The Days Ahead:

  • U.S. inflation and Fed meeting.

This Week:

  • We look at progress made since 2019.
  • It’s an impressive list with jobs and wages a clear winner.
  • There’s even progress on wage and wealth inequality.
  • And household debt is low.
  • Why then are people not happy?
  • We found out why GDI is lower than GDP.
  • GDP is the better number this year.
  • Some changes at the Fed.
  • Electric vehicles; lots of them at cheap prices but not in the U.S.

Are Things Better?

Yes. Last week we took a look at why consumer confidence was low and why the difference between the two leading surveys was at its greatest in 20 years. Some of the reasons are very prosaic. One, the University of Michigan survey, places more emphasis on gas prices and stock markets, both of which were too high and too low respectively back in October. The so-called recency bias, where we ascribe to the recent past trends which are very short-term in nature, comes into play. As in “it always rains on my birthday” when in fact it has but only for the last 4 years since you moved to Tacoma, Washington. But it didn’t rain the prior 10 years. The Michigan survey seems very prone to this sort of bias.

Two, in contrast, the Conference Board, asks broader questions like “how are your employment prospects?” Most people answer this with a “fine, thank you” if they are employed and there are no job cuts at their place of work. It’s a little less skittish and less likely to reflect every recent headline.

We think the surveys will converge but what struck us is the level of the surveys compared to how the economy, particularly wages, prices and inflation are actually doing. There’s a disconnect. People seem more concerned now than they have been in years, and in some cases, they’re gloomier than they were in GFC days. Are Americans really that worse off than before Covid-19? And if they’re not, why do they think they are?

Let’s look at some pre and post Covid-19 numbers. We’ll score them with a -1, as worse off, 0 for no change and a +1 for a positive change. It’s a bit of a chart fest, but bear with us. There’s no science to this. More of a quick gut check.

The number of unemployed is basically unchanged since 2019.

Unemployed and long term unemployed chart
Source: FactSet, 12/04/2023

Just before Covid-19, there were around 6 million people unemployed. Now it’s around 6.5 million. That would seem a move in the wrong direction. But we also know that there’s been more labor churn, with people moving jobs and often picking up higher wages. So, we’d also look at the long-term unemployed which measures those out of a job for 27-weeks or longer. That’s the point where skills begin to atrophy or job contacts become stale new and where the likelihood of finding a job in the next year falls from 76% to 36%.

The ratio of long-term unemployed to unemployed is around 18%, unchanged from pre-Covid-19 days but well down from the 2012 to 2020 average of 31%. We’ll score this a 0.

But there are more people at work than ever.

The household survey, which measures unemployment,  shows 161 million at work compared to 158 million pre-Covid-19. The number of people employed by “establishments” or companies and government agencies with more than one worksite, is now 157 million compared to 152 million pre-Covid-19.

Labor force chart
Source: FactSet, 12/04/2023

If we take the pre-Covid-19 trend line of both, then, sure, the numbers should be higher, at about 165 million and 163 million. But simple extrapolations aren’t always accurate and Covid-19 caused well over 1 million deaths and 103 million cases or about 28% of the population. We also know that labor force participation fell from 63% to 60% and is only back to 62.7%.

It fell hard for two groups.

First, for men, it fell from 69% to 66% and it’s still only at 67.9% And second for all people aged 55 and over, where it fell from 40% to 38% and never recovered. We don’t know if the reduction in labor participation is voluntary or enforced. But we do know that the disability numbers went from 6.2 million to 8.2 million.

A quick note here. The 8.2 million is the number of people in the workforce who are disabled. Some of them are working. The number of people receiving Social Security disability benefits is 7.4 million which is down from 8.3 million pre-Covid-19. If you’re receiving benefits, you are definitely not employed nor counted as part of the workforce. But the bottom line is that the number of people defined as disabled grew some 28% since Covid-19.

This is a tough one to score. There are more people at work but the number is also lower than trend and with less people participating. We feel the participation rate will gradually move up, which it has done steadily since early 2021. We’ll put more emphasis on the growth and size of the workforce and the still low unemployment rate. People working is a good thing. Score: +1.

Wages have topped Inflation.

Next, we’ll look at the basic level of income, which is wages and salaries. They’re currently at $11,975 billion or 51% of personal income. In 2019 they were $9,489 billion, also 51% of personal income. The other 49% of personal income includes bonuses (10%), income from real estate, stocks and bonds (23%) and transfers, which is mostly Social Security, at 16%.

