The consumer reigns supreme ...
And has a lot of firepower left.
… and underappreciated. July retail sales blew through consensus (more below), the latest in a constant march of upside economic surprises. Tuesday’s report lifted GDPNow’s tracking of Q3 growth to 5.8% annualized! It’s still nearly seven weeks before the government’s first official GDP estimate. Lots can happen before then. And the Atlanta Fed’s real-time model has a wide variance between current and final values, 2 percentage points either way, not to mention a built-in upside bias of a percentage point. Still, what happened to the slowdown if not outright recession many at the beginning of the year were calling for by now? To paraphrase James Carville (more below), it’s the consumer, stupid. Just as consensus pooh-poohed the $2.3 trillion mountain of excess pandemic savings upon which households drew to keep consumption growing, it failed to appreciate a labor market where shortages have companies holding on to workers and wage growth outpacing inflation, particularly among services workers where the propensity to spend is the highest. So what if the excess savings evaporate by year-end (sources vary widely on this)? Household balance sheets remain in better shape than they were before the pandemic and thanks to moderating inflation real incomes are growing!! Underestimating the consumer in an economy where they account for nearly 70% of GDP is perilous, BCA Research says. We couldn’t agree more.
Can the U.S. consumer save China? Among the reasons for its woes is the American shopper, who splurged on goods during lockdowns, much of it made in China, only to pivot strongly to travel, food and entertainment when the Covid curtains were pulled back. So, the same Chinese exporters that benefited greatly from the American buying binge faced a sudden drop in demand. This worsened China’s structural and self-inflicted wounds, from a declining working-age population to President Xi’s crackdown on private enterprise to stringent zero-Covid lockdowns that eviscerated the Chinese consumer’s psyche. The result is deflation that’s getting worse as manufacturing, retail sales and housing keep disappointing. Its biggest residential developer is on the verge of default, the second biggest (Evergrande) just filed for bankruptcy in the U.S. and a trust company for a major conglomerate missed principal payments. With the yuan this week closing near its weakest level ever against the dollar, Gavekal Research worries a “Lehman moment” beckons. The Peoples Bank of China has rushed in with more rate cuts, and optimists expect the government will unleash a large dose of fiscal stimulus. Skeptics have their doubts. If nothing else, the rolling recession in the U.S. goods market appears to be morphing into a rolling recovery. So, again we ask: might U.S. consumers bail out China?
The consumer is a headwind for the bond market. Tuesday’s strong retail sales added to fading recession expectations and the month’s sell-off in the 10-year Treasury, whose yield this week hit its highest since November 2007. But that’s not all that has bond vigilantes stirring. Yardeni Group blames the massive and ever-rising federal deficit, the flood of new issuance it entails and the Modern Monetary Theory theorists who drove it. MMT proponents helped unleash the unprecedented pandemic response ($9+ trillion worth!), arguing that fears of widening federal deficits are based on several “myths:” that the federal government should budget like a household; that deficits will harm the next generation, crowd out private investment and undermine long-term growth; and that entitlements are propelling us toward a grave fiscal crisis. It’s unfortunate, Yardeni says, that the Biden administration forgot the wisdom of Carville. The political adviser to President Clinton in 1994, he famously remarked that if there were such a thing as reincarnation, he would like to come back as the bond market. By this, he meant that he would like to wield the bond market’s immense power to discipline and rein in errant economic policymakers by driving up interest rates. In other words, don’t incite the bond vigilantes! The month’s rise in yields has spooked a stock market that tends to be volatile in summer anyway (more below). The S&P 500 through Thursday was down 4.7% from its July 31 high for the year and the Nasdaq was off 7.2% the same period. Technicals suggest the downdraft has further to go. With the economy growing above trend, and demand for goods appearing to revive, might be good to add soon. Let’s keep our eye on the prize. My fellow American consumer. Now, I’m off to the mall to pick up my new Louis Vuitton bag.
Positives
- The consumer reigns supreme July retail sales (including and excluding autos) set a new all-time high, with control group sales that feed directly into GDP jumping 1%. A lot of the services data won’t be out until month’s end, but there are hopeful signs there, too, as reflected by a 1.4% increase in spending on food services, a surge in box office receipts due to Barbenheimer and steady domestic and surging international air travel. (I’m off to see “Barbie” this weekend. Maybe the Mister will join me another day to see “Oppenheimer.”)
- Another upside surprise July industrial production report rose the most in six months, driven by increases in motor vehicles and parts, utilities and mining. Motor vehicle production rebounded from June’s 3.9% decline and is up 10.3% y/y, pushing assemblies to 11.9 million annualized, 1 million above the 2019 average.
- Immaculate disinflation The New York Fed’s monthly survey of 1-year-ahead and 3-year-ahead expected inflation rates showed the former falling from a peak of 6.8% a year-ago June to 3.6%, its lowest level since April 2021. The latter was 2.9%. Zillow reports that rent inflation for new leases has dropped from last year’s peak of 16.4% to 3.5%.
Negatives
- You can’t buy what you can’t find Mortgage purchase applications slipped again and continue to run at an extremely low level. Shrinking inventories and mortgage rates at 2-decade highs are big reasons—the Mortgage Bankers Association’s gauge of existing sales activity is at its lowest level of this century. Despite July’s above-consensus increase in starts, NAHB confidence declined for the first time this year, with builders complaining about the “lack of buildable lots” and “dearth of construction workers.”
- Hard landers beware Conference Board leading indicators fell a 16th straight month, historically a strong recession signal. But on a y/y percent change basis, the gauge is highly correlated with the manufacturing PMI, with 10 components overweight the goods sector. Recent data suggests that sector has bottomed and may be starting to improve.
- Summer blahs August and September mark not only some of the weakest months for risk-adjusted U.S. equity returns, but also some of the lowest volume periods as traders take a break for vacation. The VIX also historically has risen into late Q3/early Q4. Amplifying these seasonal trends are AAII net bullishness that remains close to one standard deviation above its long-term average, a level that’s been troublesome for performance in the past, and decelerating U.S. equity flows.
What else
OK, but perhaps we shouldn’t push the envelope … Leuthold Group shares that an expansion in the deficit’s share of GDP from 12 months earlier has been a stock market positive for the last 50-plus years, with the S&P performing almost 3x better than when the deficit as a percentage of GDP is shrinking y/y.
… but we’ll worry about that after the election While monetary policy is not aligned for the president’s reelection (as it usually is), the deficit’s path conforms closely to the average pattern traced out over the last 13 election cycles. Statistically, fiscal responsibility (now an oxymoron) has tended to peak right before midterms, followed by a spending and/or tax-cut orgy right through election day.
The cruelest day in the cruelest month On Aug. 17, 2007, the Fed unexpectedly cut its discount rate, its first formal policy response to what became the global financial crisis. On Aug. 17, 1998, Russia devalued the ruble, spurring a new down leg in the Asian Financial Crisis that spawned the collapse of U.S. hedge fund Long-Term Capital Management. What mars August? The propensity for traders to take holidays, which reduces liquidity and amplifies price reactions when surprises emerge.