A Look at the Fed’s October Decision, 3rd Quarter GDP Data, and What’s Next: October 30th was a busy day for markets. It started off with the Commerce Department announcing 3rd Quarter GDP data and rounded out with a post meeting press conference with Fed Chair Jerome Powell. GDP data came out 30 basis points higher than was expected going into the report at 1.9% annualized growth in the 3rd quarter compared to an expectation of only 1.6%. Major contributing factors included increases in consumer and government spending with the other components not creating significant drags with the exception of business investment. Business investment has consistently been a weak spot for GDP for the last several quarters with most analysts attributing the weakness to uncertainties related to trade. Later in the day, it was announced the Fed voted to reduce the target federal funds rate range by 25 basis points to between 1.5% to 1.75%. This did not come as a surprise to the markets as implied rates going into the announcement put the probability of a cut at nearly 100%. What markets and analysts have been less certain about is the path of future monetary policy for the remainder of the year and next year. This is where guidance from Fed Chair Powell in his press conference could have delivered clarity to the markets, but he opted mostly for repeating, verbatim, from the prepared statement of the committee that “the current stance of policy is likely to remain appropriate” for as long as the economy follows the Fed’s outlook for moderate (he clarified that meant around 2%) growth.
Our Takeaways: Businesses are continuing to signal that they are clamping down on the purse strings amid the current macro-economic and political climate. This continued reduced investment will have negative long-term effects for business growth and development, but it will likely be several more quarters before we start to see evidence of that. One question that was brought up at the post Fed press conference was: is there a risk that since businesses are reluctant to invest in things like buildings and equipment that they turn to employees next if they cannot strip away at expenditures to achieve improved results in what is essentially a flat to slightly negative global environment? Fed Chair Powell responded by saying that members of the committee do not think that will be the case. In contrast to this, our view is that if the macro-economic and political uncertainties continue, we will see at least pockets of this kind of activity occur - particularly in manufacturing - due to the inherent pressures of public company ownership on management to continuously generate improved performance. As we note in our commentary on the retail sales report, there are some signs of tepidness in consumer expenditures. This area was strong in the 3rd quarter helping bolster the overall GDP reading, but it is possible we are starting to see some cracks in this area. Of particular note is the automotive segment. That has been an aspect of consumer expenditure that has performed very well over the last several quarters, but has fallen off dramatically. This is a multi-factor event, but the leading causes are: 1) tightening in financing due to higher delinquencies and 2) slowdown in demand due to oversupply related to easy financing over the last several quarters. Automakers have been fairly successful over the last few years in simultaneously increasing the average sale price of vehicles (primarily through delivering more trucks and SUVs which tend to be higher in price) and increasing sales volume in unit terms (primarily through providing aggressive in-house financing options). This has sapped up consumer demand and left buyers saddled with large loans on rapidly depreciating vehicles. Turning to the Fed’s decision and Fed Chair Powell’s statements, it is clear they are signaling that they are firmly settling into a "wait and see" mode when it comes to the economy. This appears to continue the narrative that was set forth in the Beige Book report put out in mid-October that things aren't great, but they aren't bad either. A question we have begun to ask ourselves is: if the Fed can ease policy sufficiently to prevent a recession and a trade deal can be worked out with China that returns us to a historically normal level of tariffs, are businesses going to be capable (in terms of labor on hand, access to labor, capital on hand, access to capital, and business on hand/immediately available) to immediately jump into growth mode, or will it take a number of months or quarters to reverse some of the decisions/damage that have set in due to the current environment? It is not apparent given the amount of other macro economic factors (i.e. global trade uncertainty, slowing economic growth in China, negative economic activity in Europe, policy uncertainty in the U.S., etc.) that either the 100 basis point rise last year or the 75 basis point cut this year have really done much to help or hurt the economy. Since monetary policy works on a lag, the improved GDP growth we saw in 2018 was likely due to the tax cuts enacted in 2017, with growth returning this year to the policy target 2% range due to the negative impacts of the trade uncertainty with China. We are of the view that, for all practical purposes, adjustments in this rate range (i.e. 0 to 3% or so) are not capable of producing significantly positive short-term effects on the real economy. However, as a few other analysts have begun to point out, at some point the tradeoff of easy monetary policy to stimulate short-term growth no longer outweighs the long-term negative effects on savers. It is unlikely that this fact will ever be adequately addressed by policymakers who generally, as a group, have a bias towards optimizing towards short-term outcomes.
Share Buybacks are Back (At Least for Now): After slowing down a bit in the second quarter, buybacks came back strong in the 3rd quarter. Companies bought back 27% more than they did in Q3 of 2018 which was already well above historical norms. In a more thorough analysis, data from S&P Global reveals that 51.4% of buybacks came from the 20 largest companies in the S&P 500 which is abnormally disproportionate compared to the 10-year average of 44.1%. After slowing in the second quarter most analysts assumed the tailwinds from the recent tax cuts had subsided, at least insofar as buybacks were concerned, but it would appear last month's data is having them reconsider that analysis.
