A little bonus content that I felt compelled to share this morning.
From our internal log:
9/17/2024
While the bulls will cite what retail sales say about the strength of the consumer, when you look at them in real (inflation-adjusted) terms…. well:
“While Retail Sales are up 2.1% y/y, it still isn’t enough to keep up with the impact of inflation. Once you take that into account, Retail Sales have been negative on a y/y basis for seven of the last eight months and 17 of the last 22 months.” –Bespoke
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The following got me thinking about just how unusual and unintuitive the current investment setup is.
I.e., the fact that the ZEW sentiment index is so dire while German equities are a mere 1% off of all time highs, and that US stocks, as another example, sit at all time highs while the Fed is teeing up a 50 bps rate cut is, let’s say, historically unique – and speaks to the risk that current levels may be dangerously removed from fundamental reality: emphasis mine...
“ZEW. Data from ZEW (Zentrum fuer Europaeische Wirtschaftsforschung) showed a dire view of the domestic German economy. A range of other metrics showed unimpressive outlooks for the US and Eurozone, but Germany specifically is the locus of extreme weakness. As shown in the charts at right, the only times when German economic expectations measured in this survey have been worse over the last 20 years were the Global Financial Crisis and the COVID shock. This sort of negative sentiment is notable, and we would usually look to this kind of reading as a contrarian bullish view on the outlook for asset prices if not the German economy itself. But the last two times ZEW economic expectations dropped to their current level (April 2020 and February 2009) the DAX was in a 21% and 53% drawdown respectively. Today, the index is within 1% of all-time highs. As for where the weakness is most acute, ZEW also publishes industry specific indices. These pretty clearly show the drop in sentiment is being driven by industries like steel and autos, both of which plunged dramatically over the last couple of months.” --Bespoke
Of course this doesn’t mean that a waterfall selloff in global equities is close at hand, it simply says that the risk of such may be notably higher than myopic investors realize.
9/16/2024
Cameron Crise speaks precisely to a key aspect of our view that asset prices (equities in particular) are dangerously vulnerable going forward: emphasis mine...
“The great Covid money drop made a significant impact on household cash balances, helping to drive up nominal consumption and by extension, both real growth and inflation. The question of how much excess cash savings remain has been debated throughout this year, with the San Francisco Fed arguing that it has largely been depleted. This commentary took the other side of that debate a few months ago, but confidence in that argument has eroded down to essentially zero.
* While household/nonprofit cash balances as a percentage of GDP remain fairly elevated, as a percentage of net worth cash holdings have completely unwound the Covid bump. Over the past 4+ decades, recessions have often emerged after significant drawdowns in households’ cash allocations, which then need to be rebuilt by selling financial assets and cutting down on consumption.
* In fairness, cash holdings have not hit the extreme lows that preceded the 2001 or GFC recessions, so there is capacity for households to spend further on either consumption or financial assets. Still, that will ultimately just increase the risks of an unfortunate outcome, and so isn’t exactly an unalloyed positive. Meanwhile, with interest rates having been elevated over the past couple of years, it would normally be reasonable to expect that real estate would have declined in importance for consumer wealth. That’s not so, however, as the dearth of supply has kept prices rising as the total stock of mortgages continues to benefit from prior low rates. The upshot is that household real estate equity as a percentage of net worth remains near prior peaks, including that of the infamous pre-GFC housing bubble.
* Now, housing is ordinarily (and famously) an interest-rate sensitive sector, and in usual circumstances you’d expect rate cuts to provide a further boost to house prices and equity. However, there’s reason to think that things may not operate as usual this time around. Because current mortgage rates are so far above the average of the entire housing stock, we won’t see the usual stimulative effect of refinancings that typically accompany Fed easing.
* Moreover, if lower mortgage rates incentivize more people to downsize or move, the associated wall of supply could actually send prices lower. Indeed, my year-ahead preview anticipated just such a development (which admittedly has yet to materialize.) Anyhow, given the heavy weight of real estate in household net worth, any drop in prices would presumably have a knock-on effect to confidence and consumption. This isn’t necessarily a base case for the next few months, but a risk to consider moving forwards.
* Finally, households remain generally over their skis when it comes to equity exposure. While not quite at end-2021 levels (and indeed slightly lower than at the end of Q1), equity/mutual fund holdings as a percentage of net worth remains comfortably higher than at the peak of the dot-com bubble. While the economy managed to weather the equity drawdown in 2022 with heavy household exposure, that came in the context of still-elevated cash holdings. That is evidently no longer the case, leaving households with less of a cushion in the event of a financial- market shock.
* None of this is necessarily meant to be actionable today or next week, but rather something to consider moving forwards. One of the unusual aspects of the past couple of years is how little effective tightening rate hikes seemed to exert on the economy. The flip side that one needs to consider is whether rate cuts will be as stimulative as they usually are. The unusual micro-economics of the housing market would argue that they will not be, which may leave the economy more exposed than usual to a shock from another direction. The combined exposure of households to the equity and housing markets is higher than it
has ever been. That’s a pretty good place to look if you’re searching for a catalyst to the next recession.”
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