I wouldn't want to count the consumer out prematurely
Lots of reasons to expect all-important spending to hold up.
Hearing an ever-louder drumbeat about a consumer who is running out of steam. With credit card spending jumping to a record-high $1 trillion, card balances have reached 22% of the credit limit, just $69 million away from their long-term average of 24%. Credit card delinquencies have hit 3.8% and 3.6% of car loan holders have defaulted, according to credit agency Equifax. Both represent 10-year highs. Retailers including Macy’s, Kohl’s and Nordstrom have called out rising delinquency rates among their customers. Dollar General, Dollar Tree and Target have warned about slowing sales. Then there’s depleted excess savings—the amount above normal thanks to Covid stimulus. Estimates range it will be tapped out by month’s end (the San Francisco Fed) or last until next June (Goldman Sachs). Hmm. But I’m not so sure about the bearish interpretation. Yardeni Group argues consumers didn’t deplete savings to spend more over the past two years. Rather, they accumulated less net worth (by saving less) because they had accumulated so much during the pandemic. Collectively, households’ net worth totaled a near-record $140.6 trillion in Q1, up a whopping $36.4 trillion since Q1-2020, just before the Covid crisis. There’s no compelling reason for them to suddenly slam on their spending brakes. Not when both payroll employment and real wages continue to rise to record highs.
To be sure, headwinds lie ahead. Tax refunds to small businesses are being abruptly cut off, initial student loan payments that restart this month are coming in three times higher than consensus estimates, and oil and gasoline prices are rising at the same time. But while these forces, along with 7%+ mortgage rates, are likely to contribute to decelerating GDP growth in Q4, the slowdown could prove shallow and short-lived. Department of Education data shows student loan payments surged in August (a month before interest was due to start re-accruing), indicating people were ready to pay, Bank of America says. It estimates the hit will be front-loaded and equate to a 20-25 basis-point drag on consumer spending and 15-20 basis-point hit to GDP. Interest income alone from higher rates on interest-bearing assets may offset much of the impact. Goldman Sachs expects real disposable income growth to reaccelerate in 2024 and the weight of monetary tightening to vanish. It estimates real income gains will range from 4% for the top income quintile to 1.5% in the bottom quintile, which ironically to this point has been getting the biggest increases in real wages. It also projects the consumer to outperform consensus in 2024, with a 1.9% real spending growth in both y/y and Q4/Q4 terms.
S&P 500 profit estimates are rising for the first time in two years, led by cyclicals with Energy and Tech/FAANG sectors at the top. A strong argument for the soft-landing scenario. The big question is when, and how fast, does the Fed cut. The market is pricing 105 basis points of cuts over the next 16 months, a view with which our Liquidity team doesn’t agree. It doesn’t expect any cuts until late 2024. The good news is stocks and bonds typically generate positive returns throughout a pause, with high dividend payers and value stocks the leaders based on data over the last six Fed cycles. Despite a bumpy start to September, seasonality remains subpar for the month, with sentiment not yet bearish and momentum anemic—only 37% of the S&P is above the 50-day moving average. Perhaps a government shutdown will change the narrative. With a 17.4% price return through August, the rolling 8-month percent change for the S&P already ranks in the top quintile over the last 80 years of data. While returns might be less impressive over the next eight months, history shows they tend to skew favorably after such a run. September sell-offs often turn out to be good opportunities to pick fallen stocks in time for a year-end Santa Claus rally. And who are Santa’s helpers? Consumers! I’m not counting them out.
Positives
- Good news is bad news August ISM services sparked reacceleration concerns, topping all expectations and hitting a 6-month high. The report’s details were impressive, with new orders, business activity, employment and prices paid all rising. Markets sold off on the news, even as the separate S&P Global gauge decelerated. The ISM covers a broader range of industries and sectors.
- No one talks about coincident indicators Conference Board leading indicators, which have declined 16 straight months and have a strong forward correlation with economic activity, often get cited as a clear-cut sign of a looming recession. However, there’s no hint of a downturn in the Index of Coincident Economic Indicators, which rose in July to another record high.
- The Fed should like this Q2's revised productivity and costs report showed unit labor costs—a series highly correlated with CPI on a y/y basis—rose at a modest pace of 2.2%. Elsewhere, Evercore ISI’s weekly proprietary survey of apartment rents shows they continue to fall, suggesting the shelter component of PCE could post actual declines in 2024. A Chicago Fed study suggests the current hikes in place are sufficient to bring inflation back onto target.
Negatives
- Germany is a mess July’s decline in industrial production doubled expectations, with factory orders plunging 11.7%, almost triple consensus. At 39.1, its manufacturing PMI is deep in contraction, as is the overall EU’s (43.5). Slower domestic and global demand were blamed, the latter reflecting a teetering China (more below). Still, sticky German prices have markets seeing a 35% chance of another ECB hike.
- China is a mess Its services PMI fell much more than expected (though remained above a breakeven 50), while a disappointing August trade report (exports contracted 8.8% y/y on top of July’s 14.5% y/y plunge) sent the yuan to its lowest level relative to the dollar in nearly 16 years. Importantly, the sub-50 reading on new orders argues against an imminent improvement in foreign purchases of Chinese goods. An even worse print on the Taiwan new export orders sent a similar pessimistic signal.
- Slim pickings Weekly mortgage applications renewed their decline after a brief blip up the prior week, setting another record low—7% below the post-global financial crisis trough. The existing home sales market remains moribund as few homes are coming onto the market as their owners are reluctant to give up existing 30-year mortgages that average around 3% for new ones topping 7%.
What else
All eyes on Detroit … where United Auto Workers negotiations could end with a potential strike this coming Thursday. A simultaneous strike at Ford, GM and Stellantis (nee Chrysler) would be akin to about 2% of U.S. GDP on a run-rate basis, causing short-term disruptions across the broader supply chains. The UAW’s opening demand was a 46% pay hike over four years; UBS estimates a final agreement will result in a 20-30% cumulative cost increase—about 300-500 basis points of operating margin pressure.
To EV or not to EV? The answer to that question is symbolic of the split between the country’s major parties, as 54% of Dems say they may consider owning an EV in the future, vs. 71% of Republicans who say they will not, according to a Gallup poll. Six in 10 respondents were skeptical that EVs helped address climate change beyond “a little bit.”
The defense does not rest That’s the title of my new presentation, and it’s worth noting given these stats from Strategas Research. Utilities’ net new highs (highs minus lows as % of total issues) is at -93%, historically well beyond a 1st percentile reading (i.e., about as bad as it can get in the intermediate term). Goldman Sachs says defensive sectors haven’t been this cheap vs. the market in 30 years!