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A Weakening Consumer and Other Signs of Economic Stress

Equity markets were subdued this week with the S&P500 and Nasdaq held at bay by a break in the upsurge in the price of Nvidia (NVDA) which, on Thursday and Friday (June 20 and 21) gave back about -6.6% in its price (but still up 155% year to date!).

The table shows the results of the major indexes. Note that the DJIA and the Russell 2000 (small cap) have lagged the other two indexes. This is because the DJIA and Russell are not tech heavy whereas the Nasdaq and S&P500 are. The S&P500 and Nasdaq are also capitalization weighted meaning that larger companies, which, today, are generally tech, have more weight in the indexes. The DJIA is composed of industrial companies. We know from the Industrial Production data that manufacturing is in, or approaching, Recession. And small caps just don’t have the hype that today’s tech (AI) companies do.

Lagged Effect of Rate Hikes

The lagged effects of rate hikes are now appearing. The latest data show a deterioration in Retail Sales, emerging weakness in housing, and issues around banking and Commercial Real Estate (CRE).

On the retail side, same store sales are off -0.2% from a year earlier (see chart above) and are now down in seven of the last eight quarters. While real retail sales grew a meager +0.1% in May, that didn’t make up for the -0.5% fall in April. In addition, real retail sales are flat or down in seven of the last eight months and -1.0% from May ’23. These results shouldn’t have been a surprise. On the Q1 earnings calls, Target, Lowes, Macy’s, Kohl’s, Best Buy, and Foot Locker all showed negative year over year sales comps. (And Walmart, so far this year, has closed nine stores!)

The National Association of Homebuilders (NAHB) Index fell to 43 in June from 45 in May (expectations were for a rise to 46). That index peaked almost a year ago (July ’23) at 56. The sales sub-index for June fell to 47 from 51 in May. Back in March, that sub-index was 62. Worse, the prospective buyer traffic sub-index fell to 28 in June. It was already a lowly 34 back in April. Without people looking (prospective buyers), future sales look bleak. For context, for the two years ended in May ’22, this prospective buyer sub-index averaged 66.5!

Total housing starts, an important contributor to GDP, are down nearly -20% from year earlier levels, and  new building permits are off almost -10% (left side of chart).

This has occurred despite the lack of inventory in the existing home market as most homeowners are locked-in to their homes with 3% mortgage rates and can’t afford to move with new 30-year fixed rates hovering around 7%. Also shown on the right-hand side of the chart is the number of units under construction in the multi-family space. While off its peak, multi-family units under construction are still significant. As these units come online, they will continue to put downward pressure on rents, and we view this as an emerging deflationary force.

Clearly, the fall in housing starts and building permits will slow GDP growth. Apparently, the business cycle is alive and well, and monetary policy, via interest rates, is still an effective tool. In this cycle, it appears that lags have been longer than history would suggest, likely due to the free money gifts during the pandemic and large and continuing budget deficits (>6.5% of GDP).

As noted, we are seeing weaker retail activity and a definite downturn in the new housing market.

The Labor Market

Nearly every labor market indicator, except Non-Farm Payrolls (NFP), has shown weakness. In our last blog, we discussed the falloff in voluntary quits. We have noted that the Household Survey (HS) has shown a loss of more than a million full-time jobs over the past year. The U3 Unemployment Rate has risen from 3.4% to 4.0%. Historically, a 0.5 percentage point rise in U3 has always meant Recession. This rise is now 0.6 percentage points and it looks like it will rise from there. As shown in the chart, both Initial Unemployment Claims and Continuing Claims are on the rise.

Yet, despite the trends, this Fed believes (and has told us as much) that the U3 rate will be 4.0% at year’s end. Given the recent rise in jobless claims and the other weakening economic data that we’ve discussed, in our view, this has a near 0% probability of occurring.

Other Signs of Stress

  • Delinquencies are rising. Not only are the higher risk consumer loan delinquencies (credit card and auto loans) on the rise, but we note that even mortgage loan delinquencies are rising.
  • Sixty-three (63) banks are now on the FDIC’s problem bank list with $517 billion in unrealized losses (up $39 billion in Q1 alone). The unrealized losses on the banks’ balance sheets can be mitigated – all the Fed needs to do is lower rates!
  • A behemoth Japanese bank (Norinchukin, Japan’s fifth largest) has announced that it will be selling $63 billion (i.e., 10 trillion Yen) of its holdings of U.S. and European government bonds over the next nine months (prior to the end of March ’25). With this supply of bonds entering, “higher for longer” will occur by market action alone.
  • And lest we forget, the Commercial Real Estate (CRE) market continues to tank. Below is the display of a bankruptcy auction of a portfolio of apartment complexes in the Seattle/Tacoma market.

Per @TripleNetInvest: “Five years ago, I’d have never thought I’d see commercial real estate distress in the Seattle/Tacoma MSA, but here we are. The once hottest market in the US is feeling the pain and it looks to be just getting started within apartments/multi-family buildings.”

Final Thoughts

The consumer is clearly weakening as shown by flat retail sales and weakness in Q1 sales comps among the retail giants. Consumer loan delinquencies are now rising, not only in the credit card and auto loan areas, which always lead the way in Recessions, but, of much greater concern, in mortgages (shades of ’07?).

High mortgage rates have dramatically lowered the supply of existing homes, and now we see a pullback in new housing activity. The latter will have a significant impact on GDP in Q2 and going forward.

The FDIC’s problem bank list is growing both because of losses on bank bond investments (which the Fed can do something about by lowering rates) and because of rising concerns over bank loan portfolios (which the Fed can’t do much about in the short-run). This is especially true in the Regional and Community banking space because these banks have a significant amount of loans with CRE collateral. Unless the Fed lowers rates soon, we expect to see bank failures.

The U.S. isn’t the only place with banking problems. Japan’s fifth largest bank plans to sell $63 billion of U.S. and European government bonds over the next nine months. That will put upward pressure on interest rates without the Fed lifting a finger.

The Fed has acknowledged the lags in the effectiveness of monetary policy. Given the deterioration now evident in the economic data, one would think that they would have already begun to move to a less restrictive policy. Afterall, rate cuts, like rate hikes, need time to impact economic activity. But, so far, no such sign.

The fact that here have been no rate cuts in this cycle and the Fed is signaling that it is waiting for more data to do so indicates to us that there might be an unwritten and silent agenda. Perhaps they are saving the easing move for a significant break lower in equities. Afterall, financial markets always act positively to lower interest rates.

Robert Barone, Ph.D.

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

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