In the chart below, wages and salaries (the blue line) are up 26%, well above inflation (in green). Here:

Wages and salaries chart
Source: FactSet, 12/04/2023

Some of the biggest gains were in the lowest range of income, which reversed years of lagging wage growth for the lowest quintile of earners.

Wage growth by income quartile chart
Source: FactSet, 12/04/2023

At first glance this looks a bit counterintuitive. The top quartile is above the others most of the time but not anymore. A closer look shows that top quartile wage growth went from 4.5% to 7.5% before dropping down to 5.9%. The lowest quartile went from 3% to 5.7% and it’s barely dropped at all. Also, in the post GFC era, the rising tide certainly helped the higher paid see income growth nearly 50% higher than the lower two quartiles. Now, there’s hardly any difference between the groups.

Higher incomes are a good thing. The post Covid-19 recovery helped all income brackets. The rate of growth is coming down, which is good for inflation, but the gap has closed between those at the top and the bottom. We’d score this a 0.

Household net worth and debt are in good shape.

The gains in wealth have been far more evenly distributed in the years post Covid-19. The boost was through a combination of house prices, which rose 48% from 2019 to 2022 (they’ve since backed off), equity performance, higher wages and transfer payments. Debt also fell, boosting the net worth number.

On an economy-wide level, household net worth rose 32%. Here:

Household net worth chart
Source: FactSet, 12/05/2023

One pushback is that debt levels increased in absolute terms. But what matters is the ability to service debt so you really should measure any debt in the context of wealth or income. And it looks pretty good.

Household debt service levels chart
Source: FactSet, 12/05/2023

This shows households’ ability to service debt, interest and principal payments for mortgages, credit cards, auto and student loans. All the payments together are around 9% of income, well below pre-Covid-19 levels. The recent spike is partly a result of higher rates but also the removal of debt forbearance plans, especially the Covid-19 Emergency Relief Plan and Federal Student Aid program which wound down in September 2023.

There has been an uptick in credit card delinquencies, from a low of 8% in 2022 to 9.4%. But again, that’s well below the 2004 to 2019 average. The 90-day delinquency rate for auto loans, home equity loans, student loans and mortgage debt are all well below 2004 to 2019 levels. We’d score this a +1.

How about wealth inequality?

Another good story. Gains in median and average wealth were spread across income brackets and demographic groups. The chart shows the median and average gain in net worth from 2019 to 2022. The highest gains were in the mid-income brackets, especially in the 40th to 60th percentile group. There was a lot more equal distribution than the normal “well, the rich just got richer” headline we tend to see.

Net worth growth by family percentile chart
Source: Federal Reserve, Cerity Partners

Again, most of the increase in the lower income groups is because of jobs, the wage increases in the lower paid groups and transfer payments. We’d score this a +1.  

So, when we measure employment, the ability to bounce back from unemployment, wages, net worth, debt levels and wealth distribution, it looks like things are a lot better than pre Covid-19 days. Our very unscientific scoring system gave us a 3 out of a possible -5. Of course, these are all average numbers but the majority of people seem better off. And all this happened with a very deep, but short recession, rising interest rates and inflation.

Which all leads ot the question why aren’t people responding to these improvements more positively?

People believe inflation is still rising, that inflation is way above wage growth and that they’ve become less wealthy. All these are incorrect, in the aggregate, as measured by the cold hard numbers. We mentioned last week that the split between respondents from different parties is very wide. In measures for consumer sentiment, business conditions, whether it’s a “good time” to make new purchases or family finances, Democrats are 20% to 30% more confident than Republicans. Perhaps if the parties in power changed the outlook would reverse. Politics certainly comes into play. But there may also be other reasons.

Inflation is lower than it was but prices are not. Prices haven’t fallen. That means there may be more people balancing purchases, substituting some products for others and generally making purchase tradeoffs.

Unemployment is low but at one point there were 23 million out of work. That may have left some scars about the precariousness of work.

It may be simply that people don’t trust surveys or they don’t respond as much as they used to. We know, for example, that the number of people responding to the Bureau of Labor Statistics (BLS) monthly inflation survey has dropped from 71% to 57% in the last 10 years. For the employment survey it dropped from 90% to 70% and for the Job Openings Survey it’s dropped from 70% to 30%.

We don’t really have a conclusion except that to understand the American consumer, we must look at what they do, not what they say. On that measure, more people are at work on higher salaries and they’re buying more than ever. We don’t expect any major changes.

The Gross Domestic Product (GDP) and Gross Domestic Income (GDI) Dilemma (again!)