Our Takeaways: Some of the increased buyback activity is explainable given that, in August, the market had a reasonable dip off of its - at the time - all-time highs. It still remains controversial among many economists regarding the prudence of such aggressive buybacks in light of less desirable trends such as growing debt and decreasing cap. ex. In general, it seems that the key takeaway from the recent activity are that buybacks are heavily concentrated in the largest companies. This is consistent with the idea that these companies have been the financial outperformers of the last several quarters (see comparison between S&P 500 and Russell 2000) due to their ability to maintain margins in the face of higher costs (or costs that are supposed to be higher) and greater competitiveness for labor. Furthermore, these are the companies with the greatest ability to borrow money and do so at exceedingly low interest rates which makes the tradeoff between increased leverage and returning capital to shareholders (management) even more compelling.
Follow Up on Job Openings Data: As we reported in last month’s letter, the prevailing trend in for job openings for the last several months has been negative and the August figure was no exception. On a relative basis, openings declined 4% from August of last year, accelerating the decline we have seen building for the last several months. Regionally, there were some significant differences with the Midwest posting the worst decline at 13.5% from last year. Also soft were openings at hotels and restaurants. However, unlike manufacturing which has seen a significant slowdown in hiring (likely due to companies pulling those opportunities rather than filling them), it appears that the slow reading for openings at hotels and restaurants may be better explained by fulfilled demand for labor.
Our Takeaways: This is in line with the trend we highlighted in last month's note where we reported on July's figures. Now, with August's numbers out as well, we can see the trend is persisting. To uncover some of the currents below the surface, we dove deeper into some of the particularly weak areas. The Midwest region was hard hit, and it appears these declines were due to sectors outside of manufacturing. Through August, job openings for manufacturing positions remained high despite declining slightly, but we expect the declines to accelerate once September and October numbers have been reported since the ISM manufacturing index reported large monthly declines in both August and September (see notes on ISM for more details). However, hiring in the manufacturing sector has been in a contractionary trend since 2018. This presents a divergence between the headline openings data and what is actually occurring in the real economy. The common narrative so far this year has been that companies have been struggling to find qualified workers to fill these positions, but at least in the case of manufacturing it is unclear if there is enough work available (or there will be enough work available) that companies could profitably absorb all of the labor they are seeking. As for the other sectors mentioned, hospitality in particular has been strong, so it stands to reason there was economic viability in getting workers in those roles. Conversely, the falling openings could be a signal that companies in these sectors do not see the same pace of demand going forward and according to the Travel Trends Index for August, the strength in the travel/hospitality arena is coming from domestic leisure. With other areas such as inbound (to the US) international traffic presenting forward indicators that are expecting there will continue to be declines over the next 6 months. In addition, travel, particularly leisure travel, is something that historically has declined during economic pull backs. Same goes for restaurants, particularly conventional sit-down style models. In addition, delivery has started shifting some of the consumer preferences when it comes to dining, which - due to the increased headcount efficiencies for restaurants - could also be a driving factor behind lower job opening numbers.
Another Look at the U.S. 1 Month into Q4: While not technically a sign of how things have been going so far in the 4th quarter, we received in October the retail sales report for September and it was less than impressive. Sales fell 0.3% from last year and even removing auto and gas (which tend to be more volatile components of the metric) the number increased to essentially no change year-over-year. Yet, as some analysts pointed out, things like a decline in gas sales due to lower prices (which was largely the case) are not necessarily negative things for consumers since it means they got to keep a little extra money that they otherwise would likely have to have spent. One troubling component of the report was a decline in online sales. Sales at non-store retailers were down 0.3% from the previous year which is the first decline we have had in this metric since last December. All things considered, this poor performance of online retailers in general did not appear to hold back industry leader Amazon who reported 3rd quarter revenue numbers above expectations at $70 billion which is up almost 24% from the previous year.
Our Takeaways: While not a significant number, any decline at this point in the economic cycle is not particularly positive when consumer sentiment and strength are supposedly very strong. Ex-auto and fuel components, the overall trend was flat, so as suggested here, the headline figure may be a little misleading. Again, at this point in the cycle, any weakness at all is not an encouraging sign. Focusing on online sales, and we made a mention of this in our March 2019 letter, if the index is reporting a decline in sales and Amazon reports a strong quarter (which it did), then that means the rest of the companies competing in the space must not be doing very well (given Amazon's dominance in the online market). The question, even a month into the 4th quarter still remains: will the political and economic uncertainties we have been grappling with now for the better part of a year finally have a noticeable and significant impact on consumer habits? Turning to Amazon and what their earnings report may mean for the current quarter, the big piece that jumped out was weaker 4th quarter revenue guidance. Analysts’ average estimate prior to the company announcing guidance was $87.4 billion which would represent a 20.7% increase from Q4 revenue in 2018. However, Amazon's guidance of between $86.5 billion and $80.0 billion would put the company's own estimates in the 10.5% to 19.5% growth range. For a company of its size, that is still incredible growth, but for a firm that has made astronomical revenue growth numbers the norm, particularly in the 4th quarter, this has put investors on edge - at least for the time being. Now, as was pointed out numerous times in the cacophony of pundits providing their analysis after the company reported and issued this disappointing guidance, Amazon does have a habit of under promising and over delivering when it comes to its financials. So, it is entirely possible that the company is simply setting up the market for yet another strong Q4 earnings season. Although, given the recent economic data for retail sales, there is some pause in readily accepting this rosier narrative for their actions. Also possible is the scenario where this is simply Amazon putting foam on the runway for what could turn out to be an even worse quarter than they are expecting.
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