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The most important charts and themes in markets and investing…
1) The Streak is Broken
After a record 12 consecutive declines in the US inflation rate, we saw a small tick higher in July, with overall CPI moving up to 3.2% from 3.0% in June. Core inflation (excluding food/energy), however, moved down to 4.7%, its lowest level since October 2021.
Here’s the breakdown in inflation by major category. We’re still seeing outright declines in Fuel Oil, Gasoline, Gas Utilities, Used Cars, and Medical Care. And as compared to June 2022 levels (peak in overall CPI), only Shelter and Transportation have a higher inflation rate today.
Why is Shelter CPI still higher than last June? Because it’s a wildly lagging indicator that only recently has started to reflect the more recent trends in housing inflation. YoY Shelter CPI has now moved down for 4 straight months, from 8.2% in March (highest since 1982) to 7.7% in July. A continued move lower in Shelter inflation is likely, which should have a big impact on overall CPI as Shelter represents more than a third of the index.
One of the best data points in the July report was lower food price inflation, particularly food at home. At 3.6%, this is the lowest rate we’ve seen since August 2021, down from a peak of 13.5% last year.
Within food, we’re seeing sharp declines in some areas. One example: the average price of a dozen eggs in the US has moved down to $2.09, 57% lower than the peak back in January ($4.82).
2) The Road to Prosperity
After a record 25 consecutive months of negative real wage growth, wages have now outpaced inflation on a YoY basis for 3 straight months. This is great news for the American worker that hopefully continues. The road to prosperity is paved with higher real wages.
What could jeopardize that in the near future?
Rising commodity prices. Gas prices in the US have moved up to $3.96/gallon, their highest levels of the year. Declining YoY commodity prices were a major tailwind driving the CPI lower over the past year but that trend is now coming to an end.
As a result, the Cleveland Fed is forecasting another increase in CPI for the month of August, up to 3.8%.
3) US vs. Europe
The US is currently sitting in a much better position relative to its European peers, with a 3.2% inflation rate vs. 5.3% in the Eurozone, 6.2% in Germany, and 7.9% in the UK.
The result of this differential is leading to a divergence in monetary policy, with the Fed expected to pause at its next five meetings while more hikes are expected in Europe.
4) A Tale of Two Cities
Depending on who you ask, higher interest rates are leading to the best or the worst of times.
This chart tells that story. American households are earning $121 billion more in investment interest income versus a year ago but are paying $151 billion more in interest payments on their loans.
If you have no assets and variable rate debt, you are feeling the most pain. This includes the growing number of Americans with credit card debt, which has surpassed $1 trillion for the first time.
This is an increase of 16% over the last year.
With credit card interest rates now at a record 20.7%, servicing that debt has become increasingly difficult.
On the opposite end of the spectrum are those with fixed rate debt (ex: low interest rate mortgage) and a high cash balances. Their interest income has surge with 5.5% Treasury Bills while their interest expense is unchanged.
7% mortgage rates have created an affordability crisis for new homebuyers but existing homeowners locked into low fixed rates are relatively unscathed.
5) A Fiscal Imbalance
US government spending increased 14% over the last year while tax receipts declined 7%.
As a result, the federal budget deficit has widened to $2.26 trillion, the largest in 18 months.
Rising debt levels and rising interest rates are not a good combination. The interest