As some consumer tailwinds fade, new ones emerge 💨
Discover more from TKer by Sam Ro
As some consumer tailwinds fade, new ones emerge 💨
Plus a charted review of the macro crosscurrents 🔀
Stocks climbed last week with the S&P 500 rising 1.0% to close at 4,582.23. The index is now up 19.3% year to date, up 28.1% from its October 12 closing low of 3,577.03, and down 4.5% from its January 3, 2022 record closing high of 4,796.56.
The market rallied as we were reminded not to underestimate the American consumer.
On Friday, the BEA reported that personal consumption expenditures growth accelerated in June, rising to a record annualized rate of $18.4 trillion.
This matters because consumer spending is the dominant driver of the U.S. economy, with personal consumption expenditures accounting for 68% of GDP.
However, consumer behavior can be complex and nuanced.
For most of the past two years, measures of consumer sentiment have been in the dumps — largely due to inflation manifesting clearly in the rising prices of goods and services.
Yet consumer spending growth has persisted.
The explanation: Consumer finances have been in remarkably good shape thanks to a combination of excess savings and relatively low debt levels. Meanwhile, more consumers have been getting jobs, which means more consumers have been making money. If people have money, they’ll spend it.
But no economic or market narrative goes unchanged forever. The consumer tailwinds mentioned above have been showing signs of fading.
The consumer narrative is shifting in a fascinating way 🤨
In recent months, we’ve been watching excess savings shrink, consumer debt levels begin to normalize (i.e, rise from unusually low levels), and job growth cool.
These are developments that might not lead you to assume that consumer sentiment would be improving.
But believe it or not, consumer sentiment is improving.
On Friday, we learned the University of Michigan’s Index of Consumer Sentiment in July rose to its highest levels since October 2021.
On Tuesday, we learned the Conference Board’s Consumer Confidence Index in July jumped to its highest level since July 2021.
Notably, the Conference Board’s survey also found more consumers are saying their financial situation is good and fewer are saying it’s bad.
Fortunately, what we’re witnessing isn’t total madness among consumers.
While some key metrics of financial health have deteriorated in recent months, others have been improving.
Incomes are outpacing inflation 👍
As Renaissance Macro’s Neil Dutta has been highlighting for months, real income growth has been positive (i.e., consumers’ wage growth is outpacing inflation).
According to BEA data released Friday, real personal income excluding transfer receipts (e.g. Social Security benefits, unemployment insurance benefits, and welfare payments) rose to a record high in June and has been trending higher since December.
This has as much to do with wages rising as it does with inflation cooling.
Earlier this month, we learned the consumer price index in July was up just 3% from a year ago, the lowest print since March 2021.
Among the biggest forces bringing down inflation were energy prices, which were down 16.7% from year-ago levels. Gasoline prices are way down after a brutal 2022.
While policymakers tend to focus on “core” measures of inflation (which exclude volatile components like food and energy prices), headline measures of inflation can have a huge impact on sentiment as they include the prices of goods consumers confront very regularly.
"It is a good thing headline inflation has gone down a bit," Federal Reserve Chair Jerome Powell said on Wednesday (h/t Myles Udland). "I would say that having headline inflation move down that much... will strengthen the broad sense that the public has that inflation is coming down, which will, in turn, we hope, help inflation continue to move down."
And even though job growth has been cooling, there continue to be a lot of signs that the demand for labor remains robust.
This was recently confirmed in The Conference Board’s July survey, which showed that “46.9% of consumers said jobs were ‘plentiful,’ up from 45.4%. 9.7% of consumers said jobs were ‘hard to get,’ much lower than 12.6% last month.“
For more on the cooling labor market, read: The good kind of deteriorating labor market 👍
“Overall, the sharp rise in sentiment was largely attributable to the continued slowdown in inflation along with stability in labor markets,” University of Michigan’s Joanne Hsu said.
The Conference Board noted: “Despite rising interest rates, consumers are more upbeat, likely reflecting lower inflation and a tight labor market.”
