Economy Gaining Momentum The U.S. economy grew at a healthy 4.1% annual rate in the third quarter, revised figures showed, boosting hopes that the recovery is shifting into higher gear after years of sluggishness.
Friday’s report showed consumer spending—a key driver of the economy—grew at a 2% annual rate in the summer, instead of the previously estimated 1.4%.
ZeroHedge drills down:
(…) many are wondering just where this “revised” consumption came from: of the $15 billion revised increase in annualized spending, 60% was for healthcare, and another 27% was due to purchases of gasoline. The third largest upward revision: recreation services. On the flip side, the biggest revision detractors: transportation services and housing and utilities.
No boost to retailing from these revisions.
Meanwhile, profit margins keep defying the naysayers, this time because of lower taxes:
(…) after-tax corporate profits in the third quarter topped 11% of gross domestic product for the first time since the records started in 1947. At the same time, taxes paid by corporations has declined nearly 5% in the third quarter compared with a year earlier.
Another positive sign?
The U.S. economy seems to be getting “a little bit better,” said General Electric Co. Chief Executive Jeff Immelt, speaking after an investor meeting this past week. “We’ve seen some improvements in commercial demand for credit,” he said, a positive sign that companies are investing.
Wells Fargo CEO said same 10 days ago.
Is it because companies are finally investing…or because companies must now finance out of line inventories due to the lack of growth in final demand?
On the one hand, the official GDP is accelerating beyond any forecasts. On the other hand, final demand is slowing to levels which most of the time just preceded a recession. Go figure!
But don’t despair, on the next hand, here’s David Rosenberg painting a “Rosie” scenario for us all (my emphasis):
(…) But things actually are getting better. The Institute for Supply Management figures rarely lie and they are consistent with 3.5% real growth. Federal fiscal policy is set to shift to neutral from radical
restraint and the broad state/local government sector is no longer shedding jobs and is, in fact, spending on infrastructure programs again.
On top of that, manufacturing is on a visible upswing. Net exports will be supported by a firmer tone to the overseas economy. The deceleration to zero productivity growth, which has a direct link to profit margins, will finally incentivize the business sector to invest organically in their own operations with belated positive implications for capex growth.
But the centrepiece of next year’s expected acceleration really boils down to the consumer. It is the most essential sector at more than 70% of GDP. And what drives spending is less the Fed’s quest for a ‘wealth effect,’ which only makes rich people richer, but more organic income, 80% of which comes from working. And, in this sense, the news is improving, and will continue to improve. I’ll say it until I’m blue in the face.
Indeed, all fiscal policy has to do is shift to neutral, and a 1.5-percentage-point drag on growth — the major theme for 2013 — will be alleviated. With that in mind, the two-year budget deal that was just cobbled together by Paul Ryan and Patty Murray at the least takes much of the fiscal stranglehold off the economy’s neck, while at the same time removing pervasive sources of uncertainty over the policy outlook.
Since the pool of available labour is already shrinking to five-year lows and every measure of labour demand on the rise, one can reasonably expect wages to rise discernibly in coming years, unless, that is, you believe the laws of supply and demand apply to every market save for the labour market.
Let’s get real: By hook or by crook, wages are going up next year (minimum wages for sure and this trend is going global). With this in mind, the most fascinating statistic this past week was not ISM or nonfarm payrolls, but the number of times the Beige Book commented on wage pressures: 26. That’s not insignificant. Again, when I talked about this at the Thursday night dinner, eyeballs rolled.
There was much discussion about the lacklustre holiday shopping season thus far, with November sales below plan. There was little talk, however, about auto sales hitting a seven-year high in November even with lower incentives. And what’s a greater commitment to the economy — a car or a cardigan?
As I sifted through the Beige Book to see which areas of the economy were posting upward wage pressure and growing skilled labour shortages, I could see it cut a large swath: technology, construction, transportation services, restaurants, durable goods manufacturing.
