A Strapped Consumer Equals A Slowing Economy

Financial markets ended the week on a mixed note with the Nasdaq rising 1.4% and closing at a record high thanks to Nvidia’s huge win on both the top and bottom lines. The S&P 500 was flat on the week (+0.3%), while the Dow Jones, with a 606-point drop (-1.5%) on Thursday, played the loser’s role (-2.3%). Quite a mixed picture.

Concerns about incoming economic data appear to be replacing momentum in stock markets, while bond yields appear to be focused on hawkish talk from FOMC spokespeople. 10 years. Treasury rose 11 basis points (to 4.47%) over the past eight business days.

The constrained American consumer

The theme that emerges from the data is that the effects of higher interest rates, higher prices (inflation), and delayed wage growth appear to have affected consumers in America.

The chart below divides the CPI into three components: shelter, auto insurance, and “other.” As shown here, 2021 and 2022 were dominated by inflation in the “other” category. But in today’s economy, the vast majority of current inflation consists of inflating shelter costs and rising rates in the auto insurance industry. Without these two components, the inflation rate for everything else is now less than 1%.

as we discussed Nausea In our previous blogs, the shelter component of the CPI, with a weight of 35%, uses lagged shelter cost data. The chart below shows a truer picture of shelter costs, which is why we maintain our view that the inflation genie has been put back in the bottle. Note that rents fell by -0.8% in the 12 months ending in April. This is a far cry from the cost of shelter in the CPI in the chart above, which is why we are confident that inflation is falling.

Comments from Q1 earnings reports from major retailers suggest that consumer spending has begun to slow and supports our view of inflation.

  • And died: [Consumers are] “Spending more of their paychecks on non-discretionary categories and spending less on general goods.”
  • TGT: Cutting prices of 5,000 essential commodities as “inflation prompts customers to look for bargains.”
  • Babe: “The low-income consumer in the United States is stressed.”
  • MCD: “Consumers are still more discriminating.”
  • SBUX: “The deteriorating economic outlook has impacted consumer traffic; We continue to feel the impact of a more cautious consumer.
  • HD: “…Homeowners continue to take on smaller projects.”

It is unfortunate that decision makers at this particular Fed base their policy decisions on lagging rather than leading indicators. In our view, even if they start easing policy (cutting interest rates) at the next June meeting, they will still be late to the game (but better late than later).

Other incoming data

· Leading indicators have been negative since mid-2022. Their record of predicting recession, especially with this period of negative readings, is excellent (see chart).

· After spending what economists called “excess savings” (cash gifts from Uncle Sam during the early pandemic), consumers appear to have little left to continue their spending spree. We have several indicators of this:

  • Retail sales were stable in April (-0.3% in real terms, after inflation);
  • Delinquencies on credit card loans, car loans, and even mortgage loans are increasing rapidly.
  • There was an uptick in mortgage refinancing activity (+7.4% in the week of May 17y An increase of +21.2% over the previous year. This is an indication that the consumer’s ability to deal with incoming invoices has been exhausted (as evidenced by the rise in late payment cases). Who would refinance their home with mortgage rates above 7% unless they had to?

· Housing, which contributes significantly to GDP and overall economic activity, appears to be capitulating to the high interest rates imposed by the Federal Reserve.

  • New home sales in April were down -7.7% from a year earlier, and -4.7% from March levels (the downward trend is clearly accelerating). Construction workers found themselves with excess inventories (9.1 month supply at current sales levels, the highest level since November 22nd). The result was the long-awaited first decline in new housing prices.
  • “Builders are frantically lowering their models, with average new home prices down -1.4% month-on-month, falling in two of the past three months, while average prices have fallen by more than -4% in each of the four months. “It is now almost constant compared to last year’s levels.” (David RosenbergBreakfast with DaveMay 24, 2024)

· We saw Q1 GDP decline to +1.6% growth in Q1 from 3.4% in Q4. Given the incoming data, the second quarter is likely to be weaker. Regional Federal Reserve Banks trimmed Q2 GDP forecasts:

  • St. Louis: to 1.5% from 2.4%
  • New York: to 1.9% from 2.2%
  • Atlanta (always the odd one): to 3.6% from 4.2%

More about the Commission for Racial Equality

Foreclosures on commercial properties continued. The last four are shown here:

  1. The Westin Hotel, Tempe
  2. Fair Building, Los Angeles
  3. Pacific Place Mall, Seattle
  4. Grand Wailea Maui Resort

Private equity funds and banks with large CRE loan portfolios must be feeling the pressure!

Final thoughts

The stock market seems to be turning its attention towards upcoming economic data. This week, the Nasdaq advanced +1.4% on the shoulders of Nvidia’s huge win (upper and lower lines) to close at another new all-time high on Friday (May 24).y). But the S&P 500 was flat during the week, and the Dow Jones Industrial Average took the heat, falling -2.3% (-1.5% on Wednesday alone), and is now more than 900 points below the 40,000 closing level it achieved. Just a short week ago.

It is no surprise to us why the markets are down (in the absence of the AI ​​topic). Consumers (70% of GDP) appear to be strapped for cash, are now borrowing across credit card lines, and are even looking to refinance home loans (a 7% mortgage rate appears cheaper than 22%+ on credit card debt) to keep Their heads are above water. The rise in delinquencies is another sign of consumers’ plight.

Then we have comments from almost all major retailers in their Q1 earnings calls. These comments made it clear that consumers have tightened their wallets.

Housing has always been a good barometer of the state of the economy. Looks like he’s hit a snag. New home sales are down approximately -8% from last year and new home inventories are up significantly. The result is the long-awaited first decline in new housing prices. If the Fed wakes up and cuts interest rates, perhaps more existing housing inventory will hit the market and cause a similar reaction in existing home prices.

Mortgage foreclosures continue hot and heavy. While consumer distress may cause the economy to slow, CRE issues portend something more sinister.

(Joshua Barron and Eugene Hoover contributed to this blog.)

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