On the matter of rising interest rates, it’s worth remembering that the share of household debt with an adjustable interest rate is low by historical standards.
What to watch 👀
Metrics like excess savings, consumer debt, and debt delinquencies have moved unfavorably in recent months. But none of these developments are signaling that a recession is around the corner. The metrics have only eased from their hottest levels.
But will spending hold up? This will be the key dynamic to watch in the coming months.
It’s great that consumer sentiment is on the mend. And it’s even better that real incomes are on the rise.
And generally speaking, consumer finances remain very healthy. As Federal Reserve data shows, household debt service payments remain historically low relative to disposable income.
In addition to resilient measures of consumer spending at the aggregate level, anecdotes suggest discretionary spending remains very strong: Royal Caribbean says cruise bookings are surging, Bank of America says Barbie and Oppenheimer have people out and about, and even the Federal Reserve says Taylor Swift concerts are fueling local tourism.
And like consumer behavior, the dynamics of the economy are complex and nuanced. Just because some key metrics are deteriorating doesn’t mean the economy is going down. There may be other metrics offsetting these headwinds. You just have to be vigilant and open to the possibility that big narratives can change.
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Related:
Three massive economic tailwinds I can't stop thinking about 📈📈📈
The bullish 'goldilocks' soft landing scenario that everyone wants 😀
You should not be surprised by the strength of the labor market 💪
The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🏛️ The Fed hikes rates. On Wednesday, the Federal Reserve tightened monetary policy further by raising its target for the federal funds rate by 25 basis points to a range of 5.25% to 5.5%
From the Fed’s monetary policy statement: “In determining the extent of additional policy firming that may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2% objective.“
“I would say what our eyes are telling us is policy has not been restrictive enough for long enough to have its full desired effects,” Fed Chair Jerome Powell said in a press conference.
In other words, while inflation rates have cooled significantly in recent months, they remain above target levels. And so the Fed will keep monetary policy tight for a little while.
For more on the state of monetary policy, read: The Fed has become less hawkish 🦅
🎈 Inflation is cooling. The personal consumption expenditures (PCE) price index in June was up 3.0% from a year ago, down from the 3.8% increase in May. The core PCE price index — the Federal Reserve’s preferred measure of inflation — was up 4.1% during the month after coming in at 4.6% higher in the prior month.
On a month over month basis, the core PCE price index was up 0.2%. If you annualized the rolling three-month and six-month figures, the core PCE price index was up 3.4% and 4.1%, respectively.
The bottom line is that while inflation rates have been trending lower, they continue to be above the Federal Reserve’s target rate of 2%.
For more on the implications of cooling inflation, read: The bullish 'goldilocks' soft landing scenario that everyone wants 😀
💵 Labor costs are cooling. The employment cost index in the second quarter was up 4.5% from the prior year, down from 4.9% in the first quarter. On a quarter-over-quarter basis, it was up 1.0% in the second quarter, a deceleration from the 1.2% gain in the first quarter.
From Wells Fargo: “The details of the ECI report are consistent with a labor market that is still tight but is gradually cooling from the scorching heat experienced last year. Compensation growth appears to have turned a corner as labor supply and demand come into better balance.“
For more on why the Fed is concerned about high wage growth, read: The complicated mess of the markets and economy, explained 🧩
💼 Unemployment claims tick down. Initial claims for unemployment benefits fell to 221,000 during the week ending July 22, down from 228,000 the week prior. While this is up from the September low of 182,000, it continues to trend at levels associated with economic growth.
For more on the labor market, read: The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫
🇺🇸 The U.S. economy grew. U.S. GDP grew at a healthy 2.4% rate in Q2, according to the BEA’s advance estimate (via Notes). During the period, personal consumption increased at a 1.6% clip.
For more on what’s been bolstering the economy, read: Three massive forces have fueled the economic expansion for the past two years 💪
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.5% rate in Q3.