Last week’s GDP numbers was revised up from a very strong 4.9% to a whopping 5.2%. The GDI number was 1.5%. We’ve written a few times about the difference between the difference between the GDP and GDI ways to measure the economy. They should be the same but GDP is a lot easier to measure and so appears ahead of the GDI report.

GDP is just the value of production of final goods. In an economy consisting of one electric vehicle, a spicey Model EM, selling for $21,500, GDP is simply $21,500. But that $21,500 generates an income for several people and suppliers. So, another way to look at it is the wages, rent, profit and income that went to other companies to get the Model EM ready for your garage.

That’s takes a bit more work. As an example, we took the company that mines the copper, the company that buys the copper to make the battery and the company that buys the battery to make the car. The sum of all three should be the same as measuring the final cost of the car. In this example, GDP is point A and GDI is point B.

Table showing GDP and GDI example
Source: Bureau of Economic Analysis, Cerity Partners

They’re the same. Phew. We used the same example a year and half ago…apologies for the repetition.

Over the last few years, we’ve seen some big discrepancies between the two numbers. The latest one was $688 billion or 2.5% of GDP. And it’s off the charts.

Nominal GDP and GDI chart
Source: FactSet, 12/05/2023

Many of the discrepancies are revised away. For example, in the first quarter of 2022, the original difference between the two was $852 billion but it’s since been adjusted to $112 billion. Normally the two numbers end up meeting somewhere in the middle. There was also a period in 2020 to 2021 when GDI was higher and GDP was subsequently revised up. This time GDP is higher, so will it be revised down?

Not this time.

The problem all starts with the difficulty of measuring income instead of the final product. One of the inputs into income is “net interest and miscellaneous payments.” It’s at $114 billion in the latest report for Q3 down from $475 billion a year ago. It’s even down 46% over the last three months. The only way for this to happen is if companies massively reduced their debt or they started getting big interest payments from the cash or bonds they held. We know they didn’t from other sources like the Fed. It seems like very big understatement of income which would, of course, suppress the GDI report.

It happened last year but in the other direction, when the net interest payment in the Q3 2022 GDP report was originally reported at $608 billion but is now reported as $438 billion.

Normally a rise in rates would boost net interest payments although with a lag given that some debt is at variable rates which don’t adjust immediately. This is what happened from 2003 to 2008  when the fed funds rate rose from 1.0% to 5.3% and net interest income rose from $493 billion to $856 billion. And again from 2016 to 2019 when fed funds rose 0.25% to 2.5%, net interest income rose from $596 billion to $773 billion.  

But an outright decline of $343 billion just seems too hard to explain away. It’s also the line item with the biggest revisions, averaging 16% in the 1998 to 2018 period. Part of the problem is that the BLS infers the interest paid from what’s happening in the rest of the economy until they get reliable tax data from the IRS. That can take a while. But we’re pretty sure that the number will be revised up which will pull the GDI number closer to the GDP number.

Even “no change” in the net interest line from a year ago would eliminate $324 billion of the $688 billion. But even “no change” seems highly unlikely. We know companies haven’t been big issuers of bonds but they haven’t drawn down $8,000 billion of debt in three months, which is what the numbers suggest.

We’ve seen some commentary that the GDP numbers are too high and the GDI numbers are closer to the real, and thus slower growth, economy. We’ve had some sympathy with that thought in past times but not this time. It seems implausible that with employment numbers, income and consumption that the real economy has declined by 0.1% in the last year, which is what the GDI suggests, rather than the 3% growth the GDP numbers report.

We’d expect GDI numbers to be revised up gradually over the next few quarters. The GDP numbers look like the real thing.

Changes at the Fed

Members of the Federal Open Market Committee (FOMC) , the ones who sign off on the Fed policy statement eight times a tear, will change in 2024. The FOMC comprises the seven appointed members of the Fed, the New York Fed Governor and then a rotation of four members around the remaining 11 regional Feds. In the last few years, we’ve seen quite a few changes in the Fed. Excluding Chair Powell, four of the six appointed governors came on board in 2022 or later. We also saw retirement of the sorely missed and Vice Chair Lael Brainard, Esther George of the Kansas City Fed and James Bullard at the St. Louis Fed.

This is the lineup for 2024 with our best guess on the hawk-to-dove meter.

FOMC: Fed Hawk and Doves 2024
Source: Federal Reserve, Cerity Partners

What caught our attention is the number of changes since the Fed started hiking in 2022. Every “X” is a change. Some Feds have two because a position was filled with an interim voter until a permanent replacement was appointed. And then there were the normal rotations.

The upshot is that there will have been 13 changes in 18 months when the new committee meets in January.