Of the 115 million people currently working in the private sector, roughly 40 million of them are going to be reaping some benefits in the form of a higher stipend and that is 35% of the jobs pie right there. That isn’t everyone, but it is certainly enough of a critical mass to spin the dial for higher income growth (and spending) in the coming year. Macro surprises are destined to be on the high side — take it from a former bear who knows how to identify stormy clouds. (…)
On the consumer side, the aggregate debt/disposable income ratio has dropped from 125% at the 2007 peak to 100%, where it was a decade ago (down to 95% excluding student loans, an 11-year low). In other words, the entire massive 2002-07 credit expansion has been reversed, and, as such, the household sector is in far better financial position to contribute to economic activity.
On the government side, the U.S. federal deficit, 10% of GDP just four years ago, is below 4% today and on its way to below 3% a year from now, largely on the back of tough spending cuts and a big tax bite.
Then throw in the vast improvement in the balance-of-payments situation, courtesy of the energy revolution. With oil import volumes trimmed 5% over the past year and oil export volumes up a resounding 30%, the petroleum deficit in real terms has been shaved by one-quarter in just the last 12 months. This, in turn, has cut the current account deficit in half to 3% of GDP from the nearby high of 6%. (…)
In a nutshell, I feel like 2014 is going to feel a lot like 2004 and 1994 when the economy surprised to the high side after a prolonged period of unsatisfactory post-recession growth. Reparation of highly leveraged balance sheets delayed, but, in the end, did not derail a vigorous expansion.
That by no means guarantees a stellar year for the markets, because, as we saw in 2013 with a softer year for the economy, multiple expansion premised on Fed-induced liquidity can act as a very powerful antidote. Plus, a rising bond-yield environment will at some point provide some competition for the yield delivered by the stock market.
While 1994 and 2004 were hardly disasters, the market generated returns both years that were 10 percentage points lower than they were the prior year even with a more solid footing to the economy — what we gained in terms of growth, we gave up in terms of a less supportive liquidity/monetary policy backdrop.
But make no mistake, the upside for next year from a business or economic perspective as opposed to from a market standpoint is considerable.
It is open for debate as to how the stock market will respond, but it is not too difficult to predict where bond yields will be heading (up) since they are, after all, cyclical by nature. Within equities, this means caution on the rate-sensitives and the macro backdrop will augur for growth over value.
Thanks David, but…
First, let’s set the record straight:
- According to Edmunds.com’s Total Cost of Incentives (TCI) calculations, car incentives on average were flat from a year ago, though some automakers increased their incentives and even others lowered them. One car dealer said that manufacturers are pushing retailers to buy more vehicles, “slipping back into old habits”.
- The S&P 500 Index peaked at 482 in January 1994, dropped 8% to 444 at the end of June and closed the year at 459. EPS jumped 18% that year while inflation held steady around 2.5%.
- In 2004, equity markets were essentially flat all year long before spiking 7% during the last 2 months of the year. Profits jumped 24% that year while inflation rose from 1.9% to 3.3%.
- In both years, equity valuations were in a correction mode coming from Rule of 20 overvalued levels in the previous years.
Second, we should remember that car sales have been propelled by the huge pent up demand that built during the financial crisis. Like everything else, this will taper eventually. The fact remains that car sales have reached the levels of the previous 4 cyclical peaks. Consider that there are fewer people actually working these days, even fewer working full time, that the younger generation is not as keen as we were to own a car and that credit conditions remain very tight for a large “swath” of the population. And just to add a fact often overlooked by economists, car prices are up 8% from 2008 while median household income is unchanged. (Chart from CalculatedRisk)
Third, it may be true that the ISM figures rarely lie but we will shortly find out if recent production strength only served to grow inventories. To be sure, car inventories are currently very high, prompting some manufacturers to cut production plans early in 2014.
Fourth, building an economic scenario based on accelerating wages invites a discussion on inflation and interest rates, both key items for equity valuation and demand. There is no money to be made from economic scenarios, only from financial instruments. Rosie’s scenario may not be as rosy for financial markets if investors become concerned about labour demand exceeding supply. (See Lennar’s comments below).
Futures prices rose 5.9% last week in response to signs of unusually srong demand for the fuel.
Gasoline for January delivery rose 4.3 cents, or 1.6%, to $2.7831 a gallon Friday on the New York Mercantile Exchange.
(…) Thom Blischok, chief retail strategist and a senior executive adviser with Booz & Company’s retail practice in San Francisco, said many U.S. shoppers are holding back this season because they have fewer discretionary dollars.
