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The charts and themes from the past week that tell an interesting story in markets and investing…
1) On the Way Down
U.S. inflation is on the way down. Overall CPI moved to 5.0% in March, the 9th consecutive decline in the year-over-year rate of change and the lowest level since May 2021.
Since the peak in CPI last June (9.1%), most of the major components have seen a noticeable decline in their year-over-year inflation rates. The three exceptions: Food away from home (restaurants), Transportation (airline fares), and Shelter.
Of these, Shelter is by far the most important, with a 34% weight in the overall CPI Index. And its 8.2% increase in the past year is the highest housing inflation we’ve seen since 1982.
But Shelter CPI is an indicator with a really long lag, and it significantly understated the true inflation rate in 2021 and the first half of 2022.
But since then, we’ve seen the opposite, with rents and home prices declining while Shelter CPI continues to march higher.
While Shelter CPI has been playing catch, it still only shows a 16.4% increase since the start of 2020 versus a 21.4% increase in actual Rents and a 38% increase in Home Prices (nationally). Which means that we could still see more increases in Shelter CPI to close some of that gap.
But when the lag ends and Shelter CPI stops moving higher, this will have a huge impact on CPI. It’s hard to say when that will occur but with each passing month we’re getting closer.
2) A Global Trend
We’re seeing a trend of lower inflation rates not just in the U.S. but in just about every country/region around the world.
That fact combined with significant tightening has led to central bank rates that are much more aligned with inflation. While the ECB is still behind the curve (3.00% rate vs. 6.9% inflation), the US is almost there (4.88% rate vs. 5.0% inflation) and Emerging Markets like Mexico (11.25% rate vs. 6.9% inflation) and Brazil (13.75% rate vs. 4.7% inflation) seem to have room to take a more dovish stance.
3) One More Hike?
As for the Fed, their next meeting is on May 3rd, and the market is currently pricing in an 80% probability of a 10th rate hike.
That would push the Fed Funds Rate above 5% for the first time since September 2007.
The 3-Month Treasury Bill yield seems to be pricing that in, moving up to 5.14%. A year ago this yield was at 0.79% and two years ago it was just 0.02%.
As for the Fed’s balance sheet, we continue to see a normalization following the post-SVB emergency spike (+$392 billion over 2 weeks) with total assets now falling $119 billion over the past 3 weeks.
Still, this is a big shift from the Fed’s aggressive tightening plans entering the year, illustrating once again the folly of forecasting. The markets are forever throwing surprises at us, this being the latest example.
4) Other Signs of Lower Inflation
The trend of lower inflation in the CPI report is confirmed by a number of other indicators:
- US Producer Prices (PPI) increased 2.75% over the last year, the 9th consecutive decline in the YoY rate-of-change and the lowest print since January 2021. PPI peaked at 11.7% in March 2022.
- Year-ahead business inflation expectations continue to fall, down to 2.8% in the latest Atlanta Fed survey. That’s the lowest we’ve seen since July 2021.
- Global Container Freight Rates (cost of 40′ Containers) are now lower than they were in February 2020 (pre-covid), down 87% from their peak.
- US Import Prices fell 4.6% over the last year, the largest YoY decline since May 2020.
- U.S. Asking Rents are lower than they were a year ago, the first YoY decline since March 2020.
5) Fed Forecasts Recession
The Federal Reserve is now projecting a “mild recession” starting later this year (March FOMC Minutes).
The impetus: “recent banking-sector developments,” aka the 2nd and 3rd largest bank failures in U.S. history.
Supporting this thesis is recent data showing U.S. Bank Deposits falling 4.9% over the past year, the largest decline in history. With fewer deposits, lending is likely to decline, leading to lower economic activity.
Small Businesses already seem to be experiencing this, with loan availability in the most recent NFIB survey at its lowest level in over a decade.
6) Consumers Pulling Back
US retail sales increased 1.5% over the last year, the lowest growth rate since May 2020 and well below the historical average of 4.8%. After adjusting for inflation, though, the story is far worse. Real retail sales fell 3.3% over the last year, the 7th consecutive YoY decline.
With wages failing to keep pace with higher prices for a record 24 months, the pullback in spending shouldn’t come as a surprise.
And with interest rates on credit cards surging above 20% for the first time, we could see further weakness ahead.
7) Is This Time Different?
