesday, unless they can agree to redistribute targets among themselves to reflect the inability of most members to pump as much as they’re allowed.
Even a reduction of 1 million barrels a day, shared pro rata among the members, would require just six countries to make actual cuts. All the rest are pumping so far below their individual targets that a step-down would have no impact. The resulting reduction would be just 337,000 barrels a day — and that’s assuming, perhaps optimistically, that all six stick to the plan.
A contraction of 500,000 barrels a day would see just five countries needing to pump less and would deliver shrinkage in actual supply of just 126,000 barrels a day.
Any reduction will come a month before European Union sanctions on Russian crude exports come into effect on Dec. 5, complicating the outlook. Russia is a powerful and valued member of OPEC+, so despite the group’s self-declared role of balancing oil supply and demand, don’t expect other members to rally round and make up for any shortfall in global availability resulting from the EU embargo.
Seaborne crude shipments to Europe from Russia are currently running at about 820,000 barrels a day, but the sanctions could hit wider flows, with the EU also set to ban the provision of insurance and other services to tankers carrying Russian crude, no matter where they’re headed.
(…) [Saudi Arabia] can always make another of its voluntary additional cutbacks. With production now running at about 11 million barrels a day, the kingdom could certainly afford to trim output, and some of its oil infrastructure might benefit from a rest. (…)
The fact that ministers have agreed to meet face to face suggests something more meaningful than a pro-rata cut in output targets is on the table.
U.K. Makes Major U-Turn on Tax Cuts Treasury chief, Kwasi Kwarteng, ditched a plan to cut the 45% top rate of income tax, scrapping a key economic policy after turmoil in the country’s financial markets, an intervention by the Bank of England and the threat of large scale rebellion by Conservative Party lawmakers.
China Property Stocks, Bonds Rally After Report of $85 Billion Lifeline
(…) The buying spree comes after the People’s Bank of China and the China Banking and Insurance Regulatory Commission told the six largest banks to each offer at least 100 billion yuan ($14.1 billion) of financing support, including mortgages, loans to developers and purchases of their bonds, people familiar with the matter told Bloomberg News. (…)
Some doubt whether the measures announced so far will be sufficient enough to reverse the property slump.
The funding news is in line with policies announced via various regulators in the past six to nine months to support the sector, according to Zhi Wei Feng, a senior analyst at Loomis Sayles Investments Asia. “The intention is good, but the effectiveness is uncertain as the market is getting from bad to worse since the beginning of 2022 and there is no sign of any recovery.” (…)
Fed Rate Hikes Are Pushing Credit Market Toward Dysfunction, Bank of America Says
(…) Leveraged finance markets are reeling this week after the Fed’s latest rate hike in its aggressive campaign to tame inflation. US junk bonds are headed for worst year-to-date losses on record, while banks were forced to shelve a buyout deal in the leveraged loan market after struggling to attract demand from investors.
Investors fled risky assets over fears of a recession, pulling $3 billion from high-yield bonds and $1.9 billion from leveraged loans in the week ended Sept. 28, according to data from Refinitiv Lipper.
Spreads in the high-yield market could rise to around 600 to 650 basis points if the Fed continues with its pace of rate hikes, said BofA. Average high-yield spreads stand at 561 basis points on Friday, according to Bloomberg data.
- Bank CDS pricing also ticking up
John Authers: As of the end of August, the global central bank rate climbed to 2.97% based on NDR’s calculation, the highest level in the post-Global Financial Crisis period though well below the roughly 5% peak seen in 2001 and 2007. For now, the rate is simply mildly restrictive for global growth; but given the 4.00% expectation by early next year, NDR suggests things might take a turn for the worse.
This would put the rate in the most restrictive mode for the global economy, increasing the risk of severe global recession. As we’ve noted numerous times in the past, severe recessions are usually associated with more pronounced equity bear markets.
A $1 Trillion Burden Looms for World Borrowers Refinancing Debt Governments and companies around the world are facing unprecedented costs to refinance bonds, a burden that’s set to deepen fissures in debt markets and expose more vulnerabilities among weaker borrowers.
