Year: 2023

Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.

Inflation Trends Keep Fed Rate Hikes on Pause Underlying inflation picked up in September, government data showed, keeping the Federal Reserve on track to hold short-term interest rates steady at its next meeting.

The personal-consumption expenditures price index, the Fed’s preferred inflation gauge, rose 0.4% in September from the prior month, the same pace as in August, the Commerce Department said Friday. So-called core prices, which exclude volatile food and energy categories, increased 0.3% in September, compared with a 0.1% rise in August.

Core prices were up at a 2.8% annualized rate in April through September, down considerably from a 4.5% annualized rate in the prior six-month period. The Fed’s inflation target is 2%. (…)

At their meeting last month, Fed officials projected core inflation would fall to 3.7% in the fourth quarter from a year earlier. Friday’s report suggests inflation would end the year below that projection, which could strengthen the case to hold rates steady.

But some measures of underlying prices closely watched by Fed officials, such as services excluding housing and energy, showed more strength in September, highlighting why policy makers are likely to keep another rate rise on the table in the coming months. (…)

Consumer spending, the primary driver of economic growth, rose 0.7% in September from the prior month, compared with a 0.4% increase in August, Friday’s Commerce Department report showed. Americans spent more on services such as travel, housing and healthcare, as well like goods such as prescription drugs and vehicles.

Consumer spending growth in September was much faster than income gains, which rose 0.3%. The personal saving rate—a measure of how much money people have left over after spending and taxes—fell to 3.4% in September. That was the lowest rate since December of last year, suggesting households used part of their savings to finance their spending. (…)

• US Core PCE Prices Jump Most in Four Months as Spending Picks Up  One key area of concern for officials is service-sector prices, which rose by 0.5%, the most since January. Excluding housing and energy, services inflation accelerated to 0.4%, from 0.1% in the prior month.

Interesting that most media highlighted the inflation data rather than spending trends. To me, the surprise was that September demand for durable goods jumped 1.1% (+5.5% YoY), in real terms, amid very high interest rates, a depressed housing market and after 3 years of strong goods consumption.

Spending on goods is not only not falling back to trend, as widely expected, it seems to be creating a new, faster growing trend, unlike spending on services which is merely back to trend.

But this is only “transitory”: Americans are catching up on their cars/trucks purchases, delayed by the shortages during the pandemic but recently encouraged by rising labor market participation. Similar trends happened after previous recessions.

It can only be transitory because total spending has unusually diverged from disposable income (left chart) which is now 4% lower than expenditures. Whatever excess savings (deposits) remain, they are illusory since their purchasing power has been totally eroded by inflation.

  

Almost 4 years after the start of the pandemic, helicopter money and floored interest rates, we are back to basic fundamentals: income growth, inflation and savings.

This chart stacks the YoY changes in hours, employment and wages, highlighting the diminishing contribution from the actual job components while wages, up 4.2% in September (down from 4.8% last December), now contribute most of the 5.6% growth rate in total labor income.

Note, however, that wage growth slowed to 2.7% annualized in the last 2 months, well below the PCE deflator growth rate. At that rate, YoY wage growth would slow to 3.6% in December.

Headline and core PCE inflation are now in the 3.5% YoY range. However, on a MoM basis, core PCE inflation jumped from 0.1% in August to 0.3% in September mainly due to services inflation which abruptly interrupted its nice descent since January, rising at a 5.5% annualized rate in September (+4.0% in Q3 after +3.6% in Q2), more than twice the pre-pandemic pace.

Sticky rents were not the sole culprit. Services ex-housing (black bars) are also back in the 5% annualized range.

In truth, wages rising 4% are likely to keep services inflation sustained in the 4% range as well: there is a 99.7% correlation between these two series since 1994. If so, core PCE inflation should stabilize around 3.3%.

The math so far:

• job components:  1.5- 2.0% (employment + hours)
• wages:                 3.5- 4.5%
• inflation:               3.0- 4.0%
• = real income       2.0- 2.5% (worst/best cases 1.0%- 3.5%)

Real income growth averaged 4.2% in 2023.

The big wild card is what happens to savings. The savings rate fell to 3.4% in September, meaningfully lower than the 6.5% pre-pandemic average. It has very, very, very rarely, been lower…

…but even more rarely if we account for consumer interest payments. This next chart plots personal expenditures plus interest payments as a % of disposable income. It was 95.4% in September, very uncomfortably high looking at the last 30 years and significantly higher than pre-pandemic levels.

