Don't underestimate the American consumer 🛍️
Don't underestimate the American consumer 🛍️
Plus a charted review of the macro crosscurrents 🔀
🌴 NOTE: TKer will be off on Sunday, May 28. The free weekly newsletter will return on June 4. Paid pieces will go out as usual.
Stocks closed higher last week with the S&P 500 rising 1.6%. The index is now up 9.2% year to date, up 17.2% from its October 12 closing low of 3,577.03, and down 12.6% from its January 3, 2022 record closing high of 4,796.56.
As worries about recession risks linger, the focus last week shifted to the consumer. Remember: Personal consumption accounts for about 71% of GDP.
Good news: Personal consumption is holding up!
According to Census Bureau data, retail sales in April climbed 0.4% to $686.1 billion.
While the pace of sales is off its record high, it continues to trend well above pre-pandemic levels.
“Not to take issue with a popular coffee ad, but America runs on consumer spending,” JP Morgan economist Michael Feroli wrote Friday. “And consumer spending continues to run in the right direction, as this week’s strong April retail sales report confirmed.”
None of this should be very surprising to TKer readers. As we’ve discussed repeatedly, consumer finances have been in remarkably good shape despite what weak sentiment may suggest. And robust demand for labor continues to fuel job creation. All of this represents massive tailwinds powering spending, which has been bolstering economic growth for months.
Just last week, San Francisco Fed researchers estimated consumers were still collectively sitting on $500 billion in excess savings — the extra cash consumers piled up since February 2020, thanks to a combination of government financial support and limited spending options during the pandemic.
“The consensus expects a recession starting next quarter, but the upside risk to this negative forecast is that consumers still have plenty of savings left,” Torsten Slok, chief economist at Apollo Global Management, wrote on Tuesday.
For more on the consensus expectation for a recession, read: Why Warren Buffett ignores economic forecasts 🙉
Resilient, but cooling 👀
This is not to say that economic growth hasn’t been cooling. Indeed, the Federal Reserve’s campaign to fight inflation by tightening financial conditions and slowing growth has been effective.
And while aggregate retail sales grew, some categories — including electronics, furniture, and general merchandise — saw declines.
Retailer earnings, meanwhile, have been a bit mixed. Last week, Walmart reported strong sales growth whereas Target sales growth was lackluster and Home Depot sales fell.
Berkshire Hathaway CEO Warren Buffett warned earlier this month that most of his many companies expected to report lower earnings this year. In addition to weaker demand, Buffett said many of his companies would be selling goods at unfavorable prices as they clear out excess inventory.
“It is a different climate than it was six months ago, and a number of our managers were surprised,“ Buffett said. “We'll start having sales at places where we didn't need to have sales before.”
Consumer finances are normalizing 📉
While consumer finances have been strong, they have been normalizing.
The San Francisco Fed suggested that the $500 billion in estimated excess savings could dwindle by Q4 of this year, depending on how quickly consumers draw them down.
And credit card balances have been on the rise. While they remain low relative to disposable income, these metrics have been trending higher.
Meanwhile, the New York Fed’s Q1 Household Debt & Credit report shows debt delinquency rates are up from their lows. From the report (emphasis added):
Aggregate delinquency rates were roughly flat in the first quarter of 2023 and remained low, after declining sharply through the beginning of the pandemic. As of March, 2.6% of outstanding debt was in some stage of delinquency, 2.1 percentage points lower than last quarter of 2019, just before the COVID-19 pandemic hit the United States.
The share of debt newly transitioning into delinquency increased for most debt types. Transition rates into early delinquency for credit cards and auto loans increased by 0.6 and 0.2 percentage points, following similarly sized increases for the past year. Delinquency transition rates for mortgages upticked by 0.2 percentage points. Those for student loans have remained flat, as the federal repayment pause remains in place.
The number of consumers with a bankruptcy notation ticked up in Q1, but the level remains below the pre-pandemic trend.
Again, all of this is a discussion about normalization. The evaporation of excess savings only means savings levels would have returned to the pre-pandemic trend level. Same with rising delinquencies: they’re rising, but they’re mostly gravitating back to the pre-pandemic trend.
The big picture 🤔
Economic recession remains at bay thanks to an increasingly employed American consumer with a strong balance sheet.
