U.S. Personal Income & Pricing Power Firm; Spending Growth Eases

Personal income increased 0.4% last month (4.6% y/y) following a 0.5% January rise, revised from 0.4%. The increase raised y/y growth to 4.6%, its best since May 2015. A strengthened 0.5% increase (5.5% y/y) in wages & salaries has raised growth in overall income. (…)

Disposable personal income increased 0.3% (4.4% y/y) following a 0.4% rise. After accounting for a 0.1% uptick in prices, the 0.2% increase followed three months of little change. The 2.3% y/y increase was below, however, its peak of 3.5% during all of 2014 and 2015.

Personal spending improved 0.1% (4.8% y/y) in February after an unrevised 0.2% increase. When adjusted for higher prices, personal spending eased 0.1% (+2.6% y/y) after a 0.2% decline. Spending on durable goods eased 0.1% (+7.6% y/y) after a 1.1% drop. (…)

The personal savings rate improved to 5.6% from 5.4%. It was the highest level since October. The level of personal saving declined, however, by 1.7% y/y.

Inflation Tops 2% Target for First Time in Almost Five Years An important measure of inflation exceeded the Federal Reserve’s target for a 2% annual gain for the first time in nearly five years.

Why Americans Aren’t Spending Like They Used To

People socked away a bit more of what they made in February, the Commerce Department reported Friday. Personal income rose by 0.4% from a month earlier, but spending rose by just 0.1%, and fell 0.1% in inflation-adjusted terms. That pushed the saving rate to 5.6% from 5.4% —its highest level since before the election. (…)

Indeed, preliminary work by University of California, Berkeley economists Ulrike Malmendier and Leslie Shen finds that households that have lived through a high-unemployment environment spend significantly less over their lifetimes than those that haven’t. The chastened households also shift their spending in other ways, gravitating toward on-sale items, off brands and lower-end products. The experience seems particularly salient for people who were young when unemployment was high. For that reason the millennials now entering their prime spending years, and who count as America’s largest living generation, may be particularly affected by the recession experience. (…)

What’s the fuss all about? The current savings rate is lower than most of the time during the last 35 years and has been fairly stable this last cycle.

Actually, real spending growth has remained fairly constant in spite of the sharp secular deceleration in nominal income growth since the early 1980s.

Thanks to declining inflation rates, Americans’ real income have grown at steady rates even though their nominal income streams have slowed considerably.

An important factor has been the total delinking between inflation on goods and overall inflation since the mid-1980s.

Goods inflation has been essentially zero for 20 years, substantially enhancing consumer buying power for goods such as cars, apparel, appliances and tech stuff. As this next chart shows, disposable income deflated by core goods inflation has been rising within a constant 2.5-7.5% range, about twice as fast as total real income.

A significant part of this relative price deflation on core goods is due to the globalization of supply chains largely initiated by Wal-Mart’s imports from China in the 1990s but further boosted by Amazon’s technological prowess. The ensuing disruption in U.S. manufacturing output was more than offset by the positive impact on buying power for all Americans.

We shall see how President Trump’s trade initiatives modify supply chains and costs/prices in coming years.

HARD VS SOFT DATA

• Retailers are hopeful for spring/summer (chart from RBC):

• Aruoba-Diebold-Scotti Business Conditions Index

The Aruoba-Diebold-Scotti business conditions index is designed to track real business conditions at high frequency. Its underlying (seasonally adjusted) economic indicators (weekly initial jobless claims; monthly payroll employment, industrial production, personal income less transfer payments, manufacturing and trade sales; and quarterly real GDP) blend high- and low-frequency information and stock and flow data.

No acceleration there yet. The heart beat remains fairly slow:

• LOAN DATA SUGGEST WEAK DEMAND

Animal spirits are not showing up at the banks. Commercial, industrial and real estate loans have stalled in the last quarter: (charts from Raymond James)

• Below is the overall growth in bank-held private sector credit. (The Daily Shot)

• Economic Conditions Snapshot, March 2017

McKinsey Global Survey results indicate that executives are seeing “notable improvements in their home economies” but “doubt conditions will improve much more than they already have.”