“Sixty-five percent of (Americans) are survivalists. They are living from paycheck to paycheck,” he said. “Those folks simply don’t have any money to celebrate Christmas.”
People with annual income of $70,000 and up account for 33 percent of U.S. households, but 45 percent of spending, according to U.S. Census data crunched by AlixPartners. That group has seen the most benefit from the improving economy as rising home and stock prices bolster their net worth.
But even those with higher incomes are holding back.
“The era of ‘living large’ is now officially in the rear-view mirror,” said Ryan McConnell, who heads the Futures Company’s US Yankelovich Monitor survey of consumer attitudes and values.
Responses to the 2013 survey suggested that the “hangover effect” of the so-called Great Recession remained prevalent with 61 percent of respondents agreeing with the statement: “I’ll never spend my money as freely as I did before the recession.” (…)
Competing for shoppers led major retailers to significantly ramp up the frequency of their promotions in the first part of December, according to data prepared for Reuters by Market Track, a firm that provides market research for top retailers and manufacturers.
A group of eight major retail chains, including J.C. Penney Co Inc, Wal-Mart Stores Inc and Best Buy Co Inc, increased the number of circulars they published between December 3 and December 18 nearly 16 percent over the comparable period a year earlier.
Those retailers, which also include Sears and Kmart, Macy’s Inc, Kohl’s Corp and Target Corp, ramped up the online deals even more, increasing the number of promotional emails by 54.5 percent, according to the Market Track data.
The battle for shoppers has also led to the most discount-driven season since the recession, according to analysts and executives.
“There is a quicker turnover of promotions this year, and now several times, within a day,” eBay Enterprise CEO Chris Saridakis said. “It’s an all-out war.”
U.S. shoppers flocked to stores during the last weekend before Christmas as retailers piled on steeper, profit-eating discounts to maximize sales in their most important season of the year.
Retailers were offering as much as 75 percent off and keeping stores open around the clock starting Friday. “Super Saturday” was expected to be one of the busiest shopping days of the year, according to Chicago-based researcher ShopperTrak. (…)
Holiday purchases will rise 2.4 percent, the weakest gain since 2009, ShopperTrak has predicted. Sales were up 2 percent to $176.7 billion from the start of the season on Nov. 1 through Dec. 15, said the firm, which will update its figures later today. The National Retail Federation reiterated on Dec. 12 its prediction that total sales will rise 3.9 percent in November and December, more than the 3.5 percent gain a year ago.
Factset concludes with the important stuff for investors: Most S&P 500 Retail Sub-Industries Are Projected to Report a Decline in Earnings in Q4
In terms of year-over-year earnings growth, only five of the thirteen retail sub-industries in the S&P 500 are predicted to report growth in earnings for the fourth quarter. Of these five sub-industries, the
Internet Retail (66.7%) and Automotive Retail (10.3%) sub-industries are expected to see the highest earnings growth. On the other hand, the Food Retail (-20.2%), General Merchandise Stores (-10.6%), and Apparel Retail (-8.8%) sub-industries are expected to see the lowest earnings growth for the quarter.
Overall, there has been little change in the expected earnings growth rates of these thirteen retail subindustries since Black Friday. Only four sub-industries have recorded decreases in expected earnings growth of more than half a percentage point since Black Friday: Drug Retail, Food Retail, General Merchandise, and Hypermarkets & Supercenters. On the hand, no sub-industry has recorded an increase in expected earnings growth of more than half a percentage point since November 29.
These folks are unlikely to be jolly unless Congress acts, again at the last hour:
Tom Porcelli, chief U.S. economist at RBC Capital Markets, estimates that 1.3 million folks will lose their unemployment checks after this week, forcing some to take jobs they previously passed up or join the legions of workforce dropouts. If even half do the latter, the jobless rate could slip to 6.6% in fairly short order. (Barron’s)
This could have interesting consequences as JP Morgan explains:
(…) the potential expiration of federal extended unemployment benefits (formally called Emergency Unemployment Compensation) at the end of this month could push the measured unemployment rate lower.
