Discretionary Spending: A Better Recession Spotter?
(…) Rather than divide spending into categories of goods and services, we divide real consumer outlays into our own broad categories of discretionary and non-discretionary and then plot the year-over-year growth of those categories. With a sufficiently long time series, a clearly visible pattern emerges… no special gauges required.
In data going back more than 60 years, you can see how the year-over-year rate of real discretionary spending (red line) is an excellent, though not imperfect, recession monitor. Across each of the past nine cycles, there has never been a recession without a downturn in real discretionary spending. There were two false warnings or periods when real discretionary spending dipped with no recession immediately following it (once in 1967 and the second time in 1987).
As you might expect, non-discretionary outlays (blue line) tend to skirt the fallout from all but the worst recessions. This makes intuitive sense given the sort of categories we determined to be non-discretionary, such as housing, utilities and healthcare expenditures. People only cut back in these areas when they have exhausted all other options.
Non-discretionary spending stalled during the 1981 recession and again a couple of times during and immediately after the financial crisis. Only during the initial onset of the pandemic did non-discretionary spending convincingly break below the zero line, and even then it did so only briefly.
Another interesting takeaway revealed that when looking at the growth rates of discretionary vs. non-discretionary spending are how during expansions, the red line (discretionary) tends to run above the blue line (non-discretionary). Non-discretionary may be more resilient when times are tough, but it’s not as though good times result in increased outlays on categories such as utilities and healthcare. That said, when times are good, consumers do increase spending on the fun stuff.
Aside from the financial crisis and the pandemic, real discretionary outlays outpaced discretionary handily. There was a stretch in the second half of 2023 when the blue line was above the red one suggesting consumers curtailed their free-wheeling ways. It did not last. Discretionary spending grew 4.0% year-over-year through December, outpacing the mere 2.6% year-over-year growth in non-discretionary spending. (…)
The various growth drivers of discretionary spending are plotted in the bars in [the next chart]. The broad base of support is evident in the fact that every category of discretionary spending has been positive for back-to-back months.
Food services and accommodations, autos and recreational services spending have all been considerable boosts to discretionary spending over the past year. But one component in particular stands out. The largest percentage gainer over the past eight months has been recreational goods.
When looking under the hood of the recreational goods category, we find that it includes a variety of diverse categories from the big (recreational vehicles) to the small (recreational books) and everything in between (musical instruments, sporting equipment, etc.).
However, one clear standout subcategory within recreational goods emerged as the key driver, and it is an absolute mouthful: “video, audio, photo and information processing equipment”. This segment primarily includes video game and education software as well as data processing services of households, think video/computer games, Zoom, Microsoft Office.
Increased spending here is consistent with the rise in usage of online software coming out of the pandemic. While this segment of borrowing equates to only 8% of discretionary spending today, it was responsible for about 30% of the growth in the fourth quarter. Stranger things have happened in terms of obscure drivers of consumer spending.
Good analysis by Wells Fargo economists. Note how discretionary accelerated in the second half of 2023. It rarely gets stronger on a YoY basis.
Note also on the last chart, the slow down in “Sports & Recreational Vehicles” as interest rates rose, but it strengthened since spring 2023, in spite of high rates.
Business Leaders Survey Covering service firms in New York, northern New Jersey, and southwestern Connecticut
Activity continued to decline modestly in the region’s service sector, according to firms responding to the Federal Reserve
Bank of New York’s February 2024 Business Leaders Survey. The survey’s headline business activity index edged up two points to -7.3, its sixth consecutive negative reading.
The business climate index rose six points to -24.2, suggesting the business climate remains worse than normal, though to a lesser extent than last month. Employment held steady, and wage increases picked up. The pace of input price increases steepened, while selling price increases were little changed.
Looking ahead, firms were more optimistic than they have been in nearly two years, with the business climate expected to be better than normal in six months. (…)
The employment index rose to a level of around zero, suggesting that employment levels held steady after posting a modest
decline last month. The wages index moved up five points to 46.7, pointing to a pickup in wage increases.At 50.6, the prices paid index was up five points, a sign that input price increases accelerated, while the prices received index held steady at 24.5, indicating that the pace of selling price increases was little changed.
