Podcast Episode 465

by | Dec 15, 2023 | Podcasts

Podcast Episode 465

Economic Data – December 2023 – Are you ready to dissect the economy’s vital signs?

In this podcast, episode #465, we take you on a deep dive into the economy’s pulse.  We examine economic indicators that shape the current landscape. The recent Federal Reserve announcement has caused a shift in the market, signaling the end of their interest rate hike cycle. We discuss the inverted yield curve, housing starts, car sales, and the sudden surge in excavator equipment sales. Peek into the construction industry’s health through this unexpected indicator and gain insights into the future economic outlook.

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Podcast Episode 465 Transcript

Welcome back to the podcast. This is podcast episode 465.

In this week’s episode, I run through a data smorgasbord, a literal avalanche of data points that I think are worth sharing. We’ve had a very good week in the market. We’re recording this December 15th 2023. Today is a triple-witching option exploration, but besides all of that, we had some news from the Federal Reserve. It appears that they have completed their interest rate hike cycle. The market has taken that to believe that the Fed will immediately start cutting rates. We are not so sure, but regardless, if the Fed is done raising rates, that is another plus in the plus column for markets and interest rates overall.

Thanks for listening to our podcast and let’s get to the data.

Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.

Welcome back to the podcast. This is Tom Mullooly. We are recording this on December 15th, 2023.

It seems like most of Wall Street has finally come to accept the idea that the Fed has navigated a soft landing in the economy. There were many people holding out, just not believing that the Fed could actually stick the landing. It appeared that we were going to have high inflation. As a way to combat that, the Fed was going to raise interest rates, and they raised them aggressively.

And when you raise rates aggressively, according to everybody’s college economics textbook, you’re going to have what they call a hard landing or a severe economic slowdown, recession problems, whatever you want to call it. The Fed has, or what seems to be now, people accepting the thought that the Fed was able to raise rates aggressively.

The economy has continued to grow, but we’re avoiding a recession. So we are in a situation now, as we approach the end of 2023, where we have inflation cooling off. We have lower inflation, but not deflation. We have what they termed in the 80s as disinflation, where inflation is slowing down, but not to the point where we have deflation. So we have cooling inflation. We have an economy that is cooling off, but it’s not receding, so we are not heading into a recession.

We have been saying this for at least a year, and now, after the Fed meeting this week here in mid-December 2023, it is indicated by the Federal Reserve that they have completed their rate hikes. At least for the present time, it does not look like the Fed is going to be raising rates. In fact, there was a lot of discussion about the Fed possibly cutting interest rates in 2024.

We’re going to withhold judgment on that.

The market seems to believe that the Fed is going to pivot immediately from raising rates, as they did in 2022 and 2023, to immediately lowering rates. I don’t believe that is necessary. You need to cut rates when the economy is slowing down. We will see some slowing in the economy, but I don’t think it will be enough to trigger the kind of rate cuts that many on Wall Street are looking for.

I want to go through some data points that I think are important. When we are in a recession, it is usually preceded by an inverted yield curve. An inverted yield curve does not necessarily indicate that we will go into a recession. It just happens that when we do go into a recession, if you look back a year prior, you’re going to see an inverted yield curve.

The yield curve is still inverted today. That scenario has not dissipated at all.

Additionally, the Purchasing Managers Index historically, a number above 50 indicates expansion. A number below 50 indicates recession or a slowing economy. The Purchasing Managers Index is still below 50, but it has done this in even some very strong expansions that we’ve seen over the years. The Purchasing Managers report is not the best indicator when it comes to expansion or recession.

Let’s move on to housing starts. In October, the housing starts were 1.37 million. October 2023 permits to build new houses. So an indication of what’s happening in the future: 1.48 million new permits for new housing construction. Understand – this is good. It’s good to see that 1.37 million houses were started in terms of construction and permits for even more new houses were applied for.

But the number we need to see to meet the long-term demographics is somewhere between 1.6 and 1.8 million housing starts per month. So we’re still below where we really need to be to have a sustainable expansion.

Let’s look at car sales. Vehicle sales are still holding up, just a little shy of 16 million cars sold. That’s still a very good number, not as high as what we saw 15 years ago in 2004, 2005, and 2006. In 2008 and 2009, vehicle sales got down to about 9 million. They did recover pretty smartly in 2015, 2016, and 2017 to that 17 million number. So we’re a little shy of that, but still a healthy number when it comes to that.

Another data point: the Institute for Supply Management comes out every month with their ISM Purchasing Managers Report. This is an index that technically runs between zero and a hundred. It’s never gotten below 35. It’s never gotten above 70. The November number was at 52.7.

Why is this important? The Institute for Supply Management measures the Purchasing Managers Report from service companies. Services represent 89% of the US economy. Most of the economy – and 91% of non-farm jobs – are in services. So when we see a number above 50, that indicates expansion. That’s good.

Here’s another data point that I’ve shared with many people over the last few months: sales of excavator equipment. You know, this heavy equipment that they use for construction. Excavator sales have surged to a record. This was reported in The Wall Street Journal recently, indicating a boom in construction, and construction employment is at a record high.

These are very good indicators. We don’t have recessions when people are buying front-end loaders and heavy construction equipment.

So let’s move on to personal income, spending, and savings, the consumer side of the equation.

Disposable personal income is up year over year almost 8%. It’s up 7.9%. Personal outlays, or spending, is up 7.6%. So not only is spending up, but incomes are up a little more. That’s very good.

Let’s talk about jobs. Net new job formation is starting to slow down, we saw in the most recent report. We saw 199,000 net new jobs in the November report. But we’re also seeing average hourly earnings on a year-over-year basis up 4%. What we’re starting to see is that when we have net new jobs being formed, a net positive number, people will normally equate that to being inflationary.

But what helps support that? We see gross domestic product (GDP), that’s the measure of the growth in the economy, that is also up at the same time. So we’re seeing a low unemployment rate. I mean, we’re near historic lows. We’re at 3.7% on the unemployment rate.

GDP continues to grow, jobs continue to be formed, so we are seeing some productivity gains that are partially offsetting wage gains. Another point that I think is worth mentioning on top of this is that the excess demand for labor is really showing a different picture now.

If we go back to just post-COVID, say a year and a half or two years ago, at one point there were 11 million jobs that were unfilled and there were something like three or four million people looking for work. That number, that gap, is really starting to shrink. The excess demand for labor, take a look at this, there are now 8.7 million job openings.

Still a lot of jobs that are open and people are looking to hire. There are 6.3 million job seekers now back on the market and people are looking for work. So that gap is really starting to shrink.

The labor force participation rate is at 62.8%. I don’t think we ever get back to numbers that we saw 20 and 30 years ago, where the labor force participation rate was at 66, peaked at 67%. But 62.8% is still a long way from where we were during COVID, where we were at 60%. So things are starting to pick up.

There was a great headline in The Wall Street Journal, and I really believe this. This was an article that was written on October 8th, 2023, in The Wall Street Journal. I’ll just read you the headline: “The US economy’s secret weapon: seniors with money to spend.” This is so true. More and more people are retiring every day. They have income. They have money and they’re willing to spend it, which is great.

When we look at things like consumer spending out there, I want to talk about some historic yardsticks. That kind of helps put things in perspective. If you were to break all of the consumers by income into quintiles, that’s five different chunks of 20%, the lowest 20% of folks spend way more than their income.

That number has not changed in 60 years.

The second 20%, so these are people with an average income of $32,768, also spend more than they bring in. The third quintile, now we’re talking about the bottom 60% of income earners. If you’re in the third quintile, you have an average income of roughly $56,000. You are still spending more than you’re bringing in, so you are carrying some debt.

It’s not until we get to the fourth quintile. So these are people in the 60 to 80 percent range. These are people with an average income of ninety-three thousand dollars. These people spend exactly what they bring in. So that’s pretty close.

These numbers match what we’ve seen in the previous decade, in the 90s, in the 80s, even in the 70s. These percentages do not change. It’s not until you get to the top quintile, the top 20% of earners. These are people who have an average income of over $218,000 a year.

These are people who are saving far more than they are bringing in. They can’t spend enough. The bottom three quintiles, so the bottom sixty percent of earners, are spending more than they bring in. That is a tale as old as time. This just doesn’t seem to change.

The reason why I bring this up is that we’re starting to see the money supply shrink. The money supply used to match the monetary base until we reached COVID when the government decided it was in everybody’s best interest to send money. Instead of sending it directly to the banks, they sent it directly to individuals, and so M2, as a measure of money supply, exploded like we have never seen before.

That number, M2, is now shrinking. Money is coming out of circulation with rate hikes and with quantitative tightening, but we still have a long way to go, and so there’s still a lot of money sloshing around out there in the system.

I’m also going to add something, just as a point of consumer sentiment. This was a headline from The New York Times just a few weeks ago, on November 22nd, 2023. This is a headline from The New York Times: “Americans say the economy is bad. Their spending begs to differ,” and this is what is actually happening on the ground level.

