The Economist in April 2023:

• America’s economic outperformance is a marvel to behold
• The lessons from America’s astonishing economic record 

Three quotes:

• America’s dominance of the rich world is startling. Today it accounts for 58% of the G7’s GDP, compared with 40% in 1990. Adjusted for purchasing power, only those in über-rich petrostates and financial hubs enjoy a higher income per person. Average incomes have grown much faster than in western Europe or Japan. Also adjusted for purchasing power, they exceed $50,000 in Mississippi, America’s poorest state—higher than in France.
• Investors who put $100 into the S&P 500 in 1990 would have more than $2,000 today, four times what they would have earned had they invested elsewhere in the rich world.
• On a whole range of measures American dominance remains striking. And relative to its rich-world peers its lead is increasing.

Nearly one year later, American exceptionalism is on everybody’s mind.

Ed Yardeni illustrates how U.S. equities have totally outperformed world markets over the past 15 years, both in local currencies and in dollar terms:

In dollar terms, U.S. MSCI revenues jumped 65% since 2008 while World-ex-US revenues declined 20% (+16% in local currencies).

Since the pandemic, U.S. MSCI: +30% vs World-ex-US: –5% (+5% in local currencies).

These next 2 charts compare U.S. revenues with developed countries-ex-US in dollar (left) and local currencies (right).

  

The Economist again: “The world’s biggest economy is leaving its peers ever further in the dust”.

Trends are not always our friends. After a while, we tend to take them for granted, they become “natural”, ingrained, widely expected. Without a complete understanding of how they happened, we may be surprised when they end and reverse.

This chart from J.P. Morgan Asset Management shows that

over the past 50 years, there have been different regimes of U.S. vs. international outperformance. In other words, outperformance comes in waves. After a long period of U.S. outperformance, it is worth considering whether we may be transitioning to a new wave.

Source: FactSet, MSCI, J.P. Morgan Asset Management

Growth arises from many sources. The American economy benefits from several advantages compared its world competitors. To list a few:

• population growth, including immigration
• education
• productivity, dynamism, flexibility
• innovations
• energy
• dollar

These attributes have long been mainstays of the American economy over time and cycles.

One additional source of growth has emerged since 2008: the U.S. government has significantly intervened in the economy, boosting its expenditures from 21% of GDP to its current 25.5%, doing so with borrowed capital as opposed to higher revenues.

In fact, every economic shock since 1981 was used to substantially boost the U.S. debt leverage, without subsequently restoring the debt ratio. The jump in leverage since the GFC has been nothing short of spectacular: the federal public debt exploded from 62% of GDP in 2007 to 120%, in 15 years!

Among G7 countries, only the U.K. boosted its debt leverage faster than the U.S. since 2010. For the average G7 countries ex-USA, debt to GDP increased by 14 percentage points (+18%). Meanwhile, debt leverage rose by 27 pp or 39% in the USA.

In effect, the U.S. government’s increased spending provided additional revenues to the private sector without any offsetting contribution extracted from corporations or citizens.

The budget space provided by the huge decline in interest rates since the mid-90s was entirely used to raise spending and debt.

As a result, interest expense now represents 15.4% of the government budget, up from 9.2% in 2010.

• The most recent projections from the Congressional Budget Office confirm once again that America’s fiscal outlook is on an unsustainable path — increasingly driven by higher interest costs. Growing debt, in addition to the rise in interest rates over the past couple of years, has significantly increased the cost of federal borrowing. In 2023, interest costs on the national debt totaled $659 billion — surpassing most other components of the federal budget. (Peterson Foundation)
• The debt is growing faster than the
  economy, so it is unsustainable. It’s time for us
  to get back to putting a priority on fiscal sustainability. And sooner’s better
  than later. (Jay Powell at 60-Minutes)

Keep in mind that the CBO projections naively assume that inflation, real growth and real Treasury yields will all average 2% over the forecast horizon.

About one third of Treasurys will be maturing during the next 12 months, very likely with a steep markup on renewals, taking even more budget space, crowding out more discretionary spending.