On September 11, I wrote The Wealth Defect, arguing that the Fed-induced jump in household wealth has been working against FOMC policies aimed at curbing demand.

(…) The Fed’s policies boosted household wealth 15.5% above their 2019 level and 35% above trend. Thanks to rising stock prices but, principally, to rising home values due to unusually low supply of existing homes due to Fed-supplied mortgage handcuffs. (…)

From a monetary policy perspective, the wealth effect is now a wealth defect: rising interest rates have little impact on a very wealthy, under leveraged, consumer looking to enjoy life AMAP (as much as possible) post pandemic.

The coming holiday season will be an interesting test. True, the less wealthy, and often more indebted, segment of the population is under some inflation duress but unemployment is still very low and lower wage earners are enjoying strong wage increases.

This now fairly widely held theory will be put to serious test in coming months, particularly after the recent debacle in financial markets.

Maybe the Fed’s aggressive tightening will finally bite enough, perhaps even too much.

Personal interest payments (which exclude mortgage interest) have doubled since the end of 2021, jumping by $267B to 2.7% of disposable income from 1.5% in December 2021. Both the absolute and percentage numbers are bound to rise further.

The remarkable resilience of the American consumer may be reaching its zenith.

Let’s hope for a soft landing, but we’re defying the odds…

• Americans Hold Off From Big Purchases in Worrying Sign for the Economy Sales of appliances, orthodontics and boats weaken, firms say

(…) Take Whirlpool Corp., the maker of Maytag appliances. The company said consumers continue to replace machines that break, but spending on new ones for renovations or new homes — what the company dubs discretionary purchases — has been weaker than expected, Chief Executive Officer Marc Bitzer said Thursday on a call with analysts.

The softening demand, which includes customers trading down to cheaper models, has sparked discounting across the industry. Now promotions are back to pre-pandemic levels after waning the past three years because Covid-19 upended supply chains and limited production. (…)

At Abbvie Inc., sales of Botox missed estimates last quarter and other facial treatments, such as fillers, declined.

For Harley-Davidson Inc., higher borrowing rates hurt sales of motorcycles, which tumbled 15% in North America. The company has rolled out generous new incentives to stimulate demand, but even then, sales were weak in the third quarter, according to dealerships and research from UBS Group AG. (…)

Marine Products Corp., which makes Robalo boats, reported a 22% drop in revenue last quarter. Brunswick Corp. had a 16% decline in its boat segment. And revenue at Polaris Inc., maker of a wide range of snowmobiles, motorcycles and pontoon boats, fell 4% last quarter. (…)

That said,

This week’s employment indicators are likely to remain strong. Initial unemployment claims (Thu) should remain low as they have been in recent weeks suggesting that October’s unemployment rate (Fri) remained low too and that payroll employment (Fri) expanded at a solid pace during the month (chart). September’s NFIB small business owners survey showed an increase in job openings suggesting that the comparable JOLTS series (Wed) will do the same. (Ed Yardeni)

The flattening trend in Indeed’s job postings through Oct. 20th supports that view:

BTW, FYI, Taylor Swift’s 53 US concerts this year are estimated to have added $4.3 billion to GDP (Bloomberg).

China Evergrande Winding-Up Hearing Adjourned to Dec. 4

EARNINGS WATCH

245 companies in the S&P 500 Index have reported earnings for Q3 2023. Of these companies, 77.6% reported earnings above analyst expectations and 17.1% 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, 74% of companies beat the estimates and 22% missed estimates.

In aggregate, companies are reporting earnings that are 7.9% 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 4.8%.

Of these companies, 60.2% reported revenue above analyst expectations and 39.8% 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, 69% of companies beat the estimates and 31% missed estimates.

In aggregate, companies are reporting revenues that are 1.0% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.9%.

The estimated earnings growth rate for the S&P 500 for 23Q3 is 4.3% [it was estimated +1.6% on Oct.1]. If the energy sector is excluded, the growth rate improves to 9.7%.

The estimated revenue growth rate for the S&P 500 for 23Q3 is 1.4%. If the energy sector is excluded, the growth rate improves to 3.6%.

The estimated earnings growth rate for the S&P 500 for 23Q4 is 8.5% [+11.0% on  Oct. 1]. If the energy sector is excluded, the growth rate improves to 11.6%.

Trailing EPS are now $217.27. Full year 2023: $219.91e. Forward EPS: $238.46. Full year 2024: $246.10.