In the past 55 years, every time the Fed has fought high inflation (CPI >5%) with rate hikes, a recession soon followed. Will this time be different?
Judging by the responses to my recent poll, most don’t believe so. 83% of respondents said that the U.S. economy is either in a recession today or will be heading into one in the next six months.
8) Commercial Real Estate Concerns
Spreads on BBB CMBS (commercial-mortgage-backed securities) have moved up to 996 bps, their widest levels since March 2020.
Fears of defaults are rising with the office sector being the largest concern.
U.S. office vacancy rates are at their highest levels since the savings & loan crisis of the 1980s/90s.
With commercial-real estate loans accounting for 38% of loan holdings at the median U.S. bank (KBW Research), this is adding to fears of continued stress in the banking system. Smaller banks are particularly exposed, holding 80% of all commercial mortgages ($2.3 trillion in CRE debt according to Trepp Inc.).
9) Skyrocketing Car Payments
New cars are increasingly becoming unaffordable.
The average monthly payment for a new car has skyrocketed to $777, which is nearly double the average payment in late 2019 (Kelley Blue Book data). Nearly 17% of consumers who financed a new car in the first quarter of 2023 had a monthly payment of $1,000 or more (a record high), up from just 6% in the first quarter of 2021 (Edmunds data).
What’s driving this?
Higher prices and higher financing rates.
The average interest rate on a 48-month new car loan in the US has moved up to 7.46%. That’s the highest we’ve seen since 2007. A year ago the rate was 4.87%.
The 259 bps increase in new car loan financing rates is the biggest YoY spike since 1980-81.
What percent of new vehicle purchases in the US are financed? Over 80%.
10) Bull Market in Auto Parts
With new cars becoming more expensive and cars lasting longer, many are delaying their purchase of a new vehicle.
The result: the average age of passenger cars & light trucks in the US has increased from 8.4 years in 1995 to a record 12.3 years in 2023.
This has been a secular tailwind for auto parts retailers like O’Reilly ($ORLY) and AutoZone ($AZO), both of which are all-time highs.
11) Investors Loving It
Another stock hitting all-time highs is McDonald’s ($MCD), which is now trading at over 9x sales. This is its highest valuation ever.
Interestingly, $MCD is trading at a premium to not only other fast food stocks (Yum, Chipotle, Starbucks) but also many prominent tech stocks (Apple/Google/Facebook/Amazon).
Another fascinating valuation: Hershey ($HSY), which now trades at over 5x sales, its highest ever.
12) Things You Don’t Often See in a Recession
Ferrari and Louis Vuitton (LVMH) are hitting all-time highs, having completely recovered from the 2022 downturns.
A stat that really surprised me: Ferrari is now trading at a higher price to sales (9.7x vs. 7.9x) and price to earnings multiple (52.7x vs. 51.3x) than Tesla. Meanwhile, Ferrari revenues have increased 4.3% over the past year (vs. 37.2% for Tesla) while its net income has fallen 8% (vs. 60% increase for Tesla).
13) Vacation Home Slowdown
Demand for vacation homes has plummeted, now 52% below pre-pandemic levels (Redfin).
What’s driving this? Higher interest rates, the lack of affordability, a decline in remote working, and the cooling rental market are all contributing…
14) Tapping the Reserves Again
Gas prices in the U.S. have moved up to $3.64/gallon (national average), their highest level of the year.
Perhaps in response to this and the recent OPEC cuts, the Strategic Petroleum Reserve is being tapped again. After a pause over the last 3 months, the reserves declined 1.6 million barrels over the last week to the lowest levels since 1983.
15) Rising Deficits and Rising Cost of Borrowing/Spending
The U.S. Federal Budget Deficit continues to widen, hitting a 13-month high of $1.8 trillion in March. Any notion of a “debt ceiling” is of course a farce. The U.S. government continues to spend money like a drunken sailor.
It’s becoming much more difficult to ignore the rising debt load given the rapidly rising cost to service that debt. The Interest Expense on US Public Debt rose to $812 billion over the past year, a record high. If it continues to increase at the current pace it will soon be the largest line item in the Federal budget, surpassing Social Security.
16) A Rising Tide
2023 thus far has been the complete opposite of 2022, with nearly every major asset class seeing gains.
The volatility index ($VIX) has moved all the way down to 17.07, its lowest close in 15 months.
And that’s it for this week. Have a great weekend!
-Charlie
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full disclosures here.