Executives are more upbeat about current economic conditions—both globally and in their home
countries—than they were for all of 2016, in McKinsey’s latest survey on the topic. They are nearly twice as likely as in the past two surveys to say conditions in the world economy have improved in recent months, and they report notable improvements in their home economies, too. Their views on the future, though, are more tempered. Respondents are more optimistic than not about economic prospects but doubt conditions will improve much more than they already have. (…)

Views on trade are especially positive in Asia–Pacific. Just three months ago, respondents in the region were the likeliest to report declining trade: half of respondents there said trade levels had declined, compared with one-third of all respondents. Now they are twice as likely to say trade has increased than declined, much less likely than in December to say the change in trade levels has harmed their business (16 percent now, down from 43 percent), and likelier to believe trade levels will increase rather than decrease in the year ahead.

Their peers in North America, though, are much less optimistic. Respondents in the region are the least likely to say trade levels have increased in the past 12 months—followed closely by those in the Middle East and North Africa and in other developing markets, who tend to report declining trade. Looking ahead, they are the most likely to expect decreasing trade levels. Fifty-two percent in North America predict trade between their home countries and the world will decline in the next year, compared with a global average of 35 percent. (…)

• See also THE U.S. CONSUMER: FRAGILE STRENGTH

SOFT DATA REMAIN STRONG

PMIs

• Eurozone Manufacturing PMI at near six-year high as growth accelerates in Germany, Italy and France

The final Markit Eurozone Manufacturing PMI® rose to a 71-month record of 56.2 in March, up from 55.4 in February and unchanged from the earlier flash estimate. The average PMI reading over the first quarter as a whole (55.6) was the highest since the opening quarter of 2011. (…)

The trend in new export business continued to improve at euro area manufacturers in March. New export orders rose for the forty-fifth successive month, with the rate of growth hitting a near six-year high. Companies linked stronger inflows to improving global market conditions, aided in part by the relatively weak euro exchange rate.

New export business rose in almost all of the nations covered, the sole exception being Greece.

(…) the pace of job creation regained the momentum lost in February to hit a near six-year record. Underlying the increase in staff headcounts was higher new order inflows, an associated gain in backlogs of work (steepest since April 2011) and a near series-record degree of business optimism.

Manufacturers’ purchasing costs rose at a rate close to February’s 69-month high, leading to the steepest increase in factory gate selling prices since June 2011. The cost impact of the euro exchange rate and rising commodity prices remained the main factors influencing trends in both input costs and output prices.

There were also signs that improving sellers’ pricing power contributed to cost increases during March. Average vendor delivery times – a bellwether of supply chain pressures – lengthened to the greatest extent since May 2011, allowing vendors to further push up their prices.

• Euro-Area Unemployment Falls to Lowest in Eight Years

• CHINA PMIs

• Caixin China General Manufacturing PMI™ PMI points to slower improvement in operating conditions

The seasonally adjusted Purchasing Managers’ Index™ (PMI™) posted 51.2 in March, down from 51.7 in February and signalling a further improvement in the health of the sector. Although pointing to only a modest rate of improvement, the latest index reading remained amongst the highest seen over the past four years.

Chinese goods producers increased output for the ninth successive month in March, with a number of companies citing improved market conditions and rising new order volumes. That said, the rate of expansion edged down from February and was moderate overall.

In line with the trend for production, growth in new business eased slightly in March, but remained solid overall. Data indicated that a softer increase in new export work was a key factor leading to weaker growth in total new orders. Moreover, March signalled the weakest increase in new export sales in 2017 so far.

Job shedding was reported for the forty-first month in a row in March. That said, the rate of payroll cuts held close to February’s marginal pace. At the same time, there were further signs of capacity pressures, as shown by a further increase in backlogs of work, although the rate of accumulation was modest overall. (…)

Manufacturers signalled a further slowdown in the rate of input price inflation at the end of the first quarter, though the rate of increase remained sharp overall. Output charges also increased in March, albeit at the slowest pace in six months.

• Chinese Factories Humming ‘at Peak of Recovery’ China’s official manufacturing purchasing managers’ index edged up to 51.8 in March bolstered by government stimulus spending and rising prices for factory goods.

China’s official manufacturing purchasing managers index edged up to 51.8 in March from 51.6 in February, the National Bureau of Statistics said Friday.

The gauge’s subindexes for new orders, exports and production all rose, while the raw material inventory gauge edged down—all signs of vitality in the manufacturing sector. Meanwhile, the government’s nonmanufacturing PMI, also released Friday, rose to 55.1 in March, a near three-year high, from 54.2 in February. (…)

Zhao Qinghe, an economist with the statistics bureau, said in a statement on Friday that high-tech manufacturing continued to expand this month and some traditional manufacturers showed a turnaround, although many companies still face problems obtaining relatively low-cost financing. (…)

An independent survey of 2,000 Chinese companies released Thursday by the Cheung Kong Graduate School of Business found that even as production has expanded, private investment remains sluggish and overcapacity is at a historical high despite an estimated 5.5 million industrial jobs lost last year. (…)

China’s total nonfinancial-sector debt was 277% of GDP at the end of 2016, including corporate debt estimated at 164%, according to UBS Group AG.