For more on the forces bolstering economic growth, read: 9 reasons to be optimistic about the economy and markets 💪
🇺🇸 Most U.S. states are still growing. From the Philly Fed’s State Coincident Indexes report: "Over the past three months, the indexes increased in 49 states and decreased in one, for a three-month diffusion index of 96. Additionally, in the past month, the indexes increased in 43 states, decreased in two states, and remained stable in five, for a one-month diffusion index of 82."
For more on broad measures of the U.S. economy, read: Still waiting for that recession people have been worried about 🕰️
🏭 They’re building a lot of factories. From Bloomberg: “Business investment in manufacturing facilities surged to the highest level in records that go back to the late 1950s, according to data published Thursday by the Bureau of Economic Analysis. Spending on factory construction has almost doubled in the past year, after the Biden administration passed laws that provide hundreds of billions of dollars in subsidies and other support for industries like clean energy and semiconductors.“
For more on the U.S. manufacturing boom, read: Three massive forces have fueled the economic expansion for the past two years 💪
🏭 Business survey signals cooling. From S&P Global’s July Flash U.S. PMI (via Notes): “July is seeing an unwelcome combination of slower economic growth, weaker job creation, gloomier business confidence and sticky inflation. The overall rate of output growth, measured across manufacturing and services, is consistent with GDP expanding at an annualized quarterly rate of approximately 1.5% at the start of the third quarter. That's down from a 2% pace signalled by the survey in the second quarter.“
Keep in mind that during times of stress, soft data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊
🏘️ New home sales fall. Sales of newly built homes (via Notes) fell 2.5% in June to an annualized rate of 697,000 units.
For more on housing, read: The U.S. housing market has gone cold 🥶
🏠 Home prices rise. According to the S&P CoreLogic Case-Shiller index (via Notes), home prices rose 1.2% month-over-month in May. From SPDJI’s Craig Lazzara: “Home prices in the U.S. began to fall after June 2022, and May’s data bolster the case that the final month of the decline was January 2023. Granted, the last four months’ price gains could be truncated by increases in mortgage rates or by general economic weakness. But the breadth and strength of May’s report are consistent with an optimistic view of future months.“
For more on shelter prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
👍 Consumer confidence is up. From The Conference Board’s July Consumer Confidence report (via Notes): “Consumer confidence rose in July 2023 to its highest level since July 2021, reflecting pops in both current conditions and expectations… Headline confidence appears to have broken out of the sideways trend that prevailed for much of the last year. Greater confidence was evident across all age groups, and among both consumers earning incomes less than $50,000 and those making more than $100,000.“
👍 Labor market confidence improves. From The Conference Board: “46.9% of consumers said jobs were ‘plentiful,’ up from 45.4%. 9.7% of consumers said jobs were ‘hard to get,’ much lower than 12.6% last month.“
From The Conference Board’s Dana Peterson: “Assessments of the present situation rose in July on brighter views of employment conditions, where the spread between consumers saying jobs are ‘plentiful’ versus ‘hard to get’ widened further. This likely reflects upbeat feelings about a labor market that continues to outperform.“
🛍️ Consumer spending rises. According to BEA data (via Notes), personal consumption expenditures increased 0.5% month over month in June to a record annual rate of $18.4 trillion.
For more on the resilience of the consumer, read: Don't underestimate the American consumer 🛍️
💳 Card spending growth is positive. From JPMorgan Chase: “As of 23 Jul 2023, our Chase Consumer Card spending data (unadjusted) was 2.9% above the same day last year. Based on the Chase Consumer Card data through 23 Jul 2023, our estimate of the US Census July control measure of retail sales m/m is 0.46%.“
For more on spending, read: Don't underestimate the American consumer 🛍️
Putting it all together 🤔
We continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ At its June 14 policy meeting, the Fed kept rates unchanged, ending a streak of 10 consecutive rate hikes. While the central bank lifted rates again on July 26, most economists agree that the final rate hike is near.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations) to linger.
All of this means monetary policy will be unfriendly to markets for the time being, and the risk the economy sinks into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms, meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
When the Fed-sponsored market beatings could end 📈
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
The sobering stats behind 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