The S&P 500 Falls Into a Correction, Following the Nasdaq Composite. The S&P 500 entered corrections three times in 2022, according to Dow Jones Market Data, most recently in September of that year.

• Worst October for Stocks in Five Years Has Investors Exiting Market Active manager poll, positioning show investors reduce risk

(…) Surveys of professional managers show big-money allocators have cut their equities to levels last seen at the depths of the 2022 bear market. Hedge funds just pushed up single-stock shorts for an 11th straight week. Models of investor positioning show everyone from mutual funds to systematic quants reducing equity exposure well below long-term averages. (…)

Dip buyers are hard to find, with the S&P 500 falling more than 1% five different times in October and pushing the index into a correction on Friday. A gauge of projected price swings in the Nasdaq 100 Index hovers near the highest level since March. Even after tech finally caught a break Friday on solid earnings from Amazon.com Inc. and Intel Corp., the Nasdaq 100 closed out the worst two-week drop this year and is poised for its steepest October loss since 2018. (…)

Equity positioning has fallen below long-term averages for most investor categories, particularly hedge funds and mutual funds, according to Barclays Plc analysis of CFTC data. A nearly three-month ramping of short positions by professional speculators is the longest increase in the history of data, says Goldman Sachs Group Inc.’s prime brokerage.

Wall Street’s “fear gauge,” the Cboe Volatility Index, held above 20 for a second consecutive week after staying below the threshold more than 100 days. (…)

Strategists at Barclays said lower exposure to stocks, bullish technical signals and seasonality are raising the odds of a year-end rally. It’s a message that was echoed earlier at Bank of America Corp. and Deutsche Bank AG.

• Bye Bye Buybacks:  Q4 is typically a stronger quarter in terms of buybacks, but it is notable that the recent trend has been down in terms of buyback announcements. Some of this will have to do with the cost pressures dampening margins last year, but especially also with borrowing costs now a lot higher — making it more difficult a calculus for firms to fund buybacks with debt. (Callum Thomas)

Source:  @WallStHorizon via Daily Chartbook and @MikeZaccardi

US, China Agree in Principle to Hold Biden-Xi Meeting Next Month

Where Americans are moving

Data: U.S. Census American Community Survey; Chart: Erin Davis/Axios Visuals

New data from the U.S. Census shows that around 820,000 people moved out of California and 550,000 out of New York in 2022. They join more than 8 million Americans who moved states in 2022.

The rising cost of living is pushing people out of expensive coastal areas, and the trend doesn’t look likely to change in coming years: four in ten Californians and and three in ten New Yorkers say they’re considering moving out of state.

• Many of those moving are headed to Florida or Texas, the states with the largest influxes in 2022.
• But Texans worried about the “California-ing” of their state may not need to worry: Democrats are much more likely to move to blue states, while Republicans move to red states.

Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.

Economic Resilience on Display in Q3 GDP

U.S. economic output accelerated in the third quarter as real GDP rose at a 4.9% annualized rate. At the start of 2023, a number of forecasters, including many at the Federal Reserve, thought the U.S. economy would be either slowing or perhaps even entering a recession by the second half of the year. Instead, it is accelerating. Third quarter growth is more than double the pace of the prior period’s growth (+2.1%) and well-above what many observers estimate to be the potential growth rate in the U.S. economy today (~1.8%).

There’s no denying this is a strong outturn, but an $80.6 billion build in inventories was responsible for 1.3 percentage points of headline growth. Net exports were the largest surprise to us. We had anticipated a boost from trade, but net exports subtracted 0.1 percentage points from growth on stronger import activity, which does not immediately square with the advance monthly data. Real imports rose at a 5.7% annualized clip in Q3, or by the most in six quarters.

Still, growth is tempered a bit when we strip through some of these volatile components and look at the core parts of the economy. Real final sales to domestic purchasers were still robust but expanded at a more moderate 3.5% clip last quarter. As seen in the nearby chart, that’s still a pace well ahead of the roughly 2.3% quarterly annualized growth rate averaged over the previous expansion.

Economic growth was lifted by a robust pace of consumer spending throughout the period, as evidenced by fairly strong monthly retail sales data. Real personal consumption expenditures expanded at a 4.0% annualized pace, or the fastest rate of expansion since mid-2021 when the economy was bouncing back amid reopening. Growth was fairly broad based among major spending categories as well, though services continue to account for a majority of consumption (chart). Services spending rose at the fastest pace in over two years, and goods purchases bounced after a weak second quarter.