This means that the federal government is losing considerable leeway to adjust spending to economic needs and its discretionary expenditures are unlikely to provide the same economic impetus as they did since the GFC. The CBO’s baseline (and naive) projections have discretionary expenditures declining in 2024 and 2025 rising very modestly thereafter but actually declining in real terms.

The American stars (and stripes) neatly aligned themselves after the 2008-09 GFC. The federal budget exploded under both Democrat and Republican governments (R.I.P. the Tea Party) while interest rates were brought to zero. Corporate tax rates were drastically cut in 2018.

The pandemic prompted the U.S. government to further boost spending and the Fed to flood the economy with liquidity. Americans merrily spent their pandemic bounty. Meanwhile, broken trade channels and the trade dispute with China are inciting businesses to reshore production, encouraged by significant government subsidies and increased protectionism.

Manufacturing construction doubled (+$110B) since mid-2022, ten times faster than GDP, while manufacturing shipments and new orders stagnated. Actually, manufacturers spent twice more building plants in 2022-23 than during all previous 20 years.

Manufacturing capacity utilization peaked at 80% in April 2022, highest in 22 years, from 76% pre-pandemic. It has since dropped to 76.5% and is likely to get lower as the more recent projects get completed.

Most of this new capacity is not to meet new demand, creating overcapacity, mainly in China, that is now fighting for new orders, likely displacing other production in a deflationary domino effect.

The war in Ukraine also benefitted defense spending in the U.S..

Industrial production in the U.S. defense and space sector has increased 17.5% since Russia launched its full-scale invasion of Ukraine two years ago. Business is coming from European allies trying to build out their military capabilities as well as from the Pentagon, which is both buying new equipment from defense manufacturers and replenishing military stocks depleted by deliveries to Ukraine. (WSJ)

Looking ahead, many important changes are likely:

• Consumer spending will normalize, with increased volatility. Since 1959, the personal savings rate has only been lower than the current 3.7% during the 2005-08 period when Americans splurged on housing, and briefly in 2022, in total only 7% of the time. Before the pandemic, the savings rate ranged between 5.0% and 8.5%.
• Construction spending will also normalize. Since 2010, total construction spending grew 50% faster than GDP, carrying a high economic multiplier.
• Government spending ex-interest expense will measurably slow down.
• The unemployment rate is at a historical low. Employment growth will slow.
• American politics are getting increasingly toxic and inefficient.

Investors are paying top valuations for large cap stocks, clearly extrapolating the past without appreciating that the true American exceptionalism actually is all the exceptional factors that boosted its economy since 2009 and oblivious to the rising risk from its indebtedness as interest rates normalize.

We may well be in a melt-up fueled by Goldilocks sentiment and passive investing mechanically boosting the Magnificent 7 stocks, but the risk/reward ratio has reached a mined no-man’s land area.

J.P. Morgan Asset Management agrees:

Indeed, the stars do seem to be aligning for international to take the baton from the U.S. over the next decade, including: cheaper equity valuations, cheaper currencies and a combination of cyclical and structural investment themes than can help boost long-term returns.

The panel below shows valuation measures for international equity markets. The left-hand side shows the price-to-earnings discount of international vs. U.S. equities. On the right-hand side, we show the difference in dividend yields between international and U.S. stocks.

We can see that international equities are trading at a significant discount right now and that they offer an attractive yield pickup relative to U.S. equities on average.

Ed Yardeni offers these absolute P/E charts:

(MacroMicro)

Another way to contextualize current valuation ratios from JPMAM:

Since 2009, this blog has been discouraging country diversification: in single words, Europe was seen as unmanageable, Japan as unscrutable and China as uninvestable. By comparison, the U.S. was very likable, and mostly reasonably valued.

Nobody knows how long the U.S. will remain such a magnet for capital and what will trigger the change in sentiment. But alternatives are now more interesting, allowing for at least some diversification.

Back in 2009, U.S equities were selling at a discount to the world as the GFC made it “uninvestable” to many (one reader called me a “bloody fool” after I wrote a very bullish post in March 2009). The current premium is the largest ever as the U.S market has become “the only one”.

