Hey, I'm in the service business too!

My travels of late took me to San Antonio and Grand Rapids, MI, for economic, market and AI discussions. Advisors in both spots are ill at ease.  Of AI—“Won’t it take all our jobs?” and “Why haven’t we seen the so-called productivity improvements yet?” and “Autonomous vehicles, autonomous shmehicles!” (Not an exact quote, that last one.)  Of the economy and market—“Okay, you don’t expect a recession next year, but what about this year?” and “What if the Fed doesn’t cut at all in September?” and “Why are opinions so varied when the experts all look at the same things?” Speaking of shared opinions, Kamala Harris joined Donald Trump this week, calling for no taxes on tips. (Could resonate with independents in the swing states, who are generally young and earning less than $50k.) Advisors joked that they will dispense with the management fee in lieu of “tips.” Meantime, as we barrel towards Election Day(s), seasonality could be perilous for the next month or two. Early August is not when you’d expect to see a market low – more like September or even October. Still, the severity of a seasonal downturn is often a function of the market that led to it. The market had been solid before the recent difficulties, and 80% of S&P 500 names still stand above their 200-day moving averages, so a further correction could be mild. Breaking below the 200-day moving average (about 5,000) would, however, probably indicate that the market had further to fall. Most years feature a market correction of 10% or more; if we get one that would be normal and not in itself a sign of a bear. The recent volatility was indeed severe, but in the last 70 years 14 selloffs were as bad or worse. In less than half of those cases was a recession in the cards. As economist Paul Samuelson famously joked, the stock market has predicted nine of the last five recessions.

Second-quarter earnings season, now 90% complete, has been solid, reporting growth of 12.4% in earnings and 5.3% in revenues. Importantly, two-thirds of companies have seen pre-tax profit margins increase this quarter. Increased negative guidance is a concern but earnings estimates for the next twelve months (NTM) are holding up so far. That’s important because NTM earnings estimates don’t often drop except in recessions. Margin outlook sentiment reached a high, which is correlated with healthy margins realized in the following quarter. There are, however, concerns about the second half of 2024 into next year, with Q3 and Q4 earnings growth expectations revised lower. Net income growth is now due to broaden out – but at a slower pace. Current analyst consensus calls for a Q3 retreat in earnings growth to 6%, with tech-related stocks’ growth dropping from 38.7% last quarter to 19.1% in Q3, while the rest of the market flips from 5.9% to 3.4%. If history is a guide, the 6% forecast for the broad market may wind up being more like 8%. Still, that would be a third less than this quarter’s 12.4%. There may be some comfort for investors in US equities – like the cleanest dirty shirt – that the rest of the world is seeing an even weaker earnings growth outlook.  

As to the outcome, consumer strength holds the key. The New York Fed’s Quarterly Report on Household Debt and Credit shows credit card debt and delinquencies at an all-time high in Q2. Yet as a share of disposable income, delinquent debt is lower than pre-Covid levels. Also, mortgage delinquencies have gone down substantially since the pandemic because homeowners locked in mortgages when rates were low. (Mortgages make up 70% of consumer debt versus 6% for credit cards.) This week’s retail sales report cheered investors (more below), its strength in line with the Johnson Redbook and Jeffries’ consumer health index. The wealth effect could play an increasing role in consumer sentiment, with equities reaching a new high of 42% of household financial assets. Furthermore, notwithstanding last month’s tepid jobs report, employment among prime-age workers reached a new cycle high in July. And goods are moving, with the ports of Los Angeles and Long Beach showing y/y traffic gains of 17.6% and 26.8%, respectively. Still, the strong retail sales figures came as aggregate income was flat – indicating the spending came at the expense of savings, an unsustainable state of affairs if so. The job finding rate has fallen to its lowest point since September 2021. It’s an election year, though, and Biden could speed up Employee Retention Tax Credit disbursements, which might jump start small-business hiring or, at least, prevent layoffs. Count the consumer out prematurely at your peril. Indeed, as long as I’m employed and my friends haven’t been fired, guess who’s shopping! Plus, I may even get a bonus this year … er, tip.

Positives

• Retail therapy Retail sales had their best report in a year-and-a-half, rising 1% in July. Ex-auto sales rose 0.4% m/m and the control group rose 0.3% m/m. Also, the University of Michigan Consumer Sentiment Index increased more than expected in August to 67.8 up from 66.4 last month. Consumers’ inflation expectations remained unchanged at 2.9% one year out and 3% looking 5-10 years out.
• Prices moderate further The July consumer price index came in basically as expected, keeping hopes of a September rate cut on track. Headline inflation fell to 2.9% y/y while core came in at 3.2%. Shelter inflation rose 0.4%, but new leases are rising more slowly and should eventually slow rental inflation more broadly. Producer prices rose a reasonable 0.1% in July m/m on a headline basis but 0.3% m/m core.
• Small businesses are (somewhat) cheery The National Federation of Independent Business’ small business optimism index rose 2.2 points in July to 93.7, beating consensus. The index has risen five straight months but this nonetheless represents 31 straight months below the long-term average of 98.

 Negatives

• Mortgage rate declines haven’t helped yet The National Association of Home Builders’ housing market index fell 3 points in August, to 39, versus expectations of an uptick to 43. Housing starts and permits disappointed, the lowest since May and June 2020, respectively. Weather is blamed and August expected to be better, with mortgage rates down to 6.6%.
• Production softens Industrial production fell 0.6% in July, versus an expected drop of 0.3%. The Fed blames the hurricane for manufacturing’s share of the decline. The Philadelphia Fed’s manufacturing survey lost 20.9 points in August to -7.0, while the New York Fed’s Empire State survey of manufacturing conditions rose 1.9 points but remained negative, at -4.7.
• Stalled engine of European growth The German ZEW index plummeted from 41.8 to 19.2, evidencing the fragility of eurozone growth. Possible causes: worries about the US soft landing, market volatility, and angst about energy prices in the midst of strife between Israel and Iran. There has been a rise in the country of business bankruptcies and internet searches for unemployment.  

 What Else

Greater fool or safe haven? Gold is handily outperforming US equities this year, returning 20% so far, with some investors holding in case of geopolitical shocks. Interestingly, gold and Bitcoin have traded differently lately, with the latter in a downtrend, once again raising the question which of the two is the better safe-haven asset.

No more VIX spikes this year? Taking the market’s high minus the low and dividing by the low, the S&P 500 trades in an average range of 27% in any given year. So far this year, the S&P has traded in a range of 17%, suggesting we may not be done with volatility.

A straightforward rubric Over the last eight presidential elections, when the VIX peaks in July or August, the incumbent’s party has won the presidency. When the VIX increases after August, the opposition party has won.