Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.
The American Consumer Keeps Splurging
Wells Fargo provides the details. Goods consumption is still booming.
Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Economics
Growth in retail sales (+3.8% YoY) is gradually coming back in line with labor income (+5.6%) and total consumption (+5.8% in August. Sept out Friday). Payrolls were up 5.6% annualized in Q3, +6.5% a.r. in the last 2 months and +5.2% a.r. in September.
Recall that inflation on retail sales, at 1.3% YoY, is well below overall inflation (3.7%).
On October 18, the GDPNow model estimate for real GDP growth in the third quarter of 2023 is 5.4 percent, unchanged from October 17 after rounding.
Household Net Worth Surged After the Pandemic Hit The jump in household wealth included rich and poor households, Federal Reserve survey showed.
Households’ median net worth, or wealth, climbed 37% from 2019 to 2022, after adjusting for inflation, according to the Federal Reserve’s Survey of Consumer Finances released Wednesday. That was the largest increase since the survey—which comes out once every three years—began in 1989.
Rising home and stock prices that far outpaced inflation helped support the net worth increases. The rise in wealth was broad based across demographic and socioeconomic groups, in part reflecting the greater likelihood of middle-income and lower-income households to own stocks and homes last year than in 2019, Fed economists said.
- Americans’ net worth skyrocketed during the pandemic. The inflation-adjusted median jumped 37% to $192,900 from 2019 to 2022, a Fed survey showed, marking the largest three-year increase in data back to 1989—and it was more than double the next-largest one on record.
From the NY Fed:
(…) The pandemic period featured forbearances on several types of debt, along with large fiscal transfers and very low interest rates, leading to significant improvements in household cash flows. For example, about 14 million households refinanced their mortgages, reducing their mortgage bill by $30 billion per year through 2021. The red line in the next chart shows that the cumulative savings from these lower payments stood at about $120 billion as of 2023:Q2, with recent quarters bringing declines as newer mortgages carry higher balances and higher interest rates.
In addition to these savings, homeowners withdrew unusually large amounts of home equity, primarily in the form of cash-out refinances during the period of low rates. These funds, shown in the blue line below, are also available for consumption and amount to $280 billion in 2023:Q2.
Equity Extraction and Mortgage Refinances Contributed to Liquid Funds Available for Consumption
Source: New York Fed Consumer Credit Panel / Equifax
Other forms of household debt also supported consumption. Payments on student debt, which competes with auto loans to be the second largest household sector liability, have largely been in forbearance since the early stages of the pandemic. Payments on federal student loans prior to the payment moratorium totaled about $70 billion per year, meaning that through 2023:Q2 about $260 billion was left in the household sector; see the blue line in our next chart. By comparison, auto loans (red line) have made relatively small contributions to the funds available for consumption, while some of the funds that households saved have been reflected in reduced credit card balances (gold line).
Credit Card Paydowns Offset Student Loan Forbearance
Source: New York Fed Consumer Credit Panel / Equifax.
In total, mortgages—through equity extraction and lower interest payments—have provided about $400 billion of the excess savings since 2019, and nonmortgage debt has added about $110 billion as the positive cash flow from student loans is partly offset by the negative cash flow of credit cards. Of course, reduced credit card balances position households well for future consumption: since reduced balances typically mean that more credit is available for future use.
These positive cash flows from debt suggest that the household sector is in a strong position. Other indicators also support this assessment. Debt delinquencies are generally low, led by remarkably low mortgage delinquencies (shown in gold in the next chart). Auto loan and credit card delinquencies, on the other hand, have risen fairly sharply from their troughs during the pandemic and are now back to their 2019 levels. A key question going forward is whether these delinquency rates will level off or continue to rise. A further increase in delinquencies would indicate that, for at least some households, cash flow has become insufficient to support their financial obligations.
Will Delinquency Rates Continue to Rise?
Source: New York Fed Consumer Credit Panel / Equifax.
As a second set of indicators, we use data from the New York Fed’s Survey of Consumer Expectations to assess households’ near-term expectations regarding their spending, debt delinquency, household income, and earnings growth. Median year-ahead expected spending growth has retreated somewhat from its high 2022 levels, but its current reading of 5.3 percent and six-month average of 5.4 percent remain well above its pre-pandemic level in February 2020 of 3.1 percent.