A corporate treasurer or finance minister looking to issue new notes now would likely have to pay interest that’s about 156 basis points higher on average than the coupons on existing securities, after that gap surged to a record in recent days. That all adds up to about $1.01 trillion in additional costs if all those securities were refinanced, according to calculations using a Bloomberg index tracking some $65 trillion of government and corporate debt across currencies. (…)
Concerns are also growing that liquidity is draining out of the world financial system as interest-rate swaps — one of the world’s deepest markets — fluctuate wildly. The gap between the floating- and fixed-rate legs of longer-dated swaps tied to the US Secured Overnight Financing Rate swung in some recent days by the most on record for the index, which was rolled out in October 2020 as a replacement for the London interbank offered rate.
Six US-based borrowers tracked by S&P Global Ratings defaulted in August, as signs mount that higher rates are already taking a toll on stretched borrowers’ ability to keep issuing new debt to pay off old. (…)
Steps by speculative-grade companies to push out debt maturities when markets were favorable should prevent a sharp rise in global corporate defaults, according to a September report by Moody’s Investors Service. The 12-month trailing global speculative-corporate default rate was 2.3% in August and will rise to 3.8% by August 2023 in a baseline scenario, which is still below historical averages. In more pessimistic scenarios laid out in the report, the default rate could rise much more. (…)
It’s not only interest rates. Liquidity’s tanking!
The following chart shows an exercise by Hartnett at BofA to sum changes in central banks’ balance sheets across the world. On this basis, the tightening pressure is on a scale never before seen:
Credit Suisse Shares Fall on Financial-Health Concerns The Swiss bank’s shares fell a day after it tried to assuage fears about its health in a memo to employees and phone calls to investors and clients.
John Authers in Bloomberg:
The economy is not as yet giving the Fed a compelling case to stop hiking, let alone pivot. But there is another outcome that might force a reversal: a financial crisis. (…)
It’s never healthy when a CEO has to offer reassurance like this. But it’s certainly true that the day-to-day stock price performance implies great concern. (…)
Deutsche Bank and Credit Suisse are both now trading at less than 25% of their book value, but Credit Suisse has set a new low (unlike Deutsche), and for the first time since before 2008 now has lower book multiple (…).
Credit Suisse’s CDS has risen to levels to match anything that hit it in the post-Lehman era, and it now far exceeds the implicit default risk of UBS. Debt and share prices like this only make sense if these is a significant move in both the equity and credit markets to position for the risk of a default by Credit Suisse. Any such event would open the possibility of Lehman-style damage (…).
In my opinion, the scenario of a bankruptcy would be so damaging that it could not be allowed to happen; a bailout that marks another huge reverse for tighter money, however, is conceivable. A scenario in which the authorities decide that their best policy is allowing inflation to inflate the banks’ problems away could yet happen, and it wouldn’t be pretty. (…)
Morgan Stanley Says Likely Fed Pivot Won’t End Earnings Pain
Michael J. Wilson, one of Wall Street’s biggest equity bears, says a Federal Reserve pivot to dovishness is becoming likely amid falling money supply, but such a move won’t allay concerns about earnings.
“We find M2 growth in what we call the ‘danger zone’ -– the area where financial/economic accidents tend to occur,” Wilson, Morgan Stanley’s chief US equity strategist, wrote in a note on Sunday, referring to the Fed’s broadest measure for money supply. (…)
Wilson, who predicted this year’s equities selloff, wrote that the year-on-year rate of change in money supply in dollars for the US, China, the Eurozone and Japan has turned negative for the first time since March 2015, a period that immediately preceded a global manufacturing recession. Such tightness is unsustainable “and the problem can be fixed by the Fed, if it so chooses,” he wrote.
The strategist said last week that US equities are in the “final stages” of a bear market and could stage a rally in the near term going into the earnings season before selling off again.
Wilson has said that he sees an eventual low for the S&P 500 coming later this year, or early next, at the 3,000 to 3,400 point level. That implies a drop of as much as 16% from Friday’s close.
BoA’s Mike Harnett also sees a forced pivot: “we are tactical bears…“short twos & spoos” ‘til Halloween…SPX 3333 to force “policy panic” (Nov 16th G20), then rally; “Big Low” not ‘til Q1 when recession/credit shocks = “peak Fed”, “peak yields”, “peak US$”; trade of ‘23 short $, long EM, small cap, cyclicals.”