We will get the full release for September Personal Income & Spending tomorrow, which will include the monthly spending details, but we expect consumption ended the quarter quite strong, setting the fourth quarter up for a decent pace of growth as well.

Beyond consumer spending, residential investment was also pretty strong, seeing its first positive pace of growth in ten quarters (+3.9%). Nonresidential investment was weaker, but most of that weakness is attributed to slower equipment outlays during the period, which fell at an annualized rate of 3.8%. Structures investment (+1.6%) and intellectual property products (+2.6%) both expanded.

Source: U.S. Department of Commerce and Wells Fargo Economics

The pullback in equipment spending was a little larger than we had anticipated, though it is consistent with the separately released data on September Durable Goods out this morning. These data show that nondefense capital goods shipments, which feed into the BEA’s calculation of equipment investment, slipped 0.2% in September. The advance in broad durable goods orders in September was largely driven by a surge in aircraft orders, which we anticipated from previously released Boeing data. Equipment spending has been volatile in recent quarters, and we anticipate it will remain under pressure as borrowing conditions grow less favorable.

Third quarter growth demonstrates the U.S. economy remains resilient in the face of higher rates and still-elevated prices. While we still anticipate it will take a period of below-trend growth to ultimately sniff out inflation, we do not think this report changes much for monetary policymakers, who are set to meet next week. We still anticipate the FOMC will elect to leave rates unchanged at the conclusion of its meeting.

Policymakers had anticipated the strength exhibited in today’s report based on strong monthly data, with little of the underlying details coming as much of a surprise. Inflation also continued to moderate with the core PCE deflator easing to a 2.4% annualized pace in the third quarter.

Separately released data on jobless claims showed a slight uptick in initial claims for unemployment as well as those continuing to make claims. While both measures remain low and consistent with a tight labor market, the more persistent rise in continuing claims adds to some signs of moderation.

The recent upward move in longer-dated yields can also add to financial tightness in the economy. We thus anticipate the FOMC will remain cautious to take further action at this point. We also ultimately still anticipate the economy will show more meaningful signs of slowing later this year and early next year as tighter financial conditions more meaningfully materialize and begin to weigh on spending and investment decisions.

• Mounting challenges point to weaker growth in coming quarters (ING)

(…) Unfortunately, we don’t see this stellar growth rate being repeated in the fourth quarter of the year. The cumulative effects of Federal Reserve interest rate increases and reduced credit availability are showing signs of finally biting. Credit card borrowing costs are the highest since records began, car loan and personal loan rates are soaring while mortgage rates are up at 8%. At the same time, the sources of funds to spend are looking less supportive. Real household disposable income is flat lining, savings are being run down and consumer credit is starting to be paid back, with student loan repayments restarting. As such, we expect consumer spending to grow at a weaker pace in the fourth quarter with this decelerating trend continuing in 2024.

Home builder sentiment is also starting to sour, which weakens the outlook for residential construction as we head towards 2024 while that big surge in inventories seen in the third quarter may not come in as strongly in the fourth quarter.

It is obviously early days, but at this stage we see GDP growth coming in closer to 1.5% in the final three months of the year. Not terrible, but with those challenges facing the consumer sector likely intensifying, growth is set to be even weaker in 2024.

• The U.S. consumer is ‘walking towards a cliff,’ strategist warns Trouble is brewing for the U.S. economy and its pivotal consumer component.

(…) “I think the U.S. consumer is walking towards a cliff, basically,” Chris Watling, chief executive of financial advisory firm Longview Economics, told CNBC’s “Squawk Box Europe” on Tuesday.

He said that a slew of recent economic indicators had showed consumers are quickly running out of excess cash, while household savings are coming under pressure.

“Of course, retail sales have been quite strong for the last few months and everyone gets quite excited about that, but, actually, if you look at what’s going on, the household savings ratio has been run down, and, in fact, real income growth has been negative for three months,” Watling said.

“So, it’s not quite all good news. I mean, quite the reverse, I think there are some real challenges coming for the U.S. consumer.” (…)

“We see at the margins the consumer is under a lot of pressure and, in fact, the labor market is under a lot of pressure as well. We had a good payrolls month, but if you look at a lot of the indicators of where the labor market is likely to go, a lot of them are fraying at the edges,” Watling said.

“We’re going to get to the point in the next months when I think the labor market starts to deteriorate more meaningfully and that’ll kickstart the recession when we get there,” he added. (…)

Some facts FYI:

• Since the pandemic, real expenditures have exceeded both real disposable income and real labor income. Sustainable?