The same pattern is true for median expected household income growth and median expected earnings growth, which have averaged 3.2 percent and 2.9 percent, respectively, in recent months—well above their six-month averages going into the pandemic (2.7 percent and 2.4 percent, respectively). Consistent with these findings, the median probability of missing a debt payment over the next three months has been relatively low and stable over the past six months at an average of 11.3 percent, compared to a six-month average of 12.2 percent going into the pandemic.
Overall, households report solid and stable expectations for spending growth, consistent with our evidence on the strength and liquidity of household balance sheets, including relatively low delinquencies. Of course, the period of very low interest rates that supported many of these developments is decidedly over, at least for now, suggesting that household finances will likely tighten further in the coming months.
FYI:
Data: Redfin; Note: Affordable means homebuyer spends no more than 30% of income on monthly mortgage payment; Chart: Axios Visuals
The median income in the U.S. is $75,000 a year, but you’ll need to earn $40,000 more to comfortably afford the median-priced home, per a new analysis from Redfin, Emily writes.
Student Loan Payments Will Have Minimal Impact on U.S. Economy, Fed Research Shows New rules on income-driven repayment plans and accrued savings will ease some pain of monthly payments, a New York Fed blog post says.
Millions of student borrowers are likely to curtail their consumer spending by only about $56 a month on average as they restart payments on student loans, the research says.
Across 28 million federal student loan borrowers, this amounts to about $1.6 billion less in consumer expenditures a month, the researchers estimate.
“The findings suggest that the payment resumption will have a relatively small overall effect on consumption, on the order of a 0.1-percentage-point reduction in aggregate spending from August levels,” the New York Fed’s Raji Chakrabarti, Daniel Mangrum, Sasha Thomas and Wilbert van der Klaauw said in a post Wednesday on the bank’s Liberty Street Economics blog. (…)
The 43-month breather in payments gave borrowers over $260 billion in waived payments throughout the pandemic that could be used on other consumption or saved in bank accounts. Interest on federal student loans resumed in September and payments began again this month.
New rules on federal income-driven repayment plans—which can reduce monthly loan payments based on borrower income—and accrued savings will ease some of the pain in the monthly payments, according to the blog post. (…)
10-Year U.S. Treasury Yield Tops 4.9% Long-term bond yields hit a fresh 16-year high Wednesday, weighing on stocks already pressured by the conflict in Gaza and corporate earnings results.
(…) Traders are pricing in a roughly 37% probability that the central bank will raise its benchmark rate in its final policy meeting of the year, up from about 26% a week ago, according to CME Group’s federal-funds futures. (…)
Concerns about the Israel-Hamas war potentially expanding in the Middle East pushed oil prices higher. Brent crude rose 1.8% to $91.50 a barrel, the highest level this month.
A slew of quarterly earnings reports reflected challenges in the banking industry.
Morgan Stanley’s stock fell 6.8% after the bank posted a drop in quarterly net income, with investment banking and trading still in a slump. Shares of some regional banks, such as U.S. Bancorp, fell after several lenders reported being squeezed by higher interest and other expenses.
(…)About 11% of the companies in the S&P 500 have reported third-quarter earnings so far, according to FactSet. Of those, about 81% have topped analyst expectations, compared with the five-year average of 77%. (…)
John Authers: There’s Finally an Alternative to TINA
(…) For the first time this century, cash pays a higher yield in interest than the S&P 500 does in earnings — and with cash you actually get the cold hard money in your hands, rather than relying on accountants to calculate corporate profits correctly:
(…) The Fed’s Beige Book, a collation of reports on the economy from all its regional branches, was published Wednesday. Analysts now have all kinds of tools for dredging through the words to reveal patterns. And the bottom line is that this edition presented a rather downbeat version of the economy, staying only just ahead of recessionary levels. The following chart comes from Oxford Economics, who compile it via a quantitative analysis of the words in the text:
(…) Jeffrey Roach, chief economist for LPL Financial, offered the following summary, also emphasizing that this was fundamentally a downbeat, if not terrifying, assessment of an economy slowing down:
- Consumer spending was mixed since last month, especially among general retailers and auto dealers, due to differences in prices and product offerings.
- Some Districts reported slight slowing in consumer travel.
- Delinquency rates have increased lately, although still historically low.