According to Bank of America’s latest fund manager survey, institutional investors are overweight US stocks, but even more worrisome may be the concentration in smaller investor portfolios. According to a recent Wall Street Journal article citing Vanda Research, the average individual’s stock portfolio has 40% of its value tied up in just three tech stocks! (…)

Eventually, high valuations and unattainable growth expectations lead to disappointments and significant devaluations. The subsequent period of deteriorating fundamentals and weak returns causes the pendulum to swing to opposite extremes.

As a result, periods of significant outperformance tend to be followed by periods of significant underperformance, reversing much of the previously earned extraordinary gains, even for the biggest of secular themes. Positioning and valuation suggest that investors expect the US equity dominance of the past 15 years will last indefinitely, but history seems to suggest otherwise. (…)

When coupled with the prevailing bifurcation of sentiment and record market concentration, the current juncture may offer investors a once-in-a-generation opportunity to rebalance portfolios. Just as in the wake of the Internet bubble, what part of the market you own could mean the difference between another lost decade of returns for crowded and expensive assets or very attractive returns or assets where capital is truly scarce. (RBA)

To be sure, many alternatives carry their own stigmas: the Eurozone is still largely disfunctional and China is still China. But big opportunities generally hide in plain sight, particularly when nobody wants to look.

U.S. Shoppers Cut Back in January Larger-than-expected decline in retail sales came after a strong round of holiday shopping in December

U.S. retail sales fell a seasonally adjusted 0.8% in January from a month earlier, the Commerce Department said Thursday.

The larger-than-expected loss came after a strong round of holiday shopping in December, which the report revised to a 0.4% gain. Excluding autos, sales were down 0.6%; economists expected an increase. (…)

December and November sales were revised lower, a sign that consumer spending, while still robust, might not have been quite as strong in the fourth quarter as earlier reported. Economists at Goldman Sachs estimate that gross domestic product grew at a 3.2% annual rate in the fourth quarter, down a notch from the 3.3% the Commerce Department reported last month. In addition, the economists lowered their forecast of first-quarter GDP growth to a 2.5% rate from 2.9%.

Behind January’s weakness, two factors might have pushed the sales figures lower. The first was technical: The seasonal adjustments the Commerce Department applied to January sales were less supportive than in years past. The second was the cold weather that spread across much of the U.S. last month and might have significantly weighed on sales. (…)

Cold and wet weather in large parts of the country was likely a factor in weaker debit- and credit-card spending, economists at Bank of America Institute said in a report. Overall card spending among the bank’s customers fell 0.2% in January from a year earlier. But spending actually rose 1.7% in the Western U.S., where weather was relatively mild, and declined in the South, Midwest and East.

One indication of how weather might have weighed on spending last month: Sales at building materials and at lawn and garden stores fell a seasonally adjusted 4.1% from December. That decline “undoubtedly was driven by cold temperatures,” wrote Santander chief U.S. economist Stephen Stanley in a note.

But sales at food services and drinking establishments rose 0.7%, marking a bright spot in Thursday’s report. That could be an indication that the shift in spending away from goods away from services continues as Americans keep re-engaging with prepandemic behaviors. (…)

Wells Fargo:

The data suggest the consumer lost momentum at the start of the year. On a year-ago basis, control group sales growth slipped to 2.4%, which is the slowest gain since April 2020, when the economy was in the depths of the pandemic.

Even as we expect spending will moderate this year, the January slowdown may overstate the near-term pull back in consumption. Households have benefited from a real income tailwind over the past year as inflation is slowing more than wage growth.

While the unique factors of excess liquidity and easy access to cheap credit are tales of the past in the story of consumption, a still-sturdy labor market should lead to only a gradual moderation, rather than collapse in spending this year.

Consumer resilience is positive in the sense that it helps ward off economic contraction but could be problematic if it gets in the way of the downtrend in consumer inflation. This week’s inflation data showed the consumer price index (CPI) came in hotter than expected, with the core CPI up 0.4% during the month.

The data did little to give the FOMC the “greater confidence” it needs to start imminently cutting rates, but the final mile in getting inflation back to the 2% target is expected to be bumpy. How consumer demand evolves will play a key role in continued disinflation and the pullback in January sales suggests some lost momentum.

More from the WSJ:

Economists at Goldman Sachs, for instance, said in a note that cold weather doesn’t explain a decline in e-commerce, as sales by nonstore retailers fell 0.8%. Analysts at Bank of America noted that card spending remained soft in the week ended Feb. 10, despite no big weather events that week.