Yes, recession risks are up as the Fed actively tries to slow the economy.
But the macro tailwinds bolstering the economy seem likely to keep growth going.
And even if the economy does slip into recession, keep in mind that many metrics are at historically strong levels. In other words, a recession could mean the economy goes from being very strong to just slightly less very strong, with limited risk of the bottom falling out thanks to what continues to be a lot of excess demand in the economy.
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Related from TKer:
Still waiting for that recession people have been worried about 🕰️
Three massive economic tailwinds I can't stop thinking about 📈📈📈
The bullish 'goldilocks' soft landing scenario that everyone wants 😀
The glass-half-full view of what could be the next recession 🥃
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
👆 Consumer check. Last week came with April retail sales, Q1 household debt stats, and a bunch of earnings announcements from major retailers. We discussed all that above.
💵 Household debt is up. According to the New York Fed’s Household Debt & Credit report, total household debt stood at $17.05 trillion in Q1, up 0.9% from the prior quarter. From the report: “Mortgage balances shown on consumer credit reports increased by $121 billion during the first quarter of 2023 and stood at $12.04 trillion at the end of March, a modest increase. Balances on home equity lines of credit (HELOC) increased by $3 billion, the fourth consecutive quarterly increase following a nearly 13 year declining trend; the outstanding HELOC balance stands at $339 billion. Credit card balances were flat in the first quarter, at $986 billion, bucking the typical trend of balance declines in first quarters. Auto loan balances increased by $10 billion in the first quarter, continuing the upward trajectory that has been in place since 2011. Other balances, which include retail cards and other consumer loans, increased by $5 billion. Student loan balances now stand at $1.60 trillion, up by $9 billion from the previous quarter. In total, non-housing balances grew by $24 billion.“
For more on household debt, read: Consumer finances are in remarkably good shape 💰
🚗 Watch auto loan delinquencies. The NY Fed’s report showed auto loan delinquencies in aggregate were normalizing. However, delinquencies for young people have jumped well above pre-pandemic levels. On a call with reporters, New York Fed researchers said: “One area of particular concerns are younger borrowers and their auto loan accounts. … For borrowers under age 30, we've seen increases in their auto loan delinquency rates, which now surpass where they were pre-pandemic, and that's something to keep an eye on in particular because car prices had increased so much that these borrowers were taking out more for their loans than they would have been previously.“
For more on auto loans, read: What rising auto loan delinquencies tell us about the economy 🚗
🏦 Bank lending conditions tighten. The Dallas Fed’s May Banking Conditions Survey — which covers banks in Texas, New Mexico, and Louisiana — suggests things continue tighten on the banking side. From the report (emphasis added): “Loan demand declined for the sixth period in a row amid further loan pricing increases and worsening general business activity. Overall loan volumes continued to decline as well, though at a decelerated pace. Residential real estate loan volumes stabilized after falling for several months, and consumer loan volume declines slowed notably. Significant volume declines continue to be seen in commercial and industrial and commercial real estate lending. Credit conditions tightened further; 48 percent of bankers said they tightened credit standards and terms over the past six weeks, the highest share since the survey began in 2017. Loan nonperformance continued to increase slightly. The banking outlook continues to deteriorate, with contacts expecting a further contraction in business activity and loan demand and an increase in nonperforming loans over the next six months.“
For more context on banking conditions, read: Less-than-disastrous updates on the banking situation 🤷🏻♂️
🏚 Home sales cooled. Sales of previously owned homes fell 3.4% in April to an annualized rate of 4.28 million units. From NAR chief economist Lawrence Yun: “The combination of job gains, limited inventory and fluctuating mortgage rates over the last several months have created an environment of push-pull housing demand.“
For more on housing, read: The U.S. housing market has gone cold 🥶
💸 Home prices ticked up. Prices for previously owned homes rose month over month, but were down from year ago levels. From the NAR: “The median existing-home price for all housing types in April was $388,800, a decline of 1.7% from April 2022 ($395,500). Prices rose in the Northeast and Midwest but retreated in the South and West.“
🏠 Home builder sentiment jumps. From NAHB Chairman Alicia Huey: “New home construction is taking on an increased role in the marketplace because many home owners with loans well below current mortgage rates are electing to stay put, and this is keeping the supply of existing homes at a very low level… While this is fueling cautious optimism among builders, they continue to face ongoing challenges to meet a growing demand for new construction. These include shortages of transformers and other building materials and tightening credit conditions for residential real estate development and construction brought on by the actions of the Federal Reserve to raise interest rates.”