- Most Districts still reported ongoing challenges in recruiting and hiring skilled labor so investors should still expect downside pressure on unemployment.
- Businesses struggled to pass along cost pressures because consumers had grown more sensitive to prices. As a result, firms struggled to maintain desired profit margins.
So a subtle, beige-hued view of the US economy would be one that is slowing down a bit and where tighter credit standards and higher rates are just beginning to have an effect. That would also align with common sense — and perhaps offer some ammunition for bond bulls.
Fromm BoA:
China’s Economy Gets Boost From Stimulus, but Headwinds Grow Economists point to challenges including Israel-Hamas war and frosty relations with U.S.
(…) Compared with the previous three months, China’s economy in the third quarter expanded 1.3%, accelerating from a revised 0.5% pace in the previous quarter, China’s National Bureau of Statistics said Wednesday. The revision means China’s economy eked out even less growth in the April to June period than the 0.8% initially estimated, a rate that was already roughly half the average pace recorded in the five years before the pandemic.
Growth year-to-date was 5.2%, keeping the economy on track to meet the government’s goal of expanding around 5% for the year as a whole.
Sheng Laiyun, deputy chief of China’s statistics bureau, told reporters on Wednesday that the country need only record 4.4% growth in the last three months of the year to meet its annual target. (…)
Chinese authorities have unleashed a barrage of stimulus measures in recent weeks aimed at re-energizing wilting consumer spending and arresting the downward spiral in real estate. Interest rates have been slashed and funding dished out to banks to lend to households and businesses, while many cities have scrapped restrictions on home purchases. In some cases, developers have been allowed to offer big discounts to would-be buyers in an effort to unload inventories of unsold apartments. (…)
Wednesday’s data showed retail sales grew strongly in September, rising 5.5% in September compared with a year earlier and accelerating from the 4.6% rate recorded in August. Industrial production, which has been struggling thanks to weak exports, increased 4.5% from a year earlier in September, matching August’s pace.
Investment in buildings, machinery and other fixed assets slowed, however, underlining the drag from property. Investment rose 3.1% in the January-to-September period, compared with the same nine months in 2022, a weaker pace than the 3.2% expansion over the first eight months of the year.
Unemployment fell to 5% in September, from 5.2% in August. China stopped publishing data for joblessness among young people in June, citing methodology wrinkles officials said they wanted to iron out. But many analysts attributed the decision to official discomfort over how high youth unemployment had risen, with the June data showing about one in five of people aged 16 to 24 were looking for work. (…)
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China’s Country Garden Was Given a Second Chance to Make a Bond Payment. It Failed. The property giant was once considered one of the safest developers in China, but the country’s property slowdown has claimed another victim.
(…) The company hasn’t made a $15.4 million interest payment on an outstanding dollar bond, according to two investors who hold the bond. That could lead to a wave of cross-defaults on its other international debt. Country Garden had around $15.2 billion of international bonds and loans outstanding at the end of June, according to its public disclosures.
The payment was due at midnight ET on Tuesday, said a person familiar with the matter. (…)
The Foshan-based developer now joins dozens of Chinese property companies that have missed payments on their dollar bonds. Bond defaults in the sector totaled around $81 billion between 2021 and 2022, according to data from S&P Global Ratings. International investors have taken big losses, including distressed-debt funds who picked up some of the dollar bonds after prices plunged. (…)
In September, total sales at China’s largest 100 developers dropped 29% from the same month last year, according to China Real Estate Information Corp., a private industry-data provider. Country Garden’s sales plunged 81% to just $846 million last month. (…)
Country Garden had the equivalent of $187 billion in total liabilities as of June this year, including $83 billion in contract liabilities, mainly the value of apartments it still has to deliver to home buyers. (…)
The developer managed to extend the maturities on roughly $2 billion of domestic yuan-denominated bonds. It has hired financial advisers to help it deal with its debt outside of China, a sign that it is planning to restructure its international liabilities. (…)
Country Garden has told investors that it is focused on completing and delivering the homes it has presold, which would help free up some of its cash that is locked in escrow accounts. That money could be used to pay off its debts. Unlike some other Chinese developers, Country Garden doesn’t disclose the amount of cash it holds in escrow.
