CONSUMER/RECESSION WATCH
From Markit:
The overall easing of input cost pressures in January therefore provides a tentative signal of a peaking in the annual rate of US consumer price inflation, though it is clear than the rate of inflation signalled remains elevated by historical standards, and far in excess of the Fed’s policy target.
(…) a flaring of COVID-19 cases usually dampens service sector spending, notably on hospitality, but we also see a diversion of spending towards goods. This diversion does not seem to have occurred in January. Instead, factories reported even slower demand growth. This suggest that the demand recovery momentum is fading.
Second, although cost inflation has cooled, it remains highly elevated and is being supported by high wages and soaring energy costs, the latter having the potential to remain problematic in the face of rising geopolitical tensions. The impact of Omicron on Asian supply chains is also not yet evident.
Third, the FOMC is embarking on policy tightening with an increasingly aggressive stance being signalled and priced in by markets. This will dampen inevitably demand further.
- A Gallup survey finds 49% of Americans saying rising prices have caused hardship for their family, including 9% who say it has caused “severe” hardship affecting their ability to maintain their current standard of living. This is according to a Jan. 3-13 Gallup Panel survey.
Goldman Sachs:
After updating our income forecast, we now expect that household real disposable income will sequentially decline by more than 3% (annualized) from 2021Q4 to 2022Q1 and by almost 4% from 2021 to 2022 on an annual average basis. Furthermore, we now forecast that aggregate real disposable personal income will remain a bit below its pre-pandemic trend in 2022
The removal of the Child Tax Credit and other fiscal transfers will predominantly weigh on income for households in lower income quintiles that already faced the largest stepdown in income. Although we expect that income for the bottom income quintile will remain moderately above trend in 2022 due to firm wage growth and a persistent boost from food stamps benefits, we now expect real income for the bottom income quintile in 2022 will decline by almost 10% from the elevated level of 2021 on a Q4/Q4 basis and 20% on an annual average basis.
Normally such large sequential declines in income—particularly among lower-income households—and fiscal support more broadly would raise risk of recession, but we expect that three positive growth impulses—including further reopening of the service sector as health risks decline, a boost to consumer spending from pent-up savings and wealth effects, and inventory restocking—will offset these declines by enough to keep growth above trend this year. Nevertheless, the significant stepdown in household income is one reason why we expect growth will decelerate from 5.4% in 2021 to 2.4% in 2022 on a Q4/Q4 basis.
WOW!
Aggregate real disposable income will decline 4.0% YoY in 2022 per GS calculations. This has never even come close to happen since 1960. Actually, annual real DPI only declined 3 times on a YoY basis in the last 60 years (-1.1% in 1974, -0.1% in 2009 and -1.2% in 2013). And this would come on the heels of significant drops in quarterly real DPI in the last 3 quarters of 2021.
About the three growth impulses that would save us from a recession under such conditions:
- “a further reopening of the service sector as health risks decline”. Let’s hope so but that must be already embedded in their employment/income forecasts.
- “boost to consumer spending from pent-up savings and wealth effects”. Look again at the quintiles above. Let’s sure hope some dissaving occurs…from those who have some savings. But GS forecasts that 60% of households will see their real income drop by 7-20%. From my December 20, 2021 post:
The $2.75T in “excess savings” is the accumulation of the unspent income since March 2020. The positive spin is thus that a good part of this “unexpected” cushion will be spent in coming quarters/years. Nearly 15% of income to splurge with can sustain consumption for a long time.
Two questions: Where is this $2.75T excess bounty sitting and how much of it is there really?
- The latest Distribution of Household Wealth report by the Federal Reserve reveals that 70% of all liquid assets (deposits + money market funds) accumulated between Q4’19 and Q3’21 are in accounts owned by the wealthiest 20%. Cushion for the most cushioned.
- It is assumed that the money has been safely stashed away. I would not be so sure given how some of the excess savings seem to have been used, or misused as Lance Roberts shows. “A vast majority of 2020 and early 2021’s high-flying stocks are down significantly from their respective 52-week highs.”