Employment is expected to grow, and fewer firms expect wage and price increases in the months ahead.
On the issue of employment and hiring plans, about half of both service and manufacturing firms expect employment to remain unchanged in the upcoming year.
Among service firms, 35 percent said they plan to add workers, while 14 percent indicated planned reductions, which represents a positive balance similar to last November’s survey. The gap was similar for manufacturers, with expected expansions of 33 percent exceeding planned reductions of 15 percent. However, this balance was narrower than in last year’s survey, suggesting a slowing in hiring for the region’s manufacturing sector compared to last year.
Twenty-six percent of service firms and 33 percent of manufacturing firms reported that they are not actively hiring, a level roughly double the rate from last November.
The share of firms reporting raising starting wages and/or salaries for most job categories fell from roughly 60 percent last year to about 30 percent this year. When asked about the use of pay to retain existing employees, both sectors saw a similar drop. Only 28 percent of service firms and 34 percent of manufacturers increased pay more than in recent years to retain existing employees, a fall from 55 percent in both surveys one year ago.
Regarding changes to firm headcounts in the past three months, about 80 percent of respondents in both surveys indicated that they had not made any reductions. The vast majority of these firms said they had not laid off workers nor had they reduced the number of open positions.
How War in Europe Boosts the U.S. Economy European rearmament and American aid to Ukraine flow back to defense industrial base
In the two years since Russia invaded Ukraine, the U.S. defense industry has experienced a boom in orders for weapons and munitions. 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.
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, according to Federal Reserve data.
Biden administration officials say that of the $60.7 billion earmarked for Ukraine in a $95 billion supplemental defense bill, 64% will actually flow back to the U.S. defense industrial base. (…)
Recent spending by European governments on U.S. jet fighters and other military hardware represents “a generational-type investment. The past few years are equal to the prior 20 years,” said Myles Walton, a military industry analyst at Wolfe Research. (…)
The latest money, on top of previous commitments, could inject funds worth about 0.5% of one year’s gross domestic product into the U.S. industrial defense base over several years.
The State Department recently said the U.S. made more than $80 billion in major arms deals in the year through September of which about $50 billion went to European allies—more than five times the historical norm, said Walton. (…)
The cutoff of Russian gas supplies sent energy prices and inflation up sharply in Europe, while boosting European demand for U.S. liquefied natural gas.
The U.S. became the world’s largest LNG exporter last year, and its LNG exports are expected to almost double by 2030 on already-approved projects. Around two-thirds of those exports go to Europe.
Five new LNG projects are being constructed in the U.S., representing investments of around $100 billion in total, said Alex Munton, director of global gas and LNG research at Rapidan Energy Group. Most of those projects only began construction after the start of the Ukraine war, he said, as the disruption to Europe’s gas supplies proved the value of LNG to potential backers and helped to move planned projects forward. “The U.S. economy benefits significantly because of these massive investments,” Munton said.
Foreign direct investment to the U.S. increased by almost 50% between the 12 months through June 2021 and the same period in 2023, according to the Paris-based Organization for Economic Cooperation and Development, an association of market-based democracies. European companies in particular are lured by access to cheap and abundant energy. (…)
Biden administration officials say funding allocated for Ukraine is rebuilding America’s defense industrial base, jump-starting and expanding production lines for weapons and ammunition, and supporting jobs in 40 states. (…)
A $1 Trillion Conundrum: The U.S. Government’s Mounting Debt Bill Higher Treasury yields are adding an extra trillion-plus dollars in deficit spending.
The U.S. government is expected to pay an additional $1.1 trillion in interest over the coming decade, according to the Congressional Budget Office’s latest estimates. Interest costs are on pace to surpass defense this year as one of the largest government expenses in the budget. Only Social Security and Medicare are forecast to be bigger burdens in the coming years.
