Consumer Spending Diverges between High, Middle, & Low-Income Consumers: With how much ink issues surrounding policy proposals, trade disputes, and the President’s tweets receive, it may come as a surprise to some that the longest expansion on record has been driven largely by the U.S. consumer. In fact, consumer spending makes up roughly 70% of GDP growth which is massive compared to other components such as trade which makes up only 3-4%. Below the surface of the consumer spending numbers, the data tell an interesting story. According to Moody’s Analytics’s chief economist Mark Zandi, “the top 10% of earners account for nearly half of all consumer outlays.” However, spending trends for this group have remained relatively stagnant. A majority of the growth in spending has actually come from the bottom 60% of earners according to a study by Oxford Economics. This is atypical since most of the time growth in spending comes from the rising incomes of the top 40%, or so, of earners. This increase in spending by lower income earners has had some noticeable effects including higher levels of credit card debt and delinquency, higher instances of auto loan defaults, and lower savings rates. However, since job growth has remained strong, wages have been decent (albeit very slow to grow in the lower income brackets) and price inflation has not been excessive while the sentiment of consumers has remained at remarkably high levels. This overall optimism has fueled further spending despite negative headlines about tariffs, geopolitical uncertainty abroad, and political division (or at the very least, grid-lock) at home.
Our Takeaways: The importance of the U.S. consumer at this point in the economic cycle should not be understated. As we have alluded to in previous notes, it is becoming increasingly clear the U.S. consumer is underpinning the stability of not just the American economy, but also those of many European and Asian countries. This weight is not being held without a cost though. As mentioned above, the bottom 60% of earners in the U.S. are the only group continuing to increase their spending at this point in the cycle which is accounting for all of the growth in consumption. This is likely being assisted by factors such as low gas prices, falling interest rates, and/or last year’s tax bill, but in large part, it is being provided by increases in debt and the drawing down of savings. Signs of growing fragility have been present for a number of years now, but are growing at a faster rate now. More specifically, falling savings rates and climbing auto loan and credit card delinquencies highlight the growing issues with the extend and pretend behavior exhibited by middle and lower-class households. Companies for their part, in an attempt to drive more revenue/profits for shareholders, push (convince/trick) consumers to spend more than they can afford and the illusion is made possible by easy credit (i.e. credit cards, car financing, etc.). It is the drop in savings combined with the increase in debt that is particularly concerning.
End of Summer Rundown of Where the Global Economy Stands: With Labor Day marking the end of Summer, here is a brief look at where some key economic points stand as we head into the Fall. In Europe, the three largest economies (Germany, Italy, and the U.K.) all look like they are headed for a recession. Over in Asia, Japan looks just as tepid as the three European countries previously mentioned, while China is putting up some of its weakest growth data in almost 30 years. Sticking with the global theme, the trade war between the U.S. and China still seems like the most destabilizing factor in global economics, but Brexit could quickly overtake it if a smooth resolution is not adopted by the October 31st deadline or that deadline is otherwise extended. Focusing on the U.S., the recent Treasury yield curve inversions have drawn a lot of press because of their implication for a recession in the near term. Also drawing recession related commentary by members of the financial press are several indicators, such as the New York Fed’s recession probability indicator, which have been either signaling heightened recession concerns or outright recession signals. Even more discouraging are the tepid numbers from both the U.S. manufacturing and transportation sectors. Both are already in recessions and have not shown any indications of reversing course anytime soon. Capital expenditure among U.S. businesses has also been unremarkable despite record levels of cash and debt financing. As mentioned in the previous section, consumer spending remains high, but that and a relatively strong job market appear to be the bright spots as we head into the Fall.
Our Takeaways: Many market commentators have already proclaimed a recession in Europe. As we have identified in previous notes, the two big keys are going to be Germany and the U.K. (specifically how Brexit is handled) and given the complexity around these two factors we are not ready to make a determination at this time. However, it is clear that continued uncertainty will make things worse, so the simple lack of a clear path forward from either the German manufacturing downturn or Brexit may reach a point where a determination is possible. The stagnation in Japan shows that even the most extreme central bank tools cannot stave off economic and demographic forces which we will look at a little closer later in this section. This leaves China which, despite enormous central government planning and intervention, has shown the good times simply cannot continue forever. It’s clear the position of the rest of the world is wobbly at best, but what about the prospects in the U.S.? While the yield curve inversions have drawn the attention of the press and the ire of the stock market, few have pointed out that the yield curve inversion (as recession indicator) is a phenomenon that is fully understood or widely observed. In fact, while the yield curve inversion has preceded every U.S. recession for the last 70 years, the same condition is not the case anywhere else in the world. This still leaves the very unfortunate condition of the manufacturing and transport sectors which, unlike nuanced comparisons between debt yields and maturities, have more direct analogies to the health of the real economy. In the face of a potential downturn, some market participants have begun to raise concerns over the Fed’s position to provide suitable economic stimulus during the next downturn given the current low rate environment. It should be said that we cannot discount the extreme tools that may be (or at least attempted to be) used in the next downturn. Negative interest rate policy is not off the table, massive balance sheet operations are not off the table, financing public spending through closely coordinated government and central bank operations is not off the table. In fact, and possibly the scary part, all of these things have been used, or are currently being used, in one form or another throughout the world. As alluded to above, Japan has already tried, with varying degrees of success, all of these aforementioned tools, and each have ultimately proven to have their limits.
The Distinctly Political Characteristics of the Chinese Trade War: One key theme that has emerged from the monitoring of the 2020 election is Elizebeth Warren’s sustained rise in popularity. Without going into her chances of getting the democratic nomination or prognosticating on the possible outcomes of the election, it is important to note that she (along with some of the other democratic candidates) has very similar views on China as the current administration. This opens the possibility that there wouldn’t be much of a change, if any, to the U.S.’s stance on China even if the reins of power changed party hands in Washington.
Our Takeaways: This is an interesting thought because a prevailing theory (which is not to the level of sentiment at this point) is that China is "playing the long game," and waiting for the next man up (so to speak) when it comes to the trade war. They know dealing with Trump will be hard, but there is either a 1 or 5 year clock left on his position unlike the majority of Chinese governmental positions. When this trade war is looked upon as a 25, 50, or 100-year decision, having to make sacrifices over a 1-5 year period look less meaningful than day-to-day news cycles might make them seem. However, when faced with the prospect of potentially 8 more years of a hardline stance against Chinese trade policies, this might be enough to sway Beijing’s approach towards the relationship.
The FAANG Stocks - Where is the Upside from Here?: Facebook, Amazon, Apple, Netflix, and Google (commonly referred to by the financial press as FAANG) collectively account for about 20% of the value of the S&P 500. They, in turn, are responsible for a substantial portion of the S&P’s tremendous growth following the Great Recession since these 5 stocks have all enjoyed such phenomenal success. However, the last 12 to 18 months have proven to be tough on the FAANG, and thus the market as a whole. After stumbling from the summer 2018 highs and subsequently recovering in the first half of 2019, both the FAANG stocks and the market as a whole have struggled with the S&P 500 failing to make a determined push much higher than the tops set around the 3000 level despite having tested it several times in the last 12 months.
Our Takeaways: There are a number of factors that play into why the FAANG stocks have begun to lose their luster, but they can be succinctly summed up into one concept - greater scrutiny. As Michael Wursthorn of The Wall Street Journal put it, “instead of valuing them as nimble upstarts with a seemingly limitless potential for expansion, investors are increasingly pricing in slowing growth, rising costs and the potential for greater government oversight” which is probably, in one form or another, on the horizon for all of these companies. Facebook has been under intense pressure for a few years now (due to data privacy concerns, election manipulation, etc.) and a lot of these issues are likely to stay in focus through the 2020 election cycle. In addition, state AGs are gearing up for possible anti-trust action which could, at the very least, keep the company in a negative light for years to come. Apple has become the poster child for slow growing tech. Once rapidly dominating or innovating new product categories, their inability to match the space of innovation has caused the company to become the slow, lumbering behemoth that was once viewed as the antithesis to the high-growth, sexy SV tech companies. Amazon is probably the most compelling of the 5 at this stage in the game. Its huge cash and data hoards, at least in theory, will allow it to continue to target and dominate different corners of the retail economy. However, the parallels with Rockefeller and his Standard Oil are staggering which could set up a similar situation with an ambitious enough government prosecution team that would use Amazon to write the 21st century antitrust rules. Netflix is about to face massive competition which is only going to increase customer acquisition and retention costs thus driving down future profitability prospects. Unlike the anti-trust comment inducing landscapes the other FAANG players are competing (or not competing as it were) on, streaming is a space where it is an all out war for a finite pool of customer attention. Google sits in a very similar position to Amazon minus some of the issues about paying workers a "fair" wage. Google, or more correctly the parent company Alphabet (however, “FAAAN” doesn’t quite have the same ring), its atop twin peaks of cash and data with plenty of irons in the fire to continue growing and expanding in new and interesting ways. Yet, similar to the other tech giants, Google has started to lose its halo and become more susceptible to an increasingly negative public opinion.
Millennials and the Next Recession: It may come as a surprise that the economic prospects for many Millennials have not been as rosy as for other segments of the U.S. economy. Student debt, standing at around $1.5 trillion and largely owed by Millennials, has been the subject of many headlines, but less publicized are statistics such as Millennial stock ownership which is just 37% compared to 55% for Americans under the age of 35 in 2001. Less dramatic, but still impactful, is Millennial homeownership which is 8% lower than previous generations at this point in their life. This all combines together in dramatic fashion when it is observed that Millennial net worth is 40% lower than Gen Xers and 20% lower than Boomers at similar points in each generations’ lives.
Our Takeaways: The big reveal at the end is hardly surprising given the contributing factors. Debt has been shown to be a drag on spending and saving which has implications on things such as asset ownership. Homeownership, at least in recent decades this has been a significant source of wealth for many lower and middle-class Americans. Stock market participation historically has been the best way for Americans to increase their wealth through savings. However, it is an arena where you have to be able to afford the price of entry (e.g. have savings/investable capital) in order to receive the benefits. Rolling these components together with stagnant real wages, it completes the picture that many Millenials have not had the chance or ability to create much of a reserve from which they might weather the next economic downturn.
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