On the margin, the Fed will become slightly more dovish.

But this Fed is very cohesive. There were no dissentions in any of the meetings this year and the last one was in June 2022 when Esther George voted for a 0.50% hike when the rest of the FOMC voted for 0.75%. We suspect that was only because it was the first 0.75% hike since 1994. All the others were 0.25% or 0.5%.

We should see a lot less turnover in 2024. Chair Powell does not come up for reappointment until 2028. The only other retirement coming in 2024 is at the Cleveland Fed. We don’t expect any big changes in policy or ideology.

Electric Vehicle (EV) Update

Sales of EVs, which include plug-in hybrids and regular hybrids reached 18% of all vehicle sales in the U.S.

Here it is on a monthly basis.

U.S. electric vehicle sales chart
Source: FactSet, 12/06/2023

U.S. electric vehicles are still mostly in the luxury category where they account for 34% of sales. They’re only 2% of the non-luxury category. The big run up in 2022 and 2023 was partly due to the $7,500 tax credit that companies and people receive to buy or lease an EV made in the U.S. 

China remains the biggest producer and buyer of EVs with annual production over 6 million. The next biggest is the U.S. at around 1 million. Tesla makes about 1.2 million cars but some of those are made in China and Germany.

So, all good? Not quite. Some of the best EVs, as measured by range, price and performance are made by Chinese companies like Zeekr, Geely, (which owns Volvo), Nio, and BYD, which is partly owned by Berkshire Hathaway. They’re all on an export tear but there won’t be any on U.S. roads because of a 25% tariff on all vehicles coming from China, which is on top of a long-standing 2.5% tariff on all cars and 25% tariff on trucks.

Chinese EV manufacturers are way ahead of international competition partly because they started earlier and received heavy state subsidies. China sells around 26 million cars a year, compared to the U.S. at 15 million and EVs account for 36% of Chinese market. Official policy is for EVs to be 80% of the market by 2030. The Chinese auto industry went from a net car importer to exporter in 2022 and is now exports over 3 million vehicles a year making it the world’s largest car exporter.

The Chinese EV juggernaut is up and running. Meanwhile companies like General Motors, Ford, and Stellantis all announced cuts in current or planned EV production.  

It’s thus a strange mix of strong demand, loads of government subsidies, some clear winners in engineering excellence and a general desire to decarbonize as much as possible but combined with trade tariffs in the U.S. and the EU. The EU just started an anti-subsidy probe into China’s EV exports to the U.S.

It’s unclear how it’s going to end. Perhaps with more Chinese companies setting up plants in the U.S. and EU, a strategy successfully pursued by Japanese companies in the 1980s, EV’s will start to get cheaper. But there’s going to be a lot of disruption ahead.

The Bottom Line

Markets had another good week with the general melt up continuing. U.S. small cap stocks continued their run up from late October with a rise of 3% and up 13% in four weeks. U.S. Treasurys, especially the 10-Year note also rallied with yields hitting 4.1% at one point on Thursday. Remember they were at 5% on October 19. This has been one of the quickest rallies in fixed income that we can remember.

Why all the excitement? It’s all to do with a cooling of the economy that seems measured and deliberate rather that sudden and damaging. In the last week, we saw the number of job openings and quit rates fall, productivity increase, and things like the ISM surveys, the Fed’s Beige Book, and the Employment Cost Index and the NFIB are part of a long list of a cooling economy. The market reckons that a) the Fed is done hiking b) that they may cut in April to May of 2024 c) that inflation has come way back down and d) employment pressures are easing.

We’d agree with all of that although the timing on any Fed cut is more of a variable given that we’re going into an election where the Fed will do everything it can to show impartiality. So, the closer we get to November, the less they’re likely to move unless something sudden happens.

We also heard some soothing noises from the ECB, when Germany’ Isabel Schnabel, a very hawkish member of the  Executive Board, spoke of the “remarkable” fall in inflation and all but took further rate hikes off the table. Call it a German moment of when Governor Waller said very much the same thing last week with comments about confidence in getting inflation back to 2%.

Bunds, the equivalent of the U.S. 10-year Treasury, is now at 2.2% compared to 3% a month ago. European equities had another good week. They’re up between 15% to 30% this year with the broad European index up around 19%, more or less in line with the S&P 500.

We’d still caution getting too involved in markets too close to the year end. Portfolio managers tend to window dress, take winnings and book losses in the final weeks of the year. But the general mood of the market is very heathy and we expect it to remain so.

Art: Cecily Brown (b. 1969)

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