The increase revives longstanding Wall Street worries that the yearslong acceleration in government borrowing by both political parties will eventually weigh on economic growth and asset prices.
Markets have shown few signs of stress, but here’s what investors are watching. (…)
America is expected to spend $870 billion, or 3.1% of gross domestic product, on interest payments this year. That is nearly double the annual average of 1.6% of GDP since 2000. And interest costs are projected to reach 3.9% of GDP by 2034. (…)
No one seriously thinks the U.S. will miss a debt payment. Treasurys form the foundation of the global financial system, and the dollar is the world’s reserve currency. (…)
“The debt will become a problem, but it’s very hard to know exactly when.” (…)
“All else equal, a bigger government deficit means higher short-term and long-term interest rates,” said Lee Ferridge, head of macro strategy for North America at State Street Global Markets. “That means lower growth, and in theory, that means lower asset values as well.” (…)
A growing debt load isn’t necessarily bad. Increasing bond issuance and fiscal spending can boost economic growth, supporting risky assets such as stocks. But analysts are debating when all the debt becomes a drag. Some suspect that it could lead to a weakened ability to jump-start the economy out of a crisis or the next recession. (…)
Even in the event tighter fiscal policy is enacted, if it helped usher in a recession, automatic stabilizers would kick in and tax revenues would fall. The upshot: a bigger deficit.
“When you have substantial reduction in deficit spending—whether by raising taxes substantially or cutting spending—there’s an excellent chance you help precipitate a recession,” said Reganti. “It becomes a vicious cycle.”
To simplify, this is like margin debt on one’s investment: it’s not a problem, in fact it’s a positive, until it becomes a problem. Then it is a real problem.
Here’s how Wells Fargo put it in a recent analysis:
The good news is that a debt crisis does not appear imminent. Investors continue to finance budget deficits by buying Treasury securities at reasonable interest rates. Given the depth and liquidity of the market for U.S. Treasury securities, the status of the United States as the world’s largest economy and strongest military power, and the role of the U.S. dollar in the international monetary system, there simply is no substitute for Treasury bills, notes and bonds.
But there are some costs that the rising amount of federal debt imposes. The rising debt service burden can potentially constrain other areas of federal spending, and private investment spending could potentially be “crowded out” by elevated interest rates.
The Congressional Budget Office projects that the debt-to-GDP ratio of the federal government will rise from about 100% at present to 180% in thirty years. It is an open question whether investors will feel sanguine about the fiscal outlook for the federal government indefinitely. It is impossible to determine when a “hard stop” could occur, but an ever-rising debt burden clearly increases the probability of such an event occurring at some point in the future.
The higher the debt ratios, the shorter the time needed for the debt to potentially become a problem. Investors constantly assess the risk of that happening and the potential consequences. Much like how high and rising corporate debt gradually impacts valuation ratios to reflect the heightened risk.
But, it often takes a crisis to wake oblivious investors up.
For the U.S. government, valuation gauges are relative interest rate levels, corporate P/E ratios and the USD.
Wells Fargo:
With a size of $27 trillion, the market for U.S. Treasury securities is by far the largest bond market in the world, giving Treasury bills, notes and bonds unparalleled status in terms of market depth and liquidity.
The Japanese government bond market is a distant second at roughly $9 trillion. But the debt-to-GDP ratio of the Japanese government is almost double the comparable ratio for the U.S. government, and one of the major ratings agencies (Moody’s) currently rates U.S. sovereign debt as triple-A while the other two (S&P and Fitch) give it a double-A rating. In contrast, all three agencies rate Japanese government bonds as single-A.
Germany has a pristine triple-A sovereign debt rating from all three agencies, but the size of the German government bond market is less than 10% as large as the market for Treasury bills, notes and bonds.