  

Trump Administration Lays Groundwork to Keep Big Tariffs on Chinese Goods Review is expected to be announced as early as this week

(…) Beijing has said members of the WTO were required to start treating it as a market economy in December 2016, on the 15th anniversary of its membership in the Geneva-based body that oversees global trade.

However, the Obama administration declined to take steps to grant China that status, continuing to treat one of its largest trade partners as a nonmarket economy. Mr. Trump said in December that China is “not a market economy.” (…)

Gavyn Davies: Global surveys or hard data – which are the fake news?

In this month’s regular update on global economic activity, the Fulcrum nowcasts have once again identified extremely strong growth rates, especially in the advanced economies. These results continue to suggest that the global economy is expanding at the fastest rate seen since 2010, with the implication that the expansion may be reaching escape velocity, where it is no longer in need of emergency support from the central banks or fiscal authorities. (…)

Given the extremely large difference between surveys and hard data at present, it is important to consider which of these sources of evidence is likely to be giving the correct signal on the current pace of the global expansion. Based on past evidence, we continue to give considerable weight to the buoyant surveys, even when they conflict with the relative weakness of hard data. (…)

Toronto Bidding Wars So Fierce That Homebuyers Skip Inspections

THE PROFIT ILLUSION

From Evergreen/Gavekal:

Inflation has a way of making things look better than they really are. This is especially true of corporate profits. After a dismal first half last year, S&P 500 companies reported an earnings recovery in 2H16. In the final quarter, they posted profit growth of 6% YoY (with or without financials). Alas, this recovery appears to be a mirage, caused by accelerating inflation. Using official flow
of funds data for the domestic non-financial corporate sector, and adjusting for the effects of inflation, I find that US corporate returns, in real terms, were flat in the second half of 2016 and actually ticked down in 4Q. There has been no recovery in profits.

One might think that 6% nominal profit growth, in the context of 1.5-2% inflation, would give positive profit growth in real terms. It does not. It is not enough simply to deflate headline profits by an inflation index. The trouble is that conventional accounting does not adjust for the rising cost of replacing capital, such as depreciating assets and inventories. Inflation pushes up revenues,
while depreciation and the cost of goods sold are deducted based on historical costs. This makes profits look greater than they really are. (…)

Thankfully, the US flow of funds statisticians provide their own measures of corporate profits, adjusted for changes in the replacement costs of fixed capital and inventories (named “capital consumption adjustments” or CCadj, and “inventory valuation adjustments” or IVA). We then extend this logic one step further, applying what we call a “working capital adjustment”—which accounts for the fact that, like inventories and fixed assets, working capital requirements also rise and fall with inflation. Thus, during periods of inflation, a portion of inflows need to be added to working capital rather than treated as profit and consumed. After making these adjustments, whatever profit is left over can then be deflated by a price index. The resulting measure of real profits fell dramatically in 2015 and was basically flat over the course of 2016. If anything, profits have kept falling marginally,
with 4Q16 profits actually down a touch versus 3Q and versus a year prior. There has been no recovery.

The result is that return on invested capital in the US continues to slide. And with interest rates across the curve having risen in recent months, my various Wicksellian spreads between the return on capital and the cost of capital have narrowed further. Although the Fed softened its hawkish tone, it still hiked rates, and it plans to hike further this year. Investor hopes are high that these increases will be more than offset by a rebound in returns—thanks to rising animal spirits and possible policy reforms. Perhaps. But for now those are just hopes. The facts on the ground still call for caution.

With the latest data, my Wicksellian spreads* are not yet flashing red. But they are now glowing a very dark orange, as the most topical spread, based on the Fed Fund rate, suggests. According to my model, equity risk exposure should now be reduced to roughly one quarter of full risk-on levels. Instead, investors should overweight cash and treasuries (…).

Another way to look at it from Morningstar/CPMS: the P/B vs ROE are each trending differently. Ex the internet bubble, P/B is at a historical high while ROE is well below previous peak levels.

Trailing EPS have flatlined and reinvestment rates are struggling in single digit area: