It was a quiet week in the financial markets with the major indexes up about 1% (the small cap Russell 2000 was up almost 2%). No market moving news, so the markets crawled higher. Both the S&P 500 and the DJIA closed at record highs on Friday with the Nasdaq and Russell 2000 within striking distance of such. The table shows the weekly and year-to-date changes for those indexes.
The Magnificent 7 finished flat for the week, almost as if participants have lost interest. The table shows that five of the seven closed the week with minor losses and two had minor gains. It felt like August when most traders are on vacation.
Bond-land was equally quiescent. For the week, the 10-Year Treasury Yield was basically unchanged, falling two basis points, from 4.10% on Friday October 11th to close at 4.08% on Friday (October 18th).
The Economy
A “soft-landing” for the economy has now become the view of most economists and forecasters. That’s because the aggregated data has continued to show expansion (the Atlanta Fed’s GDP estimate for Q3 (ended September 30th) sits at a 3.4% Annual Rate). And the headline employment number and recent Retail Sales data confirm that view. However, a look at the private sector tells a different story:
- While nominal Retail Sales are rising, real Retail Sales (adjusted for inflation) haven’t grown.
- Industrial Production has been flat.
- Existing Home Sales are not growing, and new home sales are down from a year earlier.
- In addition, business investment has been flat all year.
What has supported the economy is government spending, not only Federal but also state and local. In a recent piece from Rosenberg Research entitled “Big Government Delivers Big Growth – But It Is a Façade,” the author discusses the low (no) growth in the private sector indicating that growth has been fueled by excessively large federal and state & local government spending. The Federal government’s deficit/GDP ratio in fiscal year 2024 was more than 6%.
To put a 6%+ budget deficit-to-GDP ratio into perspective, the United States, over the past seven decades, never once ran up such a bill until the Great Recession in 2009. Even in recessions, the typical amount of stimulus rarely took the deficit ratio much above 3%, and today, in an economic expansion, it is running more than double that figure…The deficit has become institutionalized…as in only one year since the 2020 crisis (2022 when it was 5.4%) has the federal government managed to bring the deficit below 6% of GDP. (Rosenberg 10-16-24)
Is it any wonder that we’ve had a nasty bout of inflation?
Inflation
Speaking of inflation, in past blogs, we have discussed the Bureau of Labor Statistics’ (BLS) use of lagged rent data in its CPI calculations. We’ve shown the graphs below several times.
These show an up-to-date reading for rents, indicating that they are stable/falling, not rising, thus indicating that the current CPI is biased to the high side.
If the lagged shelter data is eliminated from the CPI calculation, in effect making its impact zero (instead of its actual negative reading), the annual growth rate of the headline CPI, the number the media reports, would have been +1.1% in September, not the +2.4% year/year official number. Furthermore, if the inflation methodology of the European Union were used (Harmonized Index of Consumer Prices – HICP), the rate would be +1.6%! In either case, inflation appears to be below the Fed’s 2% target. And we expect that the headline CPI will continue to “catch-down” to below that 2% target over the next six months, nearly a guaranteed result due to the lagged rent data. We are also of the opinion that deflation will become an issue by mid-year in 2025.
Mixed Messages
The aggregated data, like GDP and Retail Sales, continue to show an expanding economy. The Atlanta Fed’s GDP estimate for Q3 (ended September 30) is a robust 3.4%. That’s quite strong this late in the business cycle, and, perhaps, the elusive “soft-landing” for the economy will actually occur. But there are emerging concerns, especially in the private sector. As noted in our last blog, while the Non-Farm Payroll number was +254K in September, government added +785K, leaving a net loss of -531K in the private sector. In fact, the raw (not seasonally adjusted) payroll number was actually the weakest September since 2019; yet the +254K seasonally adjusted number was the best in six months!
- Industrial Production fell -0.3% in September and is showing up as -0.6% on a year/year basis. Capacity Utilization is also down which implies that investment in plant and equipment (capex in economic parlance), an important input into GDP, is not needed.
- While the Retail Sales numbers looked strong in September (+0.4% versus August), that was the result of a very generous seasonal adjustment factor. The raw, not seasonally adjusted, data for September Retail Sales showed a -7.5% decline from August, the worst September showing since 2019. Normal not seasonally adjusted data for September generally shows a -6.0% decline from August (whose numbers are boosted by “Back-to School” buying). Using past seasonal factors for September would put the seasonally adjusted September number somewhere in the 0.0% to -0.2% range, not +0.4%!
- The large banks all reported solid earnings, but the improvement came from financial market returns. Loan Loss Provisions, an indicator of the health of small businesses, were $8.9 billion in Q3, up from $5.8 billion a year ago. For the trailing four quarters, they were $33.6 billion. A year ago, this number was $27.8 billion, and it was $9.1 billion two years ago. It appears from this data that small businesses have begun to struggle.
- In their Q3 reports, Costco, PepsiCo, Conagra, Citigroup, and FedEx all commented that consumers have become price conscious and are pulling back on their spending.
- Luxury Goods purveyors Louis Vuitton (LVMH) and Ferragamo reported sales declines of -3% and -7% respectively for Q3. Says something about the Consumer!
- Despite a Fed now in easing mode, Housing Starts fell in September (-0.5% versus August), with all the decline concentrated in the overbuilt Multi-Family space (-9.4%). (Single-Family starts actually rose +2.7%). Also pertinent, building permits, the leading indicator for future starts, were off -2.9% in September from August levels.
- As noted by many politicians, small business is the heart and soul of the U.S. economy. Note the current low level of the Small Business Confidence Index shown in the chart above.
- While consumer spending appears robust, many small businesses are not seeing demand growth. If sales expectations continue to weaken, that could signal an emerging slowdown in economic activity among smaller businesses (the businesses that drive job creation).
- In fact, capex spending is flat, indicating that businesses don’t expect to grow their sales by very much in the near-term. As a result, Manufacturers’ New Orders are not growing.
- One important contributor to economic growth is the housing sector. Not only were the latest new home sales (August) numbers down -4.7%, but existing home sales fell -2.5% in August and are down -4.2% from a year earlier.
So, while the aggregated data like GDP and Retail Sales are showing up on the positive side, there appears to be trouble brewing beneath the surface.
Final Thoughts
The economy’s growth appears to be dependent on large federal and state and local government deficits. That can’t last, as the bond vigilantes will soon begin to raise rates on Treasury and/or state/local bond issues; in fact, it appears that the latest uptick in yields may be the beginning.
While nominal Retail Sales are up, Real Retail Sales haven’t grown. The Industrial sector isn’t growing, home sales are down, and business investment in plant and equipment has stagnated.
Inflation appears to have been vanquished, although you wouldn’t know that from current Fed behavior. If the Bureau of Labor Statistics used current instead of lagged shelter costs, September’s headline inflation would have been +1.1%. And, if the U.S. used the European HICP method in calculating inflation, September’s year over year inflation reading would have been 1.6%!
The U.S. Industrial Economy continues to be in Recession with the Industrial Production Index falling in nine of the last 17 months. September’s output level sits below that of January 2023, nearly two years without growth.
Housing is a very important input into GDP. Housing starts and home sales are down from 2023 levels.
A Recession hasn’t yet appeared, but it is quite evident that the economy is slowing!
(Joshua Barone and Eugene Hoover contributed to this blog.)