Growth in aggregate weekly payrolls (black) slowed from 5.9% to 4.7% from December to January. Spending on goods (retail sales) suffered more than services if restaurant spending is any guide. We will get total consumer expenditures at the end of the month. Weakness in January and February is not very harmful.

US Factory Production Declines for First Time in Three Months

The 0.5% decrease in manufacturing output followed a 0.1% gain a month earlier, Federal Reserve data showed Thursday. Total industrial production, which includes mines and utilities, fell 0.1% in January as severe winter weather caused pullback in mining activity. (…)

Excluding autos, manufacturing decreased 0.6% from December, the most since March. It also marked the fourth-straight monthly decline.

Recent surveys, however, suggest the worst of the malaise is drawing to an end. The Institute for Supply Management’s factory index climbed to a 15-month high in January as the largest share of purchasing managers since April reported higher orders.

Separate regional surveys on Thursday showed a slower pace of contraction in New York state manufacturing in February and the first expansion in Philadelphia-area factory activity in six months. (…)

More evidence that the weather slowed things down in January, including hours worked, reversing balmy 2023 January. Note how more normal hours would have boosted aggregate income last month as both the number of employeds and wages were strong.

Fed’s Bostic Says May Take ‘Some Time’ to Hit Rate-Cut Threshold

(…) “The evidence from data, our surveys, and our outreach says that victory is not clearly in hand, and leaves me not yet comfortable that inflation is inexorably declining to our 2% objective,” Bostic said in a speech Thursday in New York. “That may be true for some time, even if the January CPI report turns out to be an aberration.” (…)

The Atlanta Fed chief said last month that he anticipates the first cut to occur in the third quarter of this year. He repeated that position Thursday and noted that he had projected two cuts for 2024 in the central bank’s last quarterly set of economic projections. Market participants are betting the central bank will lower interest rates starting in June. (…)

He also pointed to anecdotal evidence. Business contacts carry the “ring of expectant optimism — perhaps even pent-up exuberance” that could unleash a burst of demand that could reverse the progress made on inflation, Bostic warned. (…)

HERE WE GO!

Follow up on my Daily Edge post “Here We Go!” of January 12.

Finally a concrete measure to begin to really address China’s real estate problem. A Chinese version of the U.S. Resolution Trust Corporation (1989-95 savings and loan crisis) the Fed’s TARP program (2008-10 subprime mortgage crisis): the government and/or the central bank provide low cost funds to purchase vacant apartment buildings from troubled developers or, even better, from troubled LGFVs, thereby transferring bad debt up to the central government and/or the PBOC.

The key part is in bold (my emphasis).

China Revives Socialist Ideas to Fix Its Real-Estate Crisis Xi Jinping aims to put the state back in charge of the crumbling property market, part of a push to rein in the private sector.

Under the new strategy, the Communist Party would take over a larger share of the market, which for years has been dominated by the private sector. Underpinning it are two major programs, according to policy advisers involved in the discussions and recent government announcements.

One involves the state buying up distressed private-market projects and converting them into homes that the government would rent out or, in some cases, sell. The other calls for the state itself to build more subsidized housing for low- and middle-income families.

The goal, the policy advisers say, is to increase the share of housing built by the state for low-cost rental or sale under restricted conditions to at least 30% of China’s housing stock, from 5% or so today. (…)

Beijing’s economic mandarins, led by Xi’s top economic-policy aide, Vice Premier He Lifeng, are still hammering out how to execute the real-estate strategy. Economists caution that the plan could take years to achieve—if it’s achievable at all.

The cost would be huge: potentially up to $280 billion a year for the next five years, or a total of around $1.4 trillion, according to some analysts. (…)

Initial plans call for adding six million affordable housing units in the coming five years, government documents show.

