The Days Ahead:

Short week. Housing and retail sales

This Week:

  • The run down in savings…how much longer can it last
  • Households withdrew $414 billion in cash in the first quarter
  • We’re in a bull market, sort of
  • But definitions are flaky
  • The Fed doesn’t like to surprise and didn’t
  • Fed members sound more hawkish than they really are
  • The Treasury General Account built to 33% of its target in a week
  • And nobody noticed

The Run Down in Spending

It’s well-known by now that the excess savings, which measures how much people should save over what they actually saved, ballooned during Covid-19. A combination of high savings, government support and no opportunity to spend sent the savings rate to an unprecedented level of over 20% for most of 2021 and 2022. Households accumulated an additional $1.2 trillion in checking, bank deposits and money market funds from early 2020 to 2021 for a total of $20.3 trillion. That was just the cash portion. Household net worth, which includes real estate, bonds, equities and pensions, peaked at $152 trillion and 620% of GDP in late 2021. Since then, it’s down.

No one really expected net worth to remain at such high levels. The downturn is primarily because of lower house prices, lower stock and mutual fund values, and an increase in household debt. But people also made up for a forced spending halt by running down cash.  

The savings buffer allowed people to keep spending even as real after-tax incomes dropped. The chart below shows the latest trend of personal income and spending. These are all “real” or inflation-adjusted numbers to remove any distortions.

The trend to see is the blue line of income diverging from the green line of spending. Since early 2022, spending is up 3.5% while income is up only 0.5%. Obviously, one cannot outspend one’s income indefinitely without drawing down savings or borrowing. The amount of excess savings is a bit of a guess because it’s comparing a pre-Covid-19 trend and a post Covid-19 spending rate. What we’re looking for is “How much of the savings is gone and how long will people keep spending more than their income growth?”

We took a run at it by looking at the drawdown of cash just for the household sector, ignoring corporate, state and local government and anything that wasn’t part of the workforce. For the seven years up to 2020, households added $470 billion a year. For the two big Covid-19 years, they added an additional $3 trillion. This is what we would call “excess” over what people would have saved anyway.

They then started to run down savings in 2022 at an annual rate of $940 billion and in the first quarter of this year ran them down $414 billion or roughly at a $1,656 billion annual rate.

This is all a bit of back-of-the-envelope stuff because we’re not counting other forms of savings, like 401(k) plans, but, if the excess savings was $3 trillion and the run down has been $1.1 trillion, and is growing, then households have about another two quarters of spending at current levels. Spending will then slow rapidly.

It may slow before then. We know from the Fed that 64% of all net worth is owned by the Baby Boomer and Silent Generations. The youngest boomers are 59 so probably past their peak spending years. Yes, “experiences” are great but try climbing Machu Picchu in a Zimmer. We also know that the top 1% of Americans own 30% of the country’s wealth and the top 10% own 67%. The bottom 50% own 3% of wealth. Again, the wealthiest households don’t consume as much as less wealthy households. After all, how many TVs, cars and iPhones can you have?

Our concern, then, is that spending may fall off sooner than two more quarters. The good news is that the numbers we have for generational wealth and the wealth owned by the top 10% are based of the Survey of Consumer Finances from 2019. The distribution shares could have changed, especially as many of the Covid-19 relief programs were aimed at lower paid households. In which case, the spending could continue for longer.

We’ll admit it’s an imprecise exercise. We know that after the GFC, savings rates spiked higher and stayed high. We also know that there remains excess savings around. We’re just not sure who owns it and how they will spend it. We’ll know more in the coming months. Meanwhile, it’s a level of uncertainty we’ll live with.

We’re in a Bull Market. Sort of.

The S&P 500 is up 25% from its lows of last October but remains 10% below the all-time high of early January 2022. Headlines usually define a bear market as a 20% decline and a bull market as a 20% increase. The problem with that is that if you start with stocks at $100 and they fall 20%, you need a 25% gain to get back your $100. If the market had a 20% gain and then a 20% drop in a succession of bull and bear markets, after six years your portfolio would be $88 and after 30 years it would be $56. If you change the bull market gain to 25%, and stay with the 20% bear market correction, then your portfolio just stays flat at $100.

Simple bull and bear market definitions don’t work. Take one extreme example. If a portfolio is $100 and falls 90% to $10, is a bull market rally of 20%, which takes the portfolio up to $12 likely to provide much comfort? Probably not, as many an unfortunate holder of recent high-level IPOs would attest.

The S&P 500 peaked in September 1929 at 30 (it’s currently around 4,300) and took until 1954 to reach the same level. During that time there were 12 bull markets, but they weren’t enough to bring your principal back to your start point. Was that a 24-year bear market or a few bad years followed by some very good bull markets? If you’d been astute enough to buy at the bottom in 1932 and held until 1954, you would have made nine times your money or around 11% a year.

Famously, the Japanese Nikkei 225 Index of stocks peaked in 1989 and remains 15% below that peak. Is that a 34-year bear market? During that time, there were plenty of rallies, or bull markets of over 20%. Japanese stocks rose 126% from 2003 to 2007 and they’re up 101% since Covid-19 lows.

If we look at one-year returns, we run into another problem. Here’s a graph of natural gas prices over the last 32 years.

By some definitions it hasn’t done anything in all that time. By others, it’s rallied 150% or more seen numerous times. You can see the difficulty of applying the simple definition of bull and bear markets both over short and long periods.