The United States is home to the world’s largest economy and strongest military power, and the U.S. dollar remains the preeminent reserve currency. In short, there simply is not a good substitute for U.S. Treasury securities as an investable asset. (…)
An optimist could point out that the debt-to-GDP ratio of the Japanese government has ballooned from less than 10% in the early 1970s to more than 200% at present, yet the yield on the 30-year Japanese government bond (JGB) remains comfortably below 2%.
But readers should not infer that the Japanese experience necessarily has similar implications for the United States. Due to years of quantitative easing and a policy of “yield curve control,” the Bank of Japan (BoJ) currently owns more than 45% of outstanding JGB’s, which the BoJ is not likely to actively sell anytime soon.
Consequently, the marketable amount of JGB’s, which is equivalent to roughly 115% of GDP, is significantly less than the total amount of Japanese government debt. Moreover, less than 10% of Japanese government debt is held offshore, whereas foreigners presently own more than 25% of U.S. government debt. U.S. dollar-denominated debt generally exposes foreign creditors to foreign currency risk, which may make them more susceptible to sell those securities during periods of financial market volatility.
ECB Says Euro-Zone Wage Growth Slowed in Fourth Quarter
Negotiated pay in the euro zone rose 4.5% at the end of 2023, according to the European Central Bank — soothing fears that rising salaries could sustain inflation above the target.
While still high, fourth-quarter pay growth is down from a euro-area record of 4.7%, notched in the previous three months, the ECB’s negotiated wage indicator showed Tuesday. (…)
In December, the ECB projected nominal wage growth would gradually decline over time – to 3.3% in 2026 from 5.3% in 2023, in terms of compensation per employee. (…)
ECB Executive Board member Isabel Schnabel argued Friday that weak productivity “exacerbates the effects that the current strong growth in nominal wages has on unit labor costs for firms,” raising the risk that firms shift higher pay costs to consumers and delay inflation’s return to 2%.
Eurozone or Eurozones?
So, the ECB is setting policy on the Eurozone(s) average…
Hopefully, the Fed is not setting policy on consumer confidence surveys…
Why the divergence? The Michigan survey’s questions are highly sensitive to inflation, whereas the Conference Board’s are not. (NYT)
Chinese Banks Slash a Key Lending Rate as Economy Falters
The People’s Bank of China said Tuesday that China’s major banks reduced the five-year loan prime rate, a benchmark for home loans, to a new low of 3.95%, from 4.2% previously. It was the largest cut since the rate was introduced five years ago, and a much bigger reduction than economists had expected. (…)
More Chinese travelers hit the road during the February Lunar New Year holiday than ever before, new data showed this week, but spending per person was lower than it was in 2019, according to Goldman Sachs.
Other data Sunday showed home sales tanking further across major cities in the first six weeks of the year when compared with a year earlier, while new data on China’s balance of payments with the rest of the world showed direct investment by foreign firms rose last year by the smallest amount since at least 1998.
One particularly thorny problem is deflation. Consumer prices fell in January at their steepest pace in 14 years, while producer prices have fallen every month for more than a year. Economists fret that without more aggressive government and central bank support to rekindle growth, China could slip into a rut of falling prices that becomes harder to reverse the longer it lasts.
Bloomberg:
Lowering that rate will allow more cities in China to reduce minimum mortgage rates for homebuyers, which can stimulate sluggish demand for apartments as prices fall. The move shows an intensifying focus on measures to combat the property crisis, which has been a major drag on the world’s second-largest economy and threatens its path toward sustainable growth. (…)
Next month is traditionally a peak season for home sales, making any efforts to spur more purchases all the more timely.
Reuters:
The deeper-than-expected cut also suggests Beijing is no longer as concerned about the negative effects of lower lending rates on the currency or banks as they were last year.
A central bank-backed newspaper said on Tuesday that the benchmark mortgage rate cut would not create a negative impact on banks’ net interest margins.
China’s Premier Urges ‘Forceful’ Action to Boost Confidence
Li used a meeting of the State Council, China’s cabinet, on Sunday to urge officials to “do more things that are conductive to boosting confidence and expectations, and ensure policymaking and execution are consistent and stable,” the official Xinhua News Agency reported.
