It was a quiet week in financial markets, with the major indexes up about 1% (the small-cap Russell 2000 was up almost 2%). No market moving news so markets rallied higher. Both the S&P 500 and DJIA closed at record highs on Friday, with the Nasdaq and Russell 2000 close behind. The table shows the weekly and yearly changes in these indices.
Stock markets
Universal value advisors
Magnificent 7 ended on a flat note this week, almost as if the contestants lost interest. The table shows that five of the seven ended the week with small losses and two made small gains. It felt like August, when most traders are on vacation.
The Magnificent Seven
Universal value advisors
Bond-land was equally peaceful. During the week, the 10-year Treasury yield was broadly unchanged, falling two basis points from 4.10% on Friday, October 11vol close on Friday (October 18) at 4.08%.vol).
Economy
A “soft landing” of the economy has now become the view of most economists and forecasters. This is because aggregate data continues to show expansion (the Atlanta Fed’s GDP estimate for the third quarter (ended September 30 this year)vol) is 3.4% per year). Headcount numbers and the latest retail sales data support this view. However, a look at the private sector tells a different story:
- While nominal retail sales are growing, real retail sales (adjusted for inflation) have not increased.
- Industrial production remains stable.
- Existing home sales are not growing, and new home sales are down from a year ago.
- Moreover, corporate investment remained stable throughout the year.
The economy is supported by government spending, not only federal but also state and local. In a recent Rosenberg Research article titled “Big Government Delivers Big Growth – But It’s a Façade,” the author discusses the low (non)growth in the private sector, pointing out that growth has been fueled by excessive federal, state and local government spending. The federal government deficit to GDP ratio for fiscal year 2024 was over 6%.
To put it in perspective, a budget deficit-to-GDP ratio of over 6% has never been seen in the United States over the last seven decades until the Great Recession in 2009. Even during a recession, the typical amount of stimulus rarely took the deficit ratio much above 3 %, and now, in a period of economic expansion, it is more than twice as high… The deficit has been institutionalized… because in just one year after the crisis in 2020 (2022, when it was 5.4%), the federal government managed to bring deficit below 6% of GDP. (Rosenberg 10-16-24)
US Treasury Federal Budget Total annual surplus/deficit as a percentage of GDP
Universal value advisors
Is it any wonder that we have experienced a nasty bout of inflation?
Inflation
Speaking of inflation, in previous blogs we have discussed the Bureau of Labor Statistics’ (BLS) use of lagged rent data in its CPI calculations. We have shown the charts below several times.
Change m/m/y in the national rent index (2019-present)
List of apartments
These show the current reading of rents, indicating that they are stable/falling rather than rising, indicating that the current CPI is shifting upwards.
If the lagged shelter data is eliminated from the CPI calculation, effectively making its impact zero (instead of an actual negative reading), the annual growth rate of the headline CPI reported in the media would be +1.1% in September. , not the official figure of +2.4% year-on-year. Moreover, if the EU inflation methodology (Harmonized Index of Consumer Prices – HICP) was used, the rate would be +1.6%! In both cases, inflation appears to be below the Fed’s 2% target. We expect headline CPI to continue to catch up and fall below the 2% target over the next six months, an almost guaranteed outcome due to lagging rent data. We also believe that deflation will become a problem by mid-2025.
Mixed news
Aggregate data such as GDP and retail sales continue to point to a growing economy. The Atlanta Fed’s GDP estimate for the third quarter (ended September 30) is a solid 3.4%. This is quite a strong result at this late stage of the business cycle, and perhaps the elusive “soft landing” of the economy will indeed occur. However, there are concerns, especially in the private sector. As we noted in our last blog, while non-farm payrolls were +254k in September, the government added +785k, leaving the private sector with a net loss of -531k. In fact, raw (not seasonally adjusted) jobs data was actually the weakest September since 2019; despite this, the number is seasonally adjusted by +254 thousand. it was the best in six months!
- Industrial production fell by -0.3% in September and shows a year-on-year increase of -0.6%. Capacity utilization is also falling, which means that investment in machinery and equipment (capital expenditure in economic jargon), an important contribution to GDP, is not needed.
Industrial production
Universal value advisors
- Although September retail sales data looked good (+0.4% compared to August), this was the result of a very generous seasonal adjustment factor. Raw, non-seasonally adjusted September retail sales figures generally show a -7.5% decline from August, the worst September since 2019. Normal, non-seasonally adjusted September data generally show a -6.0% decline from August (whose numbers are boosted by Back to School Shopping). Using prior seasonal factors for September would mean that the seasonally adjusted September number would be between 0.0% and -0.2%, not +0.4%!
- All major banks posted solid profits, but the improvement was driven by returns from financial markets. Provisions for loan losses, an indicator of small business health, were $8.9 billion in the third quarter, up from $5.8 billion a year earlier. Over the last four quarters, they amounted to $33.6 billion. A year ago the figure was $27.8 billion and two years ago it was $9.1 billion. These data show that small businesses have started to struggle.
- In their third-quarter reports, Costco, PepsiCo, Conagra, Citigroup and FedEx said consumers have become price conscious and are holding off on spending.
- Luxury goods suppliers Louis Vuitton (LVMH) and Ferragamo reported sales declines of -3% and -7%, respectively, in the third quarter. Says something about the consumer!
- Even though the Fed is now in easing mode, housing starts declined in September (-0.5% compared to August), with all of the decline in rebuilt multifamily space (-9.4%). (The number of single-family investment starts actually increased by +2.7%). Significantly, building permits, a leading indicator of future work starts, fell 2.9% in September compared to August levels.
NFIB Small Business Confidence Index
Real investment advice
- As many politicians have noted, small business is the heart and soul of the American economy. Note the current low Small Business Confidence Index shown in the chart above.
- While consumer spending appears solid, many small businesses are not seeing an increase in demand. If sales expectations continue to weaken, it could signal an emerging slowdown in economic activity among smaller businesses (those that drive job creation).
- In fact, capital expenditures are holding steady, indicating that companies do not expect sales to increase significantly in the near future. As a result, the number of new orders from manufacturers is not increasing.
Manufacturers: New orders
Universal value advisors
Existing home sales
Universal value advisors
- One of the important factors of economic growth is the housing sector. Not only were the latest new home sales figures (in August) down -4.7%, but existing home sales were down -2.5% in August, down -4.2% from a year ago.
So while aggregate data such as GDP and retail sales are positive, there appear to be problems lurking beneath the surface.
Final thoughts
Economic growth appears to be dependent on large federal, state, and local government deficits. This cannot last long, as bond advocates will soon begin to raise interest rates on Treasury and/or state/local bond issues; in fact, it looks like the recent rise in yields may be a start.
While nominal retail sales increased, real retail sales did not increase. The industrial sector is not growing, home sales are declining, and business investment in machinery and equipment has stagnated.
Inflation appears to have been defeated, although this cannot be determined based on the Fed’s current behavior. If the Bureau of Labor Statistics had used current rather than lagged shelter costs, September headline inflation would have been +1.1%. And if the United States had used the European HICP method to calculate inflation, the September year-on-year inflation reading would have been 1.6%!
The U.S. manufacturing economy continues to be in recession, with the industrial production index declining for nine of the last 17 months. Production levels in September are below January 2023 levels, meaning almost two years without growth.
Housing is a very important factor influencing GDP. Housing starts and home sales are down from 2023 levels.
The recession hasn’t set in yet, but it’s pretty obvious that the economy is slowing down!
(Joshua Barone and Eugene Hoover contributed to this blog.)