Thankfully, U.S. stock markets don’t rise and fall in quick succession and bull markets last longer than bear markets, as here:

We’ve highlighted the years when there were successive down markets, which happened four times in the last 94 years. In the 1940s and 1950s, we typically saw one year of bear markets followed by two to three years of bull markets. In the 1980s, a bear market year was typically followed by three to eight years of bull markets.

The average annual bear market in the 1950s to 1960s was around -11% but the average bull market was higher, at 18%, and for longer. In the 1980s until now, the average annual down market was -14% and the average annual up market was 17%.  

What can we conclude from all that? Well, the definitions of a bull and bear market are more art than science. Putting a number on it seems arbitrary and we should look at duration and breadth, not just price moves from temporary lows. We’ve felt confident about the broad moves in the European and Japanese markets and the Nasdaq. The S&P 500 could benefit from some wider participation, as we discussed last week. We’d also like to see it return to its all-time highs. Until then, perhaps it’s not a bull market but it’s a very solid performance in which we continue to have confidence.  

The Fed does not Like to Surprise Us

Since the Bernanke Fed days in the late 2000s and the post GFC period, the Fed has bent over backwards to provide as much “forward guidance” as they can. It’s a fancy way of saying that they will message the markets as openly as they can, short of actually making any rate decisions ahead of time. What they don’t want is for the market and the Fed to misread each other and send markets into a tailspin.

There was plenty of talk ahead of Wednesday’s meeting about the case for a “pause”, where the Fed would leave rates unchanged for the first time in 10 meetings. It was made very clear by the nominated, but not confirmed, Vice Chair Philip Jefferson on May 31, 2023. He said:

“…higher interest rates and lower earnings could test the ability of businesses to service debt [and]… exacerbate stress at banking organizations, [so] skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions.”

So, there was no surprise in the decision but there were a few hawkish comments on the lines of “Well, we’re probably not done, and we’re still gathering information”. The probability of a 0.25% hike in July went up to 65%.

Here are some of our thoughts and, I’m afraid we have to start with the world’s worst graphic called the Dot Plot, which looks like someone zoned out on a Lichtenstein painting.

The summary is that the Fed members raised rate expectations for 2023 from 5.1% to 5.6% and from 4.3% to 4.6% for 2024. But it’s the range of forecasts where things get interesting. In March, there were only two of the 18 members who thought rates would end up below the 2023 forecast. Now it’s 6 of the 18. For 2024 and 2025 there is even more dispersion with one person saying rates should be 5.75% and one at 3.25%. That’s a heck of a range and suggests there’s some very different opinions floating around the Eccles Building.

Here’s a summary of other economic projections made for 2023 and 2024 since December last year.

The increase in expectations for rates comes with a revision up in growth and a revision down in unemployment and inflation. That seems odd. Why would they want to hike rates when inflation is coming down? The answer is in the core-PCE inflation which excludes energy and food prices. The Fed is focused on a “core-core” inflation which is services less shelter and accounts for around 24% of the index. The Fed’s point is that it strips out volatile sectors like gasoline and focuses on parts of the economy that are labor dependent. They don’t like the trend in wages and want to see moderation before declaring any sort of victory.

The other number that puzzles us is the unemployment projection. The latest unemployment number for May was 3.7% and the Fed expects an increase to 4.1% by year end and 4.6% by 2024. That implies 700,000 job losses for the rest of the year and 1,409,800 in the next year. The jobs market has grown by an average of 283,000 per month for the last three months, so either the Fed really wants to see employment fall or their thinking on labor is outdated. We’d lean to the latter given how much the labor market has changed in the last few years.

The market’s first reaction to two possible rate hikes was for the 10-year Treasury to sell off. But it quickly rallied in the press conference. It was the same pattern for stocks. There’s another set of inflation and jobs numbers coming ahead of the next meeting in July and a two month break before the next meeting in September. If the Fed sees inflation improve, it may just stay at current levels. It’s a close call but markets seem comfortable enough.

The Bottom Line

It was a busy data week with industrial production down a bit but mainly because utility production fell 3.8%. It’s largely irrelevant to the economy if people crank their air conditioning or heat up in any given month. What’s more important are things like business equipment and defense, both of which showed decent gains.

Retail sales grew more slowly than last month but they’re up only 1.5% over the year and inflation is up 4.0%. Again, things are slowing but not abruptly. Claims were also high for the second week at 262,000. They were last at that level in October 2021. The numbers are flakey week to week and there are some distortions between seasonally and non-seasonally adjusted data coming. Last year the difference between the two was about 20% so the next few weeks will tell us if this is a blip or trend.

One point in the dog-that-didn’t-bark category, the tremors around the Treasury’s rebuilding of the Treasury General Account (TGA) completely failed to materialize. The theory was that the TGA was $800 billion, ran down to $22 billion with the debt ceiling problems and that Treasury would rebuild it to $800 billion and put massive upward pressure on short-term rates. What they actually said was $425 billion and that they would “monitor conditions”. Well the TGA is already at $134 billion in a week. And short-term bill rates didn’t move. I mean, Cassandra was right in the end but what a pain to have to live with, eh?

Equities had a good week, up 3.1% and up 27% from last October’s low. We think it will hold.

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Art: Janet Ruttenberg (b 1931)

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