New-home prices in 70 cities, excluding state-subsidized housing, declined 0.3% last month from August, when they slipped 0.29%, National Bureau of Statistics figures showed Thursday. That was the steepest month-on-month decline since October 2022.
Prices slid 0.48% in the secondary market, matching the previous month’s decline which was the largest recorded since 2014. The price cuts came even as major cities rolled out measures to stimulate the market, such as lowering mortgage rates and down payment requirements. (…)
The value of output by China’s real estate sector contracted 2.7% in the third quarter of 2023, according to separate data released by China’s statistics bureau. Output in the sector has contracted for eight of the last nine quarters, by far the longest slump recorded since China established a private property market in the late 1990s.
EARNINGS/VALUATION WATCH
‘Magnificent-7’ 2023 Q3 Earnings Preview: Lifting S&P 500 to Positive Earnings Growth
(…) The Mag-7 group is expected to far exceed the overall index growth rate in Q3 (+35.9% y/y vs. +2.2% y/y). When excluding the Mag-7, the S&P 500 Q3 earnings growth rate declines from +2.2% y/y to -2.3% y/y as shown in the grey bar.
Exhibit 1: Mag-7 Earnings Growth Rate
Based on analyst expectations, the outperformance from the Mag-7 group is expected to continue for the following seven quarters. Looking at full-year growth, Mag-7 earnings are expected to grow 32.9% in 2023 and 19.7% the following year compared to 2.2% and 12.1% for the S&P 500 over the same period.
The Mag-7 group is expected to grow revenue by 11.3% y/y compared to 1.0% for the overall index. When excluding Mag-7, the growth rate declines to 0.0%. Like earnings, the Mag-7 group is expected to outperform the overall index for the next seven quarters based on analyst estimates.
Exhibit 2: Mag-7 Revenue Growth Rate
(…) the Mag-7 group have been responsible for the majority of price gains in the overall index year-to-date. As of October 13, the Mag-7 group has contributed 12.5 percentage points to the overall index return of 12.9 percent. If we were to exclude the Mag-7, the year-to-date return in the S&P 500 would fall from 12.9% to 0.4%.
With such a sharp rise in stock prices, these companies have a low value score (i.e. considered expensive) as defined by the Relative Value (RV) and Intrinsic Value (IV) model. RV compares a company to its regional, sector, and industry peers using six fundamental ratios, while IV uses a dividend-discount model to determine the intrinsic value of a company.
The aggregate forward four-quarter P/E ratio for the Mag-7 group is 28.6x compared to an index P/E of 18.2x. This represents a premium of 56.6%. When excluding the Mag-7, the forward P/E declines from 18.2x to 15.9x.
The aggregate forward four-quarter P/S ratio for the Mag-7 group is 5.9x compared to an index P/S of 2.1x. This represents a premium of 282.0%. When excluding the Mag-7, the forward P/S declines from 2.1x to 1.6x.
Using LSEG Datastream, we can summarize the price vs. valuation relationship in a single powerful graph (Exhibit 4). Using the scatter plot, we display every constituent in the index where the X-axis shows year-to-date performance, and the Y-axis shows the forward P/E ratio. Constituents are color-coded by sector with a special call-out for the Mag-7 group. We note a ‘C’ shape where the Mag-7 leads the pack from a price appreciation perspective. Interestingly, Nvidia has a forward P/E that is lower than others in the Mag-7 (Tesla, Amazon) and in-line with others (Apple, Amazon), even though it is the top performer from a price perspective.
Exhibit 4: S&P 500 Price vs. Forward P/E
Aside from using fundamental ratios, we can also use the Intrinsic Value model to gauge market expectations for earnings growth and try to better understand how much of the current and future news is reflected in the current stock price.
Using Nvidia Inc as an example in Exhibit 5, we turn to the ‘Market-Implied’ growth rate and solve backwards – it sets the last closing price as “fair value” then solves for the growth rate required over the next five years to justify that price.
The market has priced in a forward five-year compound annualized growth rate in earnings of 56.9%, which is far greater than the industry average of 7.9% and above the StarMine Projection of 42.8% (StarMine will adjust estimates for an ‘optimism bias’ in addition to the accuracy of analysts).
We can compare the forward growth projections to the trailing five-year growth table, which shows Nvidia Inc has underperformed the peer median (8.6% CAGR vs. 26.4%). We can see that the hopes and optimism around artificial intelligence has turbocharged growth expectations for Nvidia over the next five years.