Hartnett has caught every move perfectly. His reasoning regarding the oversold entry level is basically buying some 20% below the 200 day moving average: currently at 3374. This has worked over the past century (except 1931/37/74 and 2008). He adds: “…monster undershoot requires monster credit event & recession”. (via ZeroHedge)
Runaway Bear Market Blows Past Everything Meant to Slow It Down
(…) Bulls still point to signals that the bottom could be nigh, yet the pattern of past market cycles suggests the pain for American equities can easily persist.
Take a simple accounting of prior bear markets, where the average selloff hit 39% over 20 months. That would imply another 19% drop from here. Or look at how past tightenings have coincided with stock moves. While not all Fed hiking cycles spelled doom for equities, those that did typically failed to find a floor until the central bank reversed its course — a prospect no one on Wall Street can take seriously anytime soon until price pressures subside.
“Inflation is a major constraint because any attempt to rescue markets or international financial stability issues are likely to be inflationary,” said Steve Chiavarone, senior portfolio manager at Federated Hermes. “The market is forced to reckon with the possibility that the central-bank put is not in place.” (…)
Amid the relentless selling, bulls are yielding one after another. Retail traders, one of the most steadfast dip buyers since the 2020 pandemic crash, are bailing on stocks.
JPMorgan Chase & Co. strategist Marko Kolanovic is the latest to succumb to the gloom, citing the risk of policy errors at central banks and an escalation of war following the destruction of the Nord Stream pipelines in Europe.
“The most recent increase of geopolitical and monetary policy risks puts our 2022 price targets at risk,” Kolanovic wrote in a note Friday. “While we remain above-consensus positive, these targets may not be realized until 2023 or when the above risks ease.”
The firm’s year-end target for the S&P 500 is 4,800, a 34% gain from Friday’s close. (…)
During the previous six bear markets, all bottoms formed when the Fed was lowering rates. That’s a long way off considering bond traders currently don’t expect Fed rates to peak until April 2023. (…)
SENTIMENT WATCH
Goldman Sachs:
Hedge funds, mutual funds, and retail traders have slashed equity exposures YTD. However, investor equity positions remain elevated vs. a longer-term history and we forecast further selling in 2023.
Since the start of 2020, households have been the largest source of equity demand, buying $1.2 trillion in equities. However, household demand turned slightly negative in 2Q. Higher frequency mutual fund and ETF flow data also show evidence of slowing demand in recent weeks (see pg. 23). This selling in combination with falling equity prices has led to a sharp drop in household equity allocations (Exhibit 5).
The sharp decline in margin balances over the last 12 months is one indication that retail traders have been largely washed out of the market this year as the fast growing and speculative stocks that they favor have suffered alongside rising interest rates. Our Retail Favorites basket (GSXURFAV) has lagged the S&P 500 by 18 pp YTD.
Both hedge funds and mutual funds remain highly exposed to equities relative to the past decade. Similarly, household equity allocations stand at the 96th%-ilesince WWII, indicating further room to cut exposure should the macro environment continue to deteriorate.
Not quite there yet:
VALUATION WATCH
My June 21 Desperately Seeking The Low remains valid:
- The worst case is 2700-2900 if a crisis or stagflation.
- The Rule of 20 Fair value is in the 3300-3500 range.
- Watch inflation and the Fed, particularly if the economy slows measurably. Slower inflation might bring the doves back and a good buying opportunity along.
- Using Price/Book and ROE: 3250-3375.
- All in all, current fair value falls in the 3300-3500 range. But watch inflation…and the Fed.
As of Friday’s close:
- The S&P 500 median trailing P/E is now 17.2 (17.7 last week, 18.7 two weeks ago). On forward: 15.1 (15.7 and 16.8).
- The 6 largest stocks by weight (21.4% of the index) have an average P/E of 45.8 (47.0 and 50.2). On forward: 29.0 (29.9 last week).
- 41% of the companies have a P/E below 15.0 (39% and 37%. On forward: 49% (48%).
- 21.6% (19.6% and 16%) are below 10x. On forward: 22.2% (20.0%).
Factset:
During the third quarter, analysts lowered EPS estimates for the quarter by a larger margin than average. The Q3 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q3 for all the companies in the index) decreased by 6.6% (to $55.51 from $59.44) from June 30 to September 29.
In a typical quarter, analysts usually reduce earnings estimates during the quarter. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 2.3%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 3.3%. During the past fifteen years, (60 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.8%. During the past 20 years (80 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 3.8%.