(…) On average, the wealth of the bottom 50% of households rose by $23k since the 4th quarter of 2019 to $52.3k. Seventy-five percent of the appreciation is accounted for by real estate and durable goods (used cars?). Hard, but illiquid, cushions for this group.
I am uncomfortable resting on a $42k average “excess savings” cushion primarily held by the wealthiest segment of the population averaging more than $2M in household net worth. Given their relatively low propensity to spend, they may not prevent a slowdown/recession. Since the start of the pandemic, this group increased their durable goods assets by 20% per the Fed data. The bottom 50%? +30%.
Then there is the matter of inflation which has stealthily eroded 8% of everybody’s purchasing power since the end of 2019.
3. “inventory restocking”. Well, retail sales were quite weak in November/December and look soft in January. The largest retailers were boasting that they had ample inventory entering the holidays. They might be more in a destocking mode as we speak. Yesterday’s flash manufacturing PMI revealed that “manufacturers stated that new sales growth was often held back by weaker demand from clients amid price rises and efforts to work through inventories.”
Inflation peaking?
BlackRock would not bet on a return to the Fed’s target:
•We are in a new and unusual market regime, underpinned by a new macro landscape where inflation is shaped by supply constraints. Limits on supply have driven the surge in inflation over the past year: a profound change from the decades-long dominance of demand drivers.This fundamentally changes how we should think about the macro environment and the market implications. The key to understanding the muted response of central banks to inflation is not the timeframe but its cause: supply. Much of the 2021 debate overlooked this.
•Two broad types of supply constraint are at play in the economic restart. First, it is easier to bring back demand than production, which is constrained by the weakest link in the supply chain. But another important constraint is the reallocation across sectors due to Covid restrictions: consumer spending has shifted massively towards goods and away from contact-intense services. This has meant severe bottlenecks in some places and spare capacity in others. Prices tend to rise faster in response to bottlenecks than they tend to fall in response to spare capacity, so this has pushed inflation higher, even though overall economic activity has not fully recovered. Developments at the sector level are shaping the macro picture.
•The restart gives a glimpse of how the transition to net-zero emissions will play out: it will be akin to a drawn-out restart. Economy-wide supply limits will bind as energy costs rise. Big shifts across sectors will create supply bottlenecks. Both will add to inflation, as in the restart. A gradual, orderly transition is the least inflationary path, in our view. Whether or not carbon emissions are reduced, we believe climate change will increase inflation.
•A rewiring of globalization and population ageing in China are reducing the supply of cheap imports from China to developed markets. This will raise costs and force resources to be reallocated in those markets, making supply constraints more common. In addition, geopolitical risks threaten to disrupt energy supply.
•A world shaped by supply constraints will bring more macro volatility. Monetary policy cannot stabilize both inflation and growth: it has to choose between them. This is a marked shift in the macro landscape. When inflation was driven by demand, stabilizing inflation also stabilized growth –there was no trade-off.
•Central banks should live with supply-driven inflation, rather than destroy demand and economic activity –provided inflation expectations remain anchored. When inflation is the result of sectoral reallocation, accommodating it yields better outcomes, as recent research (Guerrieri et al, 2021) shows. Insisting on stabilizing inflation would lead to an overtightening of monetary policy, more demand destroyed and a slowing down of the needed sectoral reallocation. Given the persistence of supply constraints over many years, delivering the best outcome might require further adjustments to central banks’ inflation-targeting frameworks.
•This –together with the policy revolution that we will come back to in a follow-up publication –is why we expect the sum total of rate hikes in this cycle to be low. Central banks will take their foot off the gas to remove stimulus–but they shouldn’t go further to fight inflation, in our view. Yet we expect negative bond returns as, faced with inflation volatility in this environment, investors question –as they have in recent weeks –the perceived safety of holding longer-term government bonds at historically low yield levels.
