Yesterday I wrote http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2016/08/01/what-me-worry/ that the combination of slower GDP growth (1.2%) in the second quarter plus declining consumer sentiment worried me. Continued strong consumer spending–household consumption grew at a 4.2% rate–in the quarter added 2.8 percentage points to GDP growth in the period. In other words without the consumer stepping up big, growth in the quarter would have been negative.
Today more grist for the ol’ worry mill.
Consumer purchases rose 0.4% in June, according to a report from the Commerce Department this morning. That was ahead of the 0.3% increase forecast by economists surveyed by Bloomberg. The 0.4% gain in June followed a 0.4% increase in consumer spending in May.
That’s all good news.
It’s the implications for continued consumer spending in this morning’s income figures that concerns me. Incomes rose by a lower than expected 0.2% in June. And, no, your math isn’t crazy: Consumers spent more by putting less into savings. The savings rate dropped to 5.3% from 5.5%. That takes the savings rate to the lowest level sine March 2015.
Nothing here to indicate the immediate end of the world–for U.S. savers a 5.3% savings rate is very healthy. But consumers won’t dip into savings to fuel consumption indefinitely. It would be great news for the economy if business spending picked up and took up some of the burden now carried by consumers. Given forecasts for global growth, however, that seems unlikely in the near term.
Am I the only one who finds Friday’s GDP report of 1.2% annualized growth worrying? Especially when combined with a drop in consumer sentiment?
What’s bothering me?
The deeply disappointing second quarter GDP number was only as good as it was because consumers kept up a spending binge. Think what second quarter GDP growth would have looked like if household consumption, about 70% of U.S. economic activity, had’ t grown at a 4.2% annualized rate in the quarter. The largest increase in household consumption since the end of 2014 added 2.8 percentage points to GDP growth.
In other words without this growth in household consumption, GDP growth in the second quarter would have been negative. Not surprising since businesses continue to pull back on their spending. Spending by companies on equipment, structures and intellectual property, decreased by an annualized 2.2%. That follows on a 3.4% drop in the first quarter. Spending on equipment has now tumbled for four of the last five quarters.
You really can’t blame companies for not wanting to spend. From where they sit it’s hard to justify spending on expanding production. So far in the second quarter earnings season, 363 of the 500 companies in the Standard & Poor’s 500 have reported. On the basis of these results we’re headed for a 3.2% year over year drop in earnings for the quarter. That’s better than Wall Street analysts were expecting at the start of earnings season, but the trend, if it holds up, would still be the fourth consecutive quarter of negative earnings growth. (Revenue is down, so far, by 0.1% year over year.)
The results of the University of Michigan’s survey of consumer sentiment added some caveats to that strength in household spending. While consumers remain confident about the current economy, their attitude about the future is turning increasingly negative. The gap between positive attitudes toward the present economy and darker future expectations is the widest since 2006. The gap, which has, sometimes, signaled a coming recession, is a relatively strong indicator of the strength of future consumer spending. People tend to spend less, for obvious reasons, when they are less confident about the future than they do about the present economy.
Given that consumer spending is about all that is propping up GDP growth right now, I find this picture troubling.
I’d find it less troubling, however, if I saw signs that other investors and traders were worried about this picture.
But I don’t see a sign of worry anywhere on the horizon.
The CBOE VIX index, which reflects fear/complacency in the stock market based on how much traders and investors are willing to pay for options to hedge risk in the S&P 500, is way, way, way toward the complacent end of the scale. The VIX closed at 11.87 on Friday, down another 6.7%, and much closer to the 10.88 that marks the 52-week low on the VIX than to the 53.29 52-week high.
Technicians that I respect and follow, such as Jim Stack at InvesTech (https://www.investech.com) aren’t seeing warning signs from their indicators either. Yes, the market is over-valued on a PE basis, but momentum indicators point to a continued extension of this bull market rally.
Markets are often said to climb a wall of worry.
Right now I can’t find a molehill of worry let alone a wall.
My family and I move every 20 years or so whether we need to or not, so on Wednesday when the Fed was making its decision to keep interest rates right where they are, I was busy unpacking all the boxes that we’d packed on Tuesday. (I’m sooo looking forward to the day when you can digitize everything you own, upload it all, and then download to your new location. I’d definitely pay $1.99 for an app that did that.)
Anyway, with the benefit of hindsight–and moving- induced exhaustion–I have to say that the nothing that Fed did on Wednesday was actually extremely important as an indicator on a potential September interest rate increase.
While it did nothing on Wednesday to change interest rates, the U.S. central bank said quite a lot about the U.S. economy. The economy, the Fed said, had overcome uncertainties to achieve what looks like a sustainable moderate rate of growth. Job growth has pushed the economy to something close to full employment. And, the Fed added, it sees fewer clouds on the horizon for the U.S. economy.
This isn’t a formula that guarantees an interest rate increase when the Fed next meets on September 21, but this language does clear the way for a possible interest rate increase.
The problem facing the Fed, though, remains the same: After all the stimulus that the Fed has provided for the U.S. economy, where’s the growth?
Inflation is well below the Fed’s target of 2%. The economy shows no signs of breaking out of its low growth rut. Maybe Friday’s first read on second quarter GDP growth will come in at the 2.6% rate that economists were expecting last week, but current forecasts are looking for growth closer to 1.8%, and that would still leave the U.S. economy looking back at growth of less than 2% for the first and second quarters of 2016 and the last quarter of 2015.
Maybe, the Fed has to be wondering now, the speed limit on the U.S. economy has been lowered to 2% instead of 3%. Maybe current growth is about as good as this economy–domestic and global–can deliver. And if that’s the case, what’s the point, exactly, of raising interest rates? To make sure that growth stays well below 3%? To head off nonexistent inflation?
