(…) Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being.
But officials also agreed to soon begin the years long process of shrinking the central bank’s securities holdings, perhaps as early as September, according to the minutes released following the customary three-week lag. (…)
For now, the position of Fed Chairwoman Janet Yellen and other top Fed leaders hasn’t changed. In congressional testimony last month, she dismissed weakening inflation as a temporary phenomenon caused by cheaper cellphone plans and prescription drugs.
“It probably remains prudent to continue on a gradual path of rate increases,†she told the Senate Banking Committee.
But the minutes suggest Ms. Yellen’s position has its skeptics within the Fed, and officials have publicly aired their disagreement since the meeting. (…)
The main challenge for the Fed is to make a correct assessment of the state of the consumer. Recent revisions on some key stats, namely personal income and expenditures, and the related savings rate, as well as retail sales this week, give conflicting trends on what has been the only solid pillar for the whole economy since 2009. Slow wage growth and slowing employment growth are currently offset by slower inflation. If this is indeed “temporary†and the Fed raises rates, consumers will get squeezed from all sides. If deflationary forces are real, it also means a lack of demand from 70% of the economy, which would not justify raising interest rates.
July’s jump in retail sales is very puzzling to that effect. It would be dangerous to base monetary policy on such a volatile and imprecise stat.
Meanwhile, Americans are the victims of all the uncertainty surrounding health care costs. A normal reaction would be to raise savings for a while. Let alone everything else going on in D.C..
Builders Pull Back on Home Construction Despite Strong Demand The apartment-construction boom is coming to an end, and builders aren’t ramping up single-family construction quickly enough to fill the void.
(…) Overall U.S. housing starts declined for the fourth time in five months in July, the Commerce Department reported Wednesday. Total housing starts decreased 4.8% from the previous month to a seasonally adjusted annual rate of 1.155 million.
While starts edged 0.5% lower for single-family construction, they plummeted 17.1% for construction on buildings with five or more units.
That isn’t necessarily bad news for the U.S. economy, because single-family construction employs three times as many workers per unit as multifamily construction, according to Rob Dietz, chief economist at the National Association of Home Builders. (…)
Starts in the first seven months of the year were up 2.4% from the same period in 2016, including an 8.6% jump in single-family construction. Apartment and condominium starts for buildings with five or more units are down 10.4% so far this year. (…)
- Homes are still affordable relative to historical levels. However, affordability has declined sharply in recent months as home prices outpace wages. (The Daily Shot)
SENTIMENT WATCH
Risk assets across the globe, despite already high valuations, have recovered impressively from a sell-off triggered by concerns about a North Korean nuclear attack. In doing so, they have again highlighted the extent to which traders and investors — highly confident about the environment they operate in (be it economic, financial or institutional) — have developed endogenous stabilizers. And while there is a limit to the effectiveness of these stabilizers over time, disrupting them in the short run would require deeper and more sustained adverse shocks, be they internal or external. Over the longer term, however, they cannot obviate the need for a handoff to more sustainable engines of value creation. (…)
The recovery in risk assets has a lot to do with a “buy the dips†mentality that is now deeply ingrained in markets and that, repeatedly, has proven highly remunerative. It is underpinned by four related beliefs held by a very wide set of traders and investors and supported by high-frequency data and other recent signals:
- A Goldilocks global economy in which prospects for relatively stable nominal gross domestic product have been enhanced by a fall of the threat of material slowdown that has occurred without materially increasing the risk of an inflationary outbreak.
- Supportive central banks that continue to show considerable caution when it comes to both raising interest rates (recent examples come from the Bank of England and the Federal Reserve) and tapering large-scale balance sheet purchases (see: European Central Bank and the Bank of Japan).
- Continued migration to passive vehicles, including exchange-traded funds, which dull stock differentiation and provide consistent overall support to markets.
- Strong performance of corporate profits, which also helps to bolster companies’ cash holdings and expands prospects for dividend payouts, stock buybacks and mergers-and-acquisitions activities. (…)
Yesterday in the FT:
(…) But to buy now you have to hope either that dividends will start growing at a much faster rate (there is no reason to expect this) or that multiples and profit margins will continue to expand. As both tend to be mean-reverting over time, buying US stocks requires a belief that “it’s different this time†with respect to the valuations that people will put on stocks, and the margins that companies can command. To quote [GMO’s] Messrs Kadnar and Montier: “The historical record for this assumption is quite thin, to put it kindly. It is remarkably easy to assume that the recent past should continue indefinitely but it is an extremely dangerous assumption when it comes to asset markets. Particularly expensive ones, as the S&P 500 appears to be.†(…)
Today in the FT:
(…) Even Ben Inker, head of asset allocation at GMO — the Boston asset manager famous for refusing to buy internet stocks in the late 1990s dotcom boom and calling an asset bubble ahead of the 2008 crisis, has started to think something fundamental may have changed in the world economy. “Are things going to revert to the old normal? To me that is the biggest question. These markets are really quite different from bubbles that we’ve seen in the past.†(…)
“Having studied every one of these [bear markets] in some detail, I’m not sure there is a parallel for today. We just don’t have precedents for going into a recession with interest rates at this level and inflation so low,†says Mr Napier. (…)
Consider yourself well warned by GMO, a highly respectable firm: stocks are very expensive and you should avoid them because things will mean-revert, as they always do. But then, maybe, perhaps, things could be different this time after all and, well, they may not…
There seems to be a divide between investors’ confidence and what is really going on in the world:
- The FOMC is totally puzzled by what’s going on with wages and inflation.
- The ECB is entering a similar debate on its own QE program.
- The BOE is also unsure of what to really do next.
- Washington is embroiled in a wide state of chaos.
- The U.S. consumer is very fragile.
- China seem to be slowing again.
But:
- no recession in sight, just yet at least.
- no reason for the Fed to cause one.
- earnings remain surprisingly strong on surprising revenue growth rates and rising margins.
S&P 500 operating EPS are up 12.0% (GAAP EPS +24.3%) on 5.1% revenue growth in Q2. Q1 operating EPS growth was 15.3% (GAAP EPS +26.4%). Pre-announcements for Q3 so far are encouraging with fewer negative and more positive than in both Q2’17 and Q3’16 at the same date.
Trailing 12-month EPS are now $125.96, up 3.4% from 3 months ago, 7.4% from 6 months ago and 9.3% from 12 months ago. Rising earnings and slowing inflation are boosting the Rule of 20 “fair value†(yellow lineâ€), providing a powerful backwind to moderately overvalued equities per this gauge.
Trump’s Business Councils Disband After CEOs Defect Business leaders disbanded two CEO councils created by the White House, a move they said was protesting Donald Trump’s failure to sufficiently condemn racism, marking a dramatic break between U.S. companies and a president who has sought close ties with them.​
The biggest bullish factor for Chinese construction remains intact: Massive housing inventories, which depressed construction growth for years, are still falling. Vacant, unsold housing floor space in China fell 10 million square meters in July to the lowest level since February 2014, according to data released earlier in the month. Vacant floor space is down 20% on the year. (…)