The state of North Carolina offers a potential testing ground for this thesis. In July, the North Carolina government decided to no longer offer extended benefits, even though the state still met the economic conditions to qualify for this federal program. Since July, the North Carolina unemployment rate has fallen 1.5%-points; in the same period the national unemployment rate has fallen 0.4%-point. (…)
The information from one data point is a long way from statistical certainty, but the limited evidence from North Carolina suggests that the potential expiration of extended benefits will place further downward pressure on the measured unemployment rate. In which case the Fed could soon have some ‘splainin’ to do about what “well past” 6.5% means with respect to their unemployment rate threshold.
Rampant Returns Plague E-Retailers Behind the uptick in e-commerce is a secret: As much as a third of all Internet sales gets returned, in part because of easy policies on free shipping. Retailers are trying some new tactics to address the problem.
(…) Retailers are zeroing in on high-frequency returners like Paula Cuneo, a 54-year-old teacher in Ashland, Mass., who recently ordered 10 pairs of corduroy pants in varying sizes and colors on Gap Inc. GPS +0.73% ‘s website, only to return seven of them. Ms. Cuneo is shopping online for Christmas gifts this year, ordering coats and shoes in a range of sizes and colors. She will let her four children choose the items they want—and return the rest.
Ms. Cuneo acknowledged the high costs retailers absorb to take back the clothes she returns, but said retailers’ lenient shipping policies drove her to shop more.
“I feel justified,” she said. “After all, I am the customer.” (…)
The incoming director of the regulatory agency that oversees Fannie Mae and Freddie Mac said he would delay an increase in mortgage fees charged by the housing-finance giants.
(…) Upon being sworn in, “I intend to announce that the FHFA will delay implementation” of the loan-fee increases “until such time as I have had the opportunity to evaluate fully the rationale for the plan,” he said in a statement.
The FHFA signaled that it would increase certain fees charged by Fannie and Freddie that are typically passed on to mortgage borrowers on Dec. 9, on the eve of Mr. Watt’s Senate confirmation. (…)
In updates posted to their websites on Monday, Fannie and Freddie showed that fees will rise sharply for many borrowers who don’t have down payments of at least 20% and who have credit scores of 680 to 760. (Under a system devised by Fair Isaac Corp., credit scores range from 300 to a top of 850.) (…)
Surely, the housing market does not need more headwinds. ISI’s homebuilders survey is continuing to plunge, existing house sales have declined sharply, and existing house prices are down -1.6% from their peak. In addition, ISI’s house price survey has been flat for five months. On the other hand, NAHB’s survey is at a new high, and housing starts surged in November. Inventory accumulation?
Meanwhile, costs are skyrocketing:
Lennar noted that while its “aggressive” pricing strategies led to significant margin improvements, labor and construction material costs last quarter were up about 12% from a year ago, and that labor costs were up by “more” than material costs. (CalculatedRisk)
I remain concerned that higher inflation is slowly sneaking in, hidden behind weighted indices while un-weighted measures suggest that prices are being regularly ratcheted up. The median CPI, measured by the Cleveland Fed, is still up 2.0% YoY even though the weighted CPI is down to +1.0% YoY.
Differences between changes in the CPI and the median consumer price
change underscore the impact of the distribution of price movements on our monthly interpretation of inflation. The median price change is a potentially useful indicator of current monetary inflation because it minimizes, in a nonsubjective way, the influence of these transitory relative price movements.
Assume there is no abnormal inventory accumulation and that David Rosenberg’s scenario pans out, we might get both demand pull and cost push inflation simultaneously. Far from a rosy scenario. Mrs. Yellen would have her hands full.
As 2013 draws to a close, executives are more optimistic about economic improvements than they have been all year, both at home and in the global economy. They also anticipate that conditions will continue to improve, thanks to the steady (though modest) improvements in the developed world that many expect to see.
In McKinsey’s newest survey on economic conditions, the responses affirm that economic momentum has shifted—and will continue to move—from the developed to the developing world, as we first observed in September. Indeed, executives say the slowdown in emerging markets was one of the biggest business challenges this year, and respondents working in those markets are less sanguine than others about the current state of their home economies.
Respondents from all regions agree, though, on the world economy: for the first time since we began asking in early 2012, a majority of executives say global conditions have improved in the past six months.