In these circumstances and with this data, the Fed is being asked to figure out not just what is happening but why. Are we in for a long period of slow economic growth because something has changed in the US. and global economy?
The Fed would like to know.
I’m sure investors would like to figure out an answer too–since the answer has major implications for portfolio design and risk taking.
At the moment the Fed funds futures market hasn’t raised the odds for a September move beyond the 18% or so of the days before the Fed meeting.
Second quarter earnings results announced this morning by JPMorgan Chase (JPM) held solidly good news for the U.S. economy. Not as much good news for the bank and the banking sector in general, though. JPMorgan Chase is the first of the big banks to report with Citigroup (C) and Wells Fargo (WFC) on deck tomorrow.
Loans of all kinds extended by JPMorgan Chase rose $106 billion from the second quarter of 2015. That’s a 16% increase. “We had broad-based demand for loans pretty much across categories, whether it was auto, business banking, cards, so I would say that speaks well for the U.S. economy and the consumer in particular,” Chief Financial Officer Marianne Lake said.
Figuring out how the bank itself did in the quarter is harder. As reported earnings were $1.55 a share, up from $1.54 a share in the second quarter of 2015, and ahead of the $1.43 a share estimated by analysts. (Net income was down year to year from $6.29 billion in 2015 to $6.2 billion on a lower share count because of share buybacks.)
But that as reported earnings figure included all kinds of one-time charges and credits including an accounting gain and a legal benefit plus a gain from the sale of the bank’s stake in Visa Europe and a loss on the bank’s investment in Square. Adjusting for all those one-time gains and losses earnings came to $1.50 a share, down from $1.54 in the second quarter of 2015 but still above Wall Street estimates of $1.43 a share.
Revenue growth wasn’t as robust as you might expect from growth in the bank’s loan portfolio or those earnings per share figures. Revenue climbed just 2.8% year over year to $25.2 billion powered by a big 35% jump in revenue from fixed income trading. Revenue from equity trading rose just 1.5%.
Earnings grow was so much stronger than revenue growth because JPMorgan Chase continued to cut costs. Non-interest expenses fell 6%. Compensation costs at the corporate and investment bank fell 6% in the first six months of 2016.
I’d look to see if consumer units at Citigroup and at Wells Fargo tomorrow report that same strong picture. (Pay special attention to Wells Fargo’s big mortgage unit.) If consumer lending is as strong tomorrow at those banks as at JPMorgan Chase today that’s good news for the economy as a whole. Make sure to pay special attention to provisions for credit losses. That item rose to $1.4 billion at JPMorgan Chase, an increase of $467 million, from the second quarter of 2015. The bank said that was a result of the increase in the loan portfolio and not a sign of a deterioration in credit quality. See if other banks echo that comment.
The U.S. economy added only a net 38,000 jobs in May, according to the jobs report from the Bureau of Labor Statistics this morning. Economists surveyed by Bloomberg had projected job gains of 90,000 to 215,000 with the median forecast at 160,000.
The details below the shockingly bad headline number made ugly reading. The government statisticians revised the April job gains, already weak at 136,000, down to 123,000. The unemployment rate sank to 4.7% from 5%, but only because more Americans left the workforce. Even noting the one-time effect of the Verizon strike in May–which took 35,000 workers out of the job count–the longer term trend is decidedly soft: The economy has averaged a gain of 116,000 jobs a month for the last 12 months. That’s down from an average of 229,000 in the same period last year.
No wonder that the markets have decided that today’s jobs report takes a June interest rate increase from the Federal Reserve almost completely off the table. Odds of a June move, based on prices in the Fed funds futures market, fell back to just 4% from 22% yesterday. (The odds of a June increase were at 4% before the release of the Fed minutes for April and a series of speeches from Fed officials designed to stress the Fed’s intention to raise interest rates sooner rather than later.) Odds for a July interest rate increase fell to 31% from 55% yesterday.
Other economic news this morning supported the market’s negative conclusions about the jobs market and U.S. economic growth. The service sector index from the Institute for Supply Management fell in May to 52.9 from 55.7 in April. Anything above 50 signals expansion in the sector but the trend is in the wrong direction. The employment sub-index for the services sector fell for the first time since February.
Some of the restraint in the market’s reaction comes, I think, because investors are figuring out which way to jump. Oil was down as of 1:30–with West Texas Intermediate falling 1.63% to $48.37 and Brent dropping 1.42% to $49.33%–on the theory, I’d speculate, that slower U.S. growth, if confirmed, would mean lower U.S. demand. Yet other commodities moved up on the theory that a delay in any interest rate increase from the Fed would mean a weaker dollar–and commodities priced in dollars go up in nominal terms when the dollar falls. Following on that theory the dollar fell strongly against the euro–to 1.1341–and the yen and dropped 1.3% against the 10 currencies in the Bloomberg Dollar Spot Index.
On the same weak dollar is good theory emerging market assets climbed with the iShares MSCI Emerging Markets ETF (EEM) rising 1.35%–although I think you can make a strong case too for slower U.S. economic growth being bad for the global economy and for growth in commodity prices and developing economies in particular.
Gold climbed 2.39% to $1239.93 an ounce as of 1:30 as some investors sought a safe haven from volatility, but the VIX volatility index (VIX), which measures volatility for the S&P 500 by looking at what prices traders are willing to pay to hedge against volatility has barely moved from recent very low levels. The Vix was up just 0.81% as of 1:30 today.
With so much uncertainty in the market’s reaction to the news it’s hard today to figure out whether to go long or short and in what. Especially because there’s a very good chance that the market’s reaction on Monday, after a weekend of cogitation, will be very different than what it has been today.