Thus, the decline in the bottom-up EPS estimate recorded during the third quarter was larger than the 5-year average, the 10-year average, the 15-year average, and the 20-year average. The third quarter also marked the largest decrease in the bottom-up EPS estimate during a quarter since Q2 2020 (-37.0%).
While analysts were decreasing EPS estimates in aggregate for the third quarter, they were also decreasing EPS estimates in aggregate for the fourth quarter. The bottom-up EPS estimate for the fourth quarter declined by 4.5% (to $58.01 from $60.73) from June 30 to September 29.
In addition, analysts lowered earnings estimates for CY 2023 during this time, as the bottom-up EPS estimate for CY 2023 decreased by 3.5% (to $241.83 from $250.60) from June 30 to September 29.
PLAYING THE ODDS GAME?
Stats and charts are invading the blogosphere, to suggest the lows are near or lower or further out. (Via Callum Thomas)
- The 24-month Williams%R Oscillator is showing up increasingly extreme oversold…albeit, the early-2000’s shows how the market can stay oversold, and 08/09 shows how the market can get even more oversold!
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Of the 26 S&P 500 lows since 1932, nine (35%) were in October and 5 (19%) in March. How can it be that only 2 months account for more than half of the lows? That’s no random walk, is it? My guess is that it has to do with earnings expectations which are often reset in October (after Q3 results) and/or March (after year-end). But, interestingly, a casual survey reveals that 15 of the 20 declines in Fed funds rates between 1957 and 2019 occurred either in the fall (10) or in the spring (5). The current consensus is for the dovish Fed to return next spring.
Two Putin allies ridicule Russia’s war machine in public
The withdrawal of Russian forces from a strategically important town in eastern Ukraine has prompted two powerful allies of President Vladimir Putin to do something rare in modern Russia: publicly ridicule the war machine’s top brass.
Russia’s loss of the bastion of Lyman, which puts western parts of Luhansk region under threat, touched a nerve for Ramzan Kadyrov, the leader of the southern Russian republic of Chechnya.
[Kadyrov] suggested that Russia should consider using a small tactical nuclear weapon in Ukraine in response to the loss. (…)
Such public contempt for the generals running Russia’s war is significant because it indicates the level of frustration within Putin’s elite over the conduct of the war while also piercing the Kremlin’s carefully controlled narrative. (…)
Brazil’s Leftist Former President Wins First Round of Election The result means current President Jair Bolsonaro and Luiz Inácio Lula da Silva, who served two terms but was jailed on a corruption charge, will face each other in an Oct. 30 runoff.
Mr. da Silva, a standard-bearer of the Latin American left who is widely popular among the poor despite having been jailed on a corruption conviction in 2018, clinched 48.2% of the vote. The tally was just shy of the majority he needed to win outright, with 99.1% of votes counted Sunday night, according to Brazil’s electoral court.
Brazil’s right-wing leader notched 43.4% of the vote, nearly 51 million and far more than the 36%-37% support that polls from Datafolha and Ipec said that the ex-army captain would garner. Allies of Mr. Bolsonaro also swept to victory in an election that included votes for members of congress and state governors. (…)
A victory by Mr. da Silva in Brazil, home to 215 million people, would mean that every major country in South America, from Argentina to Venezuela, would be led by a leftist government. (…)
Iran Protesters Circumvent Internet Disruptions They are finding new ways to challenge the Islamic Republic after the government imposed sweeping disruptions to the internet that have affected the movement’s ability to use social media to spread its message.
(…) Some activists are trying to skirt internet disruptions that started almost two weeks ago by using secure connections, such as virtual-private networks, say residents in Tehran. These people say they are turning to Farsi-speaking satellite broadcasts such as London-based Iran International, which publishes footage of the protests and provides updates on planned demonstrations.
(…) in private, some officials have shown understanding for the protesters’ grievances over Ms. Amini’s death. “But the government is stuck,” said an Iranian official. “It has made the veil a foundation of the system so it can’t backtrack.”
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Khamenei Slams Protests as Security Forces Target Universities University campuses were a critical driver of the 1979 revolution and students formed a core part of opposition groups that toppled the Shah of Iran. The Islamic Republic has always heavily controlled and suppressed political activity at universities.