The People’s Bank of China has set aside 500 billion yuan, or roughly $70 billion, in low-cost financing to policy banks to help get the strategy rolling. A handful of projects funded with that money are under way. (…)

Today, more than 90% of Chinese households own their own homes, compared with around 66% in the U.S. (…)

In internal policy discussions, Vice Premier He, one of Xi’s most trusted lieutenants, argued that getting the state more involved would be a way for the government to absorb excess home supply, put a floor under falling prices and help protect banks from having to write down hundreds of billions of dollars of property loans if the market kept getting worse. (…)

The PBOC, China’s central bank, has since allocated 70% of the roughly $70 billion it is making available to three policy banks, China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China, PBOC disclosures show.

China Development Bank disclosed on Dec. 19 that it had granted a line of credit totaling 202 million yuan to the city of Fuzhou to build an affordable housing project. Upon its completion, expected in 2026, the project will have some 701 housing units, which the local government plans to sell to modest-income families at discounted prices.

The bank also extended a 10 million yuan loan to the government of Hunan, a province south of the Yangtze River, to develop government housing in a rundown inner-city district, according to information from the Hunan government.

It’s unclear how much of those funds would be used to develop new projects or to purchase and repurpose existing properties from commercial developers. The bank and Hunan’s government didn’t respond to requests for comment. (…)

Arrest the price declines, solidify the main developers, restore confidence. The cycle will gradually restart.

China steps up ‘whitelist’ mechanism for property sector

Five state-owned Chinese banks have been matched with more than 8,200 residential projects for development loans under the “whitelist” mechanism aimed at injecting liquidity into the crisis-hit sector, government-backed media The Paper reported.

The high number of projects already approved for possible support highlights the government’s efforts to free up funding for the debt-riddled industry, although it is unclear how many will secure loans.

“The progress for whitelist projects is faster than expected and it looks like regulators have put much higher pressure on banks to lend to developers this time,” said Raymond Cheng, head of China research at CGS International.

Under the “project whitelist” mechanism launched on Jan. 26, city governments are recommending to banks residential projects suitable for financial support, and are coordinating with financial institutions to meet projects’ needs. (…)

China Holiday Travel Surge Hints at Consumer Spending Pickup

More than 61 million rail trips were made in the first six days of the national new year holiday, according to official reports. That was the highest in data compiled by Bloomberg News in the last five years, and it marked a 61% increase over the same vacation period in 2023.

“The Chinese consumer is beginning to stir,” said Frederic Neumann, chief Asia economist at HSBC Holdings Plc., adding that spending indicators had exceeded expectations. He acknowledged, though, that surpassing 2023 was a “low bar” given the country was still contending with a rampant outbreak of Covid-19 at the time. (…)

Hotel sales on Chinese e-commerce platforms surged more than 60% from a year earlier, according to media reports citing the Ministry of Commerce.

Just ahead of the holiday, Shanghai reported some 8.8 million tourists, up more than 50% year-on-year, according to state broadcaster China Central Television.

The average daily consumer spending on Meituan’s online platforms during the holiday period jumped some 36% from the same period last year, according to a report from the delivery giant. The report didn’t give the actual value of consumption, but said it exceeded pre-Covid levels in 2019. There was also strong growth from restaurant spending in the first five days of the Chinese New Year break, with overall order volume from groups rising by 161% from last year.

Chinese shoppers also took their spending overseas during the long holiday week, with tourists from the country spending 70% more on food and beverages compared to 2019, according to data from fintech giant Ant Group. Among the top destinations for Chinese travelers were Hong Kong, Japan, Thailand, France and Australia. (…)

Consumer confidence in China has been weak for a range of reasons, including declines in home prices. Sales of some goods such as cars have also lost steam: Passenger car sales fell 26% in January compared to December, according to the China Association of Automobile Manufacturers. (…)

Nvidia bubble?

Source: @financialtimes  Read full article

I am not a fan of these comparisons, easy to make up with time and price scales. But NVDA’s recent trends do remind me of CSCO in the late 1990s.

Using Koyfin data, current NVDA vs peak CSCO in 2000:

                               CSCO      NVDA

Trailing P/E:            235.1       95.7

Forward P/E:          155.0       35.6

EV/EBITDA (trl):     125.6       79.8

EV/EBITDA (fw):       n.a.        28.6

 Those were the days, my friend, we thought they’d never end…

OpenAI joins race to make videos from text prompts OpenAI on Thursday announced Sora, its first tool that can turn a text prompt into a video of up to one minute in length.