Various departments should focus on solving practical problems faced by individuals and companies as the Lunar New Year holiday ends, Li said, adding that they need to “win the trust of the people with real work and achievement.” Xinhua didn’t outline any specific steps. (…)
They now understand the need to restore confidence, critical for real estate to restart.
EARNINGS WATCH
Goldman Lifts S&P 500 Target With Profit Optimism to Drive Rally Sees S&P 500 at 5,200 by end of year
“Increased profit estimates are the driver of the revision,” a team led by David Kostin wrote in a note to clients dated Friday. The 12-month forward earnings expectations are at a record high for the US stock index after forecasts bottomed out a year ago. (…)
The firm’s strategists upgraded their earnings-per-share forecast for the year to $241 and $256 in 2025, from $237 and $250 previously. That reflects their expectation for “stronger economic growth and higher profits” for the information technology and communication-services sectors, which contain five of the so-called Magnificent Seven stocks (…).
Out of the near 84% of the S&P 500’s market capitalization which have reported so far, 79% of firms beat expectations. (…)
The Goldman strategists expect valuation multiples for both the S&P 500 and its equal-weighted brethren to remain close to current levels — at 20 and 16 times earnings, respectively, “making earnings growth the primary driver of remaining upside this year.” (…)
Profits in the 500-member gauge are expected to grow 8.8% in 2024 from a year ago, data compiled by Bloomberg Intelligence show. (…)
The surprise factor is +6.9%, broadly distributed. Reported earnings so far are up 7.3% on a 3.5% revenue gain. Rising margins. GS says that margins surprised to the upside in every sector.
If NVDA reports estimates in line with consensus, the Magnificent 7 will have grown sales by 15% year/year and lifted margins by 582 bp year/year, leading to earnings growth of 58%. In contrast, the remaining 493 stocks in the S&P 500 grew sales by 3% year/year while margins contracted by 56 bp and earnings fell by 2%. This weakness was primarily driven by Energy and understates the growth of the “typical” S&P 500 stock; the median index constituent grew EPS by 6% y/y in 4Q.
During the past 3 months, Magnificent 7 earnings estimates have been revised upwards by 7% and margins have been revised upwards by 86 bp. This compares with a 3% downward revision to earnings and 30 bp downward revision to margins for the remaining 493 stocks. The Magnificent 7 accounted for 11% of total 2023 S&P 500 sales and 18% of earnings, and consensus expects the stocks to grow EPS by 20% in 2024.
Our macro model for the median S&P 500 stock’s operating margins points to slight margin expansion in 2024 as input cost appreciation, including wage growth, continues to moderate alongside robust sales growth and only modest further price disinflation.
Trailing EPS are now $222.71. Full year 2024: $242.90.
Of last week’s 17 pre-announcements, 11 were negative and 6 positive.
An extremely bullish signal from value stocks
While examining the market breadth page on the website Thursday evening, I noticed a substantial increase in annual highs for Financial and Industrial sector stocks during Thursday’s session, with both groups surpassing 25% of total issues. For perspective, the Healthcare sector recorded the third-highest reading at 10.94%.
As the arrows on this chart depict, an expansion in annual highs for Financial and Industrial sector stocks, like now, typically aligns with broad market uptrends.
When both Financial and Industrial sector stocks recorded annual highs surpassing 25% concurrently, the world’s most benchmarked index displayed exceptional returns, win rates, and z-scores. A year later, the S&P 500 was higher in all but one case.
Using the backtest engine data shows a 100% win rate a year later. (…)
Women’s Lib!
Young women who increasingly identify as liberal are driving a stark political gender gap with their male counterparts, Axios’ Noah Bressner reports.
The gender gap first passed 10 points in 2017, when former President Trump took office.
- The #MeToo movement took off the same year, potentially pushing a younger generation of women to the left as they entered adulthood.
- Abortion rights also became a more pressing issue after Roe v. Wade was overturned in 2022.
Data: Gallup; Chart: Axios Visuals