Exhibit 5: StarMine IV Model for Nvidia Inc
Source: LSEG WorkspaceEven with such high growth expectations, analysts have been largely bullish with the Mag-7 group as shown by the Analyst Revision Model (ARM) score in Exhibit 2. Five of the seven companies have an ARM score above 80 with Nvidia Corp having a score of 100. Tesla has the lowest score (6). Over the last 90 days, Alphabet Inc has seen the largest positive rate of change in the ARM score (35) followed by Amazon Inc (17). Apple Inc and Microsoft Inc have seen the largest negative rate of change, with both companies seeing their ARM score decline by 11 points.
Value-Momentum (Val-Mo) combines our two Momentum and two Value models into a multi-factor score. Meta Platforms has the highest Val-Mo score (81) followed by Alphabet Inc (73). Finally, the Combined Alpha Model (CAM) combines all alpha-generating models into a single score using an optimal, static, linear combination.
Based on analyst estimates, Nvidia Inc is expected to have the largest net profit margin this quarter at 51.4%, followed by Microsoft Corp (36.2%), Meta Platforms Inc (27.7%), Apple Inc (24.3%), Alphabet Inc (24.0%), Tesla Inc (9.7%), and Amazon Inc (4.2%).
At an aggregate level, the Mag-7 group is expected to post a Q3 net profit margin of 19.8% as shown in Exhibit 6. This compares to an index profit margin of 12.4%. When excluding the Mag-7 group, the S&P 500 net profit margin falls from 12.4% to 11.7%.
On a full-year basis, the Mag-7 net profit margin is expected to rise by 120 basis points in 2024 in comparison to an 80-basis point rise in the overall index.
Exhibit 6: Net Profit Margin
Although the Mag-7 have been largely contributing towards the year-to-date performance in the S&P 500, it can be justified based on earnings and revenue growth. According to analyst estimates, the Mag-7 group is expected to significantly outperform the broader index for the next several quarters on a year-over-year basis. Furthermore, the group is highly profitable as shown by the net profit margin ratio.
- Valuations based on the 24-month earnings projections remain decoupled from real rates.
Source: @TheTerminal, Bloomberg Finance L.P.
- S&P 500 Large Cap Index – 13/34–Week EMA Trend
Opportunities in fixed income
From RBA:
1. Real Yield (TIPS): Treasury Inflation-Protected Securities (TIPS) currently offer compelling value with 10-year real yields at approximately 2.5%. This is the first opportunity investors have had to lock in real returns above 2% since the Financial Crisis and the top 25th percentile of yield since TIPS were first issued in 1997.
Despite increased nominal yields and inflationary pressures — particularly given a 34% surge in oil prices since June — inflation expectations have remained relatively stable. If inflation expectations were to rise, TIPS could experience a significant increase in returns. Conversely, if nominal yields were to decrease while inflation expectations remain steady, TIPS returns could be on par with those of Treasuries.
2. Yield Curve Steepeners: Given the nearly historic inversion of the 2s10s yield curve, we see a potential opportunity to benefit from either an economic reacceleration or a severe downturn, both of which would likely lead to a steeper yield curve.
In the scenario of renewed growth and inflation, we anticipate further bear steepening, where long-term yields rise more than short-term yields as the long end of the interest rate curve is most sensitive to long term growth and inflation expectations.
Conversely, in the event of an economic contraction, bull steepening would likely occur, with short-term yields declining more than long-term yields as the market prices Fed rate cuts.
3. Preferred Securities: Unlike corporate credit, where spreads remain remarkably tight despite credit stress and increasing defaults, preferreds “realized their event” when the regional banks underwent stress earlier this year. This has cheapened even high-quality bank preferreds and the overall market in general. A reacceleration of earnings growth, the potential for a steeper yield curve, and attractive valuations make these hybrid securities among the most attractive cyclical options in fixed income.
4. Agency Mortgages: Though still realizing structural selling pressure, agency mortgage-backed debt is beginning to look attractive. Although RBA remains underweight the asset class, we have been opportunistically adding as housing fundamentals remain very strong. The lack of new issuance, minimal default risk and positive convexity (2) are all tailwinds for these securitized products.
Opportunities are clearly materializing in Fixed Income.
Timing?