Looking ahead to 2014, many executives expect economic progress despite growing concern over asset bubbles and political conflicts—particularly in the United States. Respondents there say that ongoing political disputes and the government shutdown in October have had a
notable impact on business sentiment, despite the less noticeable effect on the country’s recent economic data. Still, at the company level, executives maintain the consistently positive views on workforce size, demand, and profits that they have shared all year. (…)
Amid the shifting expectations for growth that we saw in 2013, executives’ company-level views have held steady and been relatively positive throughout the year. Since March, respondents most often reported that their workforce sizes would stay the same, that demand
for their companies’ products would grow, and that their companies’ profits would increase over the next six months; the latest results are no different.
Executives are still very focused on increasing margins!
Across regions, executives working in developed Asia are the most optimistic—and those in the eurozone are the most pessimistic—about their companies’ prospects. Forty-four percent of those in developed Asia say their workforces will grow in the next six months, while just 7 percent say they will shrink; in contrast, 31 percent of executives in the eurozone expect a decrease in workforce size. Two-thirds of respondents in developed Asia expect demand for their companies’ products and services to increase in the coming months, and they are least likely among their peers in other regions to expect a decrease in company profits.
In their investment decisions, though, executives note a new concern: rising asset prices, which could affect company-level (as well as macroeconomic) growth in the coming year. Of the executives who say their companies are postponing capital investments or M&A decisions they would typically consider good for growth, the largest shares of the year now cite high asset valuations as a reason their companies are waiting.
Borrowing costs in China’s money market soared again, as the central bank’s recent fund injection failed to appease jittery investors amid a seasonal surge in demand for cash by banks.
Borrowing costs in China’s money market soared again after a brief fall earlier Monday, as the central bank’s recent fund injection failed to appease jittery investors amid a seasonal surge in demand for cash by banks.
The seven-day repurchase-agreement rate, a benchmark measure of the cost that banks charge each other for short-term loans, rose to 9.8%, up from 8.2% Friday and its highest level since it hit 11.62% on June 20, at the peak of China’s summer cash crunch. (…)
The stress in the banking system has spread elsewhere, with stocks in Shanghai falling for a ninth straight day Friday to the weakest level in four months while government bonds dropped, pushing the 10-yield up to near the highest in eight years.
The country’s gross domestic product grew 5.42% this year, compared with 5.25% in 2012, the government’s General Statistics Office said Monday. Last year’s GDP, the slowest since 1999, was revised up from 5.03%. Inflation was down as well.
The government said on-year growth in the fourth quarter was 6.04%, compared with 5.54% in the third quarter.
Planned sales tax increase forecast to hit consumption
The Japanese government forecast on Saturday that real gross domestic product will grow by 1.4 per cent for the fiscal year starting March 2014, slowing from an expected 2.6 per cent growth for the current year as a planned sales tax increase is seen dampening consumption. (…)
The government also forecast that consumer prices will rise by about 1.2 per cent in the 2014 fiscal year, without considering an impact from the sales tax hike. Consumer prices are expected to show a rise of 0.7 per cent in the current fiscal year. The Bank of Japan launched a massive monetary stimulus programme aimed at pushing the inflation rate up to 2.0 per cent in two years, in a bid to wrench the country out of a long phase of deflation.
Money managers and analysts say they are beginning to think the Federal Reserve is succeeding in restoring economic growth.
(…) Ned Davis, founder of Ned Davis Research in Venice, Fla., and a skeptic by nature, told clients last week that the economic picture is brightening. “There are still mixed indicators regarding economic growth, but most of our forward-looking indicators are suggesting the economy is accelerating to at least ‘glass-half-full’ growth rates,” he wrote. (…)
Because they now think the economy is on the mend, many money managers share the view that, while 2014 probably won’t match 2013, indexes probably will finish the year with gains. (…)
(…) While the S&P 500 is unlikely to match the 27 per cent jump it achieved in 2013, the odds favour another strong year for equities. Investors with a long time horizon have little to fear from wading into the market, even after a 168 per cent run-up from the index’s post-financial crisis nadir. (…)
It is no secret that companies have cut their way to profitability growth. They have put off investment, including in wages and hiring; they have slashed their financing costs by issuing record amounts of debt at this year’s rock-bottom interest rates; and they have juiced earnings per share further by buying back and cancelling shares at a pace not seen for five years.