The New York Times, in my opinion, rarely gets things right. This time they were right on the money, and so we are seeing that individuals are spending money, they have money, but yet they will all say that the economy is very bad.

Let’s take a look at the stock market and earnings, something that I want to point out to folks. I’ve mentioned this in several phone calls with clients. Over the last 85 years, earnings growth has ranged between an increase of 5% and an increase of 7% per year. When we talk about earnings fluctuating, we had a period of time in the late 1930s and then in the late 1940s where the growth in reported earnings per share dropped below 5%.

Once we reached 1946, earnings went up, and in fact, in 1947 we saw earnings at a number far above 7%, but for the most part, from the late ’40s moving forward. So, we’re talking now about the last 70 years. There have only been two times where we’ve seen earnings growth. This is the S&P reported earnings per share growth.

We’ve only seen two times where earnings dipped below an increase of 5% per year. Earnings and interest rates drive stock prices. Earnings were less than 5% in 1991, as we were coming off a recession. They were below 5% again in 2002, during another recession.

In 2008, the earnings per share growth got down to 5%, but it didn’t go below that. In 2020, during COVID, earnings growth got down to 5%, but again it did not go below 5%, and so we’re going to see earnings fluctuate between an increase of 5% and an increase of 7%. Anything above or below that is really extraordinary. We’re going to have earnings growth. That is how capitalism works.

Just know that there won’t be that many surprises, even though CNBC will tell you otherwise.

Let’s take a look at the Consumer Price Index. I think this is very important. The monthly annualized number is now at 1.2%. Now, this is different than what’s being reported, and I think it’s worth spending a minute to talk about this.

When you take the Consumer Price Index on a monthly basis, the monthly rate of change, and do that on a year-over-year basis, we’re now seeing the rate of inflation down, using that as your yardstick, at 1.2%. So, things are really starting to slow down.

In fact, the CEO of Walmart, Doug McMillan, was quoted in The Wall Street Journal on November 17th, just a few weeks ago, saying we may be managing through a period of deflation in the months to come. The headline on the article was “Retailers See Price Increases Ebbing.” His quote was, “We may be managing through a period of deflation in the months to come.”

Now, he just said this a few weeks ago, and while that “would put more unit pressure on us, we welcome it – because it’s better for our customers.” Again, that was the CEO of Walmart, Doug McMillan. In fact, that day he was also on CNBC saying the exact same thing: Walmart would need to further reduce expenses as prices fall further, so they’re losing some of the margin.

That is not a comment on Walmart, nor is it a recommendation to buy or sell. It’s a comment on what’s happening, what Walmart, the biggest retailer out there, is seeing on the ground floor. Prices are starting to come down. That’s better for the consumer.

Let’s also talk about rent. As rent rises cool off, so will inflation, something a lot of people forget. Whether it’s owner-occupied rent equivalent, meaning your mortgage payment, or your monthly rent, as rent increases rise or fall, that is going to drive inflation. Why?

Because rent or owner-occupied equivalent rent is 31% of the formula that goes into calculating the rate of inflation. A big part of why is because rent increases have been slowing down. Shelter costs, which account for about 31% of the Labor Department’s measure of core spending, have been playing a large role in the decline in core inflation.

This is so important to understand. There’s a long lag when you look at mortgage payments and rent payments. First of all, with many people owning or carrying a mortgage that’s below 4%, people are reluctant to move. So there’s less inventory out there for people to buy and initiate new mortgage payments at 6% or 7%.

Additionally, when you’re talking about leases on rentals, that has a very long lag factor. It takes a long time. Someone may have leased and had it for several years where their contract was tied up. Now it’s finally starting to come to an end.

Shelter in particular has a long way to drop. We saw in the beginning of this year, rent increases averaging 8% in late in the fourth quarter of last year and the beginning of the first quarter of this year. Now we’re seeing rent leases getting rolled over at a number closer to 6.5%.

The average historical rate is somewhere between 3% and 4%, so we are starting to finally see shelter costs coming down. That’s very important as it will have a huge impact on inflation going forward.

We see a lot of positive reasons why we’re going to see inflation continuing to slow down.

We also got news this week that the Fed has now finally decided that they’re going to stop raising rates. As I mentioned earlier in the episode, I do not believe that the Fed is going to necessarily be in a hurry to lower interest rates.

Markets don’t like rate increases, or when the Fed is being aggressive in terms of taking a hawkish stance and saying that they need to raise rates. Of course, lower rates will give the stock market some juice to move. But let’s not get too excited out there.

That’s going to wrap up this week’s message for the podcast. Thanks again for tuning in. Catch you again on the next episode.

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