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A Strapped Consumer = A Slowing Economy

Rampant CRE Foreclosures Portend Something More Sinister

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

It appears that concerns over incoming economic data have begun to replace momentum in the equities markets while bond yields appear to be fixated on hawkish talk from FOMC speakers. The 10-Yr. Treasury rose 11 basis points (to 4.47%) over the last eight business days.

America’s Strapped Consumer

The theme emerging from the incoming data is that the effects of higher interest rates, higher prices (inflation) and lagging wage growth appears to have caught up with America’s consumers.

The chart below breaks down CPI into three components: shelter, auto insurance, and “other.” As shown therein, inflation in the “other” category dominated in 2021 and 2022. But in today’s economy, the vast majority of the current inflation consists of shelter cost inflation and rising prices in the auto insurance industry. Without those two elements, inflation for everything else is now less than 1%.

As we have discussed ad nauseum in our past blogs, the shelter component of the CPI, with its 35% weight, uses lagged shelter cost data. The chart below shows a truer picture of shelter costs and is why we have maintained our view that the inflation genie has been put back into the bottle. Note that rents are down -0.8% for the 12 months ended in April. That’s a far cry from the shelter cost in the CPI in the chart above, and is why we are confident that inflation is on the wane.

Comments from the Q1 earnings reports from major retailers indicate that consumer spending has begun to slow and backs up our inflation view.

  • WMT: [Consumers are] “spending more of their paychecks on non-discretionary categories and less on general merchandise.”
  • TGT: Lowering prices on 5,000 basic goods as “inflation sends customers scrounging for deals.”
  • PEP: “The lower income consumer in the U.S. is stretched.”
  • MCD: “Consumers continue to be even more discriminating.”
  • SBUX: “A deteriorating economic outlook has weighted on consumer traffic; we continue to feel the impact of a more cautious consumer.”
  • HD: “…homeowners continue to take on smaller projects.”

Unfortunately, the decision makers at this particular Fed apparently base their policy decisions on lagging, not leading, indicators. It is our view that, even if they began to ease policy (lower interest rates) at its upcoming June meeting, they would still be late to the game (but, better late than later).

Other Incoming Data

  • The leading indicators have been negative since mid-2022. Their track record in forecasting Recessions, especially with this span of negative readings, is stellar (see chart).
  • After spending down something economists called “excess savings” (the cash gifts from Uncle Sam during the early pandemic period), consumers appear to have little left to continue their spending spree. We have several indicators of this:
    • Retail sales flatlined in April (-0.3% in real, after inflation, terms);
    • Credit card, auto loan, and even mortgage loan delinquencies are rising rapidly.
  • There has been a spike in mortgage refinance activity (+7.4% the week of May 17th and up +21.2% from a year earlier. This is a sign that the consumer has run out of his/her ability to deal with incoming bills (as indicated by the rise in delinquencies). Who would be refinancing their home at mortgage rates above 7% unless they had to?
  • Housing, a large contributor to GDP and economic activity in general, appears to be succumbing to the Fed’s higher interest rates.
  • New home sales in April were off -7.7% from a year earlier, and down -4.7% from their March levels (clearly the downtrend is accelerating). Builders have found themselves with excess inventories (9.1 months’ supply at current sales levels, the highest level since November ’22). The result has been the much awaited first fall in new home prices.

“The builders are frantically discounting their models, with median new home prices dropping -1.4% MoM and having declined in two of the past three months, while average prices receded over -4% in each of the last four months and are now virtually flat compared to year-ago levels.” (David Rosenberg, Breakfast With Dave, May 24, 2024)

  • We saw Q1’s GDP fall to +1.6% growth in Q1 from Q4’s 3.4%. Given the incoming data, Q2’s is likely to be even weaker. Forecasts from Regional Federal Reserve banks have pared back their Q2 GDP forecasts:
    • St. Louis: To 1.5% from 2.4%
    • New York: To 1.9% from 2.2%
    • Atlanta (always the outlier): To 3.6% from 4.2%

More on CRE

Foreclosures on Commercial Real Estate (CRE) have continued. Four recent ones are shown here:

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

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

Final Thoughts

The equity market appears to be turning its attention to incoming economic data. This week, the Nasdaq advanced +1.4% on the shoulders of the huge Nvidia beat (both top and bottom lines) closing at another new all-time high on Friday (May 24th). But the S&P 500 was flat for the week, and the Dow Industrials took heat, falling -2.3% (-1.5% on Wednesday alone), now more than 900 points below the 40,000 closing level achieved just a short week ago.

It isn’t a wonder to us why the markets appear to be softening (absent the AI theme). The consumer (70% of GDP) appears to be strapped, now borrowing on credit card lines, and even looking to home loan refis (apparently a 7% mortgage rate is cheaper than 22%+ on credit card debt) to keep their heads above water. Rising delinquencies is another sign of the consumers’ plight.

Then we have comments from nearly all the major retailers in their Q1 earnings calls. Those comments have made it clear that consumers have tightened their purse strings.

Housing has always been a good barometer of the state of the economy. It appears to have hit a snag. New home sales are down nearly -8% from last year and new home inventories have skyrocketed. The result is the long awaited first fall in new home prices. If the Fed would wake up and lower interest rates, perhaps more existing home inventory would hit the market and cause a similar reaction in existing home pricing.

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

Robert Barone, Ph.D.

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

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