🔨 New home construction rises. Housing starts climbed 2.2% in April to an annualized rate of 1.4 million units, according to Census Bureau data released Thursday. Building permits declined by 1.5% to an annualized rate of 1.42 million units.
🏭 Industrial activity picks up. Industrial production activity in April was up 0.5% from March levels, with manufacturing output climbing 1.0%. Though activity in prior months was revised lower.
For more on broad measures of the U.S. economy, read: Still waiting for that recession people have been worried about 🕰️
💼 Unemployment claims remain questionable. Initial claims for unemployment benefits fell to 242,000 during the week ending May 13, down from 264,000 the week prior. As we previously noted, last week’s claims figure was reportedly inflated by fraudulent claims filed in Massachusetts.
If there’s a silver lining, it’s that fraudulent claims inflate these figures – meaning that the number of people actually seeking out unemployment benefits is likely lower.
That said, no one’s really refuting the claim that the labor market has been cooling.
For more, read: The good kind of deteriorating labor market 👍
🏢 Offices are very empty. From Kastle Systems: “Office occupancy remains around 50%, falling two-thirds of a point last week to 49.3%, according to Kastle’s 10-city Back to Work Barometer. Nearly all tracked cities—except New York City—saw declines of less than a point. Only Houston and Austin, Texas experienced larger declines, falling 1.8 points to 60% and 2.5 points to 60.6%, respectively. New York City rose 0.6 points to 48.9%. The daily high was Tuesday at 57.7%, and the low was Friday at 33.1%.”
For more on office occupancy, read: This stat about offices reminds us things are far from normal 🏢
✈️ People are flying. From Renaissance Macro Research: “More passengers being screened at airports. TSA traveler throughput ran 2.63 million as of May 18, the highest level since the pandemic. Over the last 7 days, traveler throughput has averaged 101% of 2019 levels.”
🏟️ People are going to events. From Chartr with Live Nation Entertainment data:
🏛️ Debt ceiling drama continues. There’s still no deal to resolve the debt ceiling issue. But there’s still some time before it becomes a very serious problem for the financial markets. That said, raising the debt ceiling is nothing new. From Visual Capitalist:
For some thoughts on the debt ceiling, read: A brief note about the debt ceiling... 🫠
😬 The pros are worried about stuff. According to BofA’s April Global Fund Manager Survey (via Notes), fund managers identified “Credit crunch & global recession” as the “biggest tail risk.”
The truth is we’re always worried about something. That’s just the nature of investing.
For more on risks, read: Sorry, but uncertainty will always be high 😰
Putting it all together 🤔
Despite recent banking tumult, 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.“ And on May 3, the Fed signaled that the end of interest rate hikes may be here.
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 the market beatings may continue for the time being, and the risk the economy sinks into a recession will be relatively elevated.
At the same time, it’s important to remember that while recession risks are 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 »
For more on why this is an unusually unfavorable environment for the stock market, read: The market beatings will continue until inflation improves 🥊 »
For a closer look at where we are and how we got here, read: The complicated mess of the markets and economy, explained 🧩 »
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%.
Thanks for another great post. When I put everything together as you did, it seems like we're coming in for a soft landing. We may hit some turbulence (earnings, debt ceiling)and feel a drop, but ultimately, I think we land, taxi for a bit, then start to gradually take off again. For me, close to early retirement, it means I stay 50/50. If we drop ~10% I buy to 55/45. If we go up from here, I'm ok missing out a bit. Thanks Sam!
I noticed that Q1 2023 CC balances were flat from last quarter and didn’t trend down as it normally does after the q4 holiday spend, it alluded to personal savings drying up to the point that many households are only able to pay the min interest. But contrary to that data the BEA’s personal savings moved up from $650m in Oct 2022 to $1b in April 2023 and the savings rate moved up back over 5%. Is this the equilibrium level between “have’s & have not’s” or something different?