•The primary risk we see is that central banks hit the brakes by raising rates to restrictive levels. As in recent weeks, we can expect markets to price some of this at points, as they adapt to the new macro landscape. But if central banks do go ahead and hit the brakes, they will likely learn that the damage to growth to get inflation down is too great and will be forced to reverse course –flattening or even inverting yield curves.
Valuation, History, Bursting Bubbles: In Search of the Floor
(…) One simple model is price versus profit. The Nasdaq 100 trades at 25 times forward earnings, down from 30 at the end of 2021. In the past two major selloffs, the price-to-earnings ratio fell at least to 18 and as low as 16 before a meaningful rebound started. At the current earnings forecast of $569.6 per share, the index would need to fall more than 25% before the P/E hits 18.
Another framework is history. The market’s capacity to tank while the Fed withdraws stimulus was demonstrated in the fourth quarter of 2018, when the S&P 500 slid to within points of a 20% correction. That selloff, the worst of the post-crisis era before the coronavirus panic, was a brutal test of trader fortitude. It saw the S&P 500 plunge more than 2% eight separate times. Based on earnings, stocks were cheaper in those days — roughly 20 times annual earnings when the rout began, compared with more than 26 at the end of 2021. (…)
The S&P 500 low in December 2018 was at a P/E of 14.6x trailing (now 20.8) and 14.4x forward (now 20.1) and a Rule of 20 P/E of 16.9 (now 26.3). Fed funds were at 2.3% and ten-Y Ts were yielding 2.7% (now 1.8%). GDP was rising 2.5-3.0% and inflation was stable around 2.2% and profits were rising 20%+. The only reason for the hawkish Fed was unemployment below 4%.
The good “old” days of preemptive strikes.
The significant increase in the weights of a few large stocks in the S&P 500 Index can blur the picture. The 10 largest stocks, 30.6% of the index, carry an average weight of 35.9x. So if the forward P/E of the weighted S&P is 20.1, its equal-weighted P/E is 17.3x at yesterday’s close (per CPMS/Morningstar data), right on the average of the last 30 years.
If we use this equal-weighted P/E, the Rule of 20 P/E becomes 22.8. While still 14% above the “20” Fair Value, it is not as scary as the 31.5% “weighted” reading.
Interestingly in the same vein, the median P/E on the S&P 500 index is 22.0x trailing, but 19.0x forward. Since 1990, the range is 15-20 excluding the GFC years with an average of about 17x. On that basis, the downside to the average is 12%. That said, note that in 2018, and again in 2020, the median P/E troughed at 15, 20% below!
- Bloomberg: Goldman, Citi Strategists Say It’s Now Time to Buy Stocks Rout
- Reuters: Goldman Sachs: markets have not reached “danger zone” levels yet
Companies’ U.S. Pension Plans Are More Overfunded Than They Have Been in Years Further increases in 2022 could spur CFOs to revise their pension strategies
(…) An estimated 40 of the largest 100 U.S. pension plans were funded at 100% or more in 2021, the most since 2007, and up from 16 in 2020 and 13 in 2019, according to data from advisory firm Willis Towers Watson PLC. The 40 plans, all of them defined-benefit plans that promise fixed payouts to retirees, were overfunded by a total of $45.49 billion last year, up from $22.58 billion among the overfunded 16 plans in 2020, Willis Towers said. (…)
Defined-benefit plans had an aggregated funding status of 96% at the end of 2021, up from 88% a year earlier, according to WTW’s review of 361 Fortune 1000 companies.
Funding levels in excess of 100% allow companies to further reduce financial risks stemming from their pension obligations—for example, by purchasing annuities, terminating their plan or switching to more conservative investments such as fixed-income securities. An increase in funding also provides breathing room for plans that are below 100%. (…)
“For all the spending of all types through January 17, 2022, we have seen it up over 11% versus the start of ’21, which is well up over ’20 and ’19.” – Bank of America (BAC) CEO Brian Moynihan
John Authers: 