• Sustainable only with more credit or lower savings, which did not happen this cycle:

• Helicopter money is responsible for the spending surge. The so-called excess savings generated excess spending. Wells Fargo says that “the benchmark revisions to the National Accounts caused some pretty big changes to our measure of excess savings again. Essentially, the data now suggest there is $1.1T remaining in excess savings through August, whereas the previous data suggested only about $339B remaining through July.”
• Not everybody agrees with this but Wells Fargo supports its view with this chart showing “excess deposits”:

• The only problem with these “excess deposits” is that inflation has brought their real spending power below trend. In real terms, helicopter money has disappeared.

So we are back to the old normal where consumption generally grows with labor income, up 5.6% YoY in September, +5.3% a.r. in the last 3 months and +6.6% a.r. in the last 2 even if wages grew only 2.7% a.r..

The October flash PMI provides a few clues of the most recent trends:

At 51.0 in October, the headline S&P Global Flash US PMI Composite Output Index rose from 50.2 at the end of the third quarter to signal a modest uptick in business activity. Growth in output was the strongest since July, albeit only slight overall.

The overall upturn was supported by expansions in activity at manufacturers and service providers at the start of the fourth quarter. Production at manufacturing firms rose at the quickest pace since April, while output growth at service sector firms was the fastest in three months. (…)

US businesses continued to hire additional workers during October, albeit at a slightly reduced pace compared to September. (…)

Companies raised their average selling prices for goods and services at the slowest pace since June 2020 in October.

Slow growth, but growth nonetheless, with subdued inflation.

Evergrande Talks With Holdout Creditors Ahead of Wind-Up Hearing Risk of liquidation looms as builder reassesses restructuring

(…) The clock is ticking on Evergrande, the world’s most indebted developer with about 2.39 trillion yuan ($327 billion) of total liabilities. It faces a winding-up hearing in Hong Kong on Monday, where it needs to present “concrete” restructuring progress to help avoid the once-unthinkable risk of a liquidation. The fate of Evergrande and even bigger peer Country Garden Holdings Co.—deemed in default for the first time ever this week—is of broader significance to an economy where the property market and related industries account for about 20% of gross domestic product.

Evergrande said last week that it’s revising the terms of its restructuring plan without giving details, after scrapping creditor meetings at the last-minute in September and saying it would need to reassess its proposals. (…)

• Country Garden’s Missed Bond Payment Triggers CDS Payout Note’s trustee says coupon nonpayment an ‘event of default’

(…) With $186 billion of total liabilities, Country Garden is one of the world’s most indebted builders and a symbol of China’s broader property debt woes. (…)

A messy overhaul by Country Garden risks sending the sector into deeper turmoil and posing a threat to social stability, given its large number of projects and heavy presence in smaller cities. (…)

• China Selloff Threatens $27 Billion of ‘Snowball’ Derivatives Hitting knock-in level may trigger selling of index futures

Another 10% decline in a major Chinese equity gauge may trigger a wave of selling in index futures tied to structured products, adding fresh risks to the slumping stock market.

Investors face losses in complex “snowball” derivatives at maturity when a benchmark falls below a so-called knock-in level. For those tied to the CSI Smallcap 500 Index, the average threshold is 4,865, according to estimates by China International Capital Corp. The gauge traded at around 5,417 as of 9:52 a.m. Friday.

A relentless rout in Chinese stocks has turned the spotlight on the risk of those derivatives, which promise bond-like coupons as long as underlying assets trade within a certain range. Snowballs, similar to autocallables in other countries, gained popularity in 2021 among China’s institutional and wealthy investors and have expanded into a market worth $27 billion. Brokers may rush to liquidate hedging positions once the knock-in level is reached.

Investors in South Korea, another huge market for structured notes, have billions of dollars worth of bets placed on products tied to the Hang Seng China Enterprises Index that are also at risk.

Snowball notes with the CSI 1000 as the underlying index have an average knock-in barrier at 4,997, according to CICC estimates. That’s about 14% below Friday morning levels. (…)

“If there is forced selling of index futures, the impact could spill over as the drop in derivatives will hit sentiment or could force closing of long stock positions,” said Yu Yingbo, fund manager at Shenzhen Qianhai United Fortune Fund Management Co. Ltd. Still, the regulators should be less worried due to the tighter oversight in recent years, he added.

CICC estimated that any selling of index futures triggered by the breach of knock-in levels will still have limited impact on the spot stock market, as traders will reduce positions in a “diversified manner” and the volume will be small when compared to the total futures market.