These are trends that will all be slow to reverse. Slack in the economy will keep the lid on what companies have to spend on employees, and the benefits of those low financing costs are locked in for years to come. To the extent that wages and interest rates rise, it will be because the economic outlook is brightening, which will fill in the missing piece of the puzzle: top line revenue growth. (…)
In the historical context, current return on equity for the S&P 500 is not high; at 14.1 per cent during the last quarterly reporting season, it was only 5 basis points above the average since 1990. Profit growth, in other words, is as likely to carry on rising as it is to U-turn.
The path of least resistance for equities is still up. There is a whole swath of bond investors who are yet to reassess their overweights in that asset class, who may do so when January’s miserable annual statements land. The diversifying “alternative” investments – hedge fund-like mutual funds and their mutant brethren – remain too expensive to become significant parts of a portfolio for most investors.
The S&P 500’s down years have all, with the exception of 1994, been recession years. Of course, the spectre of 1994 is haunting, since that was precisely when the Federal Reserve last attempted a big reversal of policy and began to raise interest rates to choke off inflation.
There is an asterisk to even the most bullish equity forecast, which is that all bets will be off if the Fed loses control of rates, dragging bond yields higher not just in the US where they might be justified, but also across the world, where they could snuff out a nascent recovery in Europe and cause untold harm in emerging markets.
After the smooth market reaction to the announcement of a slowdown in quantitative easing last week, a disaster scenario looks even more unlikely. And lest we forget, tapering is not tightening, so 2014 is not 1994.
If the S&P 500 closes out the year where it began this week, 2013 will go down as the fifth best year for share price gains since the index was created in 1957. Each of the four occasions when it did better – 1958, 1975, 1995 and 1997 – were followed by an additional year of strong returns, ranging from 8.5 per cent to 26.7 per cent.
Equity markets should maintain their positive momentum as long as the global economy maintains its, and the odds look good. Even in middle age, a bull can pack some power.
Equities will rise 12 percent in 2014, according to the average projection of 18 forecasters tracked by Bloomberg News.Ian Scott of Barclays Plc says the StoxxEurope 600 Index can rally 25 percent because shares are cheap even after a 49 percent gain since 2011. (…)
The average estimate is the most bullish since at least 2010, with no strategist predicting a gain of less than 3.3 percent, and comes even as company analysts reduced income forecasts for an 85th straight week. While more than 2.7 trillion euros ($3.7 trillion) has been restored to European equity values since September 2011, shares would have to gain another 65 percent to match the advance in the Standard & Poor’s 500 Index during the last five years.
“You would have lacked credibility being bullish on Europe 18 months ago, although stocks were very cheap and the economy was bottoming,” said Paul Jackson, a strategist at Societe Generale SA inLondon, who predicts a 15 percent jump for the Stoxx 600 next year. “As soon as the market started to do well, suddenly everybody wants to listen. And now not only is everybody listening, but everyone is saying the same thing. The time to worry about the Armageddon scenario is gone.” (…)
Analysts have downgraded earnings estimates on European companies excluding the U.K. for 85 weeks, a record streak, according to Citigroup Inc. data on Bloomberg. Mark Burgess, chief investment officer at Threadneedle Asset Management Ltd., says European earnings will probably disappoint again. (…)
“The region remains beset by relatively poor growth dynamics compared with the rest of the developed world,” Burgess, who helps oversee $140 billion from London, said in e-mailed comments on Dec. 11. “This year’s stock market recovery could easily herald a false dawn. While for the first time in three years we believe Europe is likely to return to positive GDP growth in 2014, earnings growth is likely to be steady rather than dramatic.” (…)
Evans at Deutsche Bank says his team at Europe’s largest bank has become “increasingly convinced” that lending in the region will rebound and will help companies beat estimates in what he calls investors’ “complete loss of confidence in the earnings cycle.”
The ECB said in a quarterly survey released Oct. 30 that banks expect to relax standards on corporate lending this quarter. That’s the first such response since the fourth quarter of 2009 and, if it occurs, would mark the first easing of conditions since the second quarter of 2007. Lenders also plan to simplify access to consumer loans and mortgages, and predicted a rise in loan demand.
Everybody is jumping on the bandwagon on the basis of an accelerating economy and equity momentum.
Time to stay rationale and disciplined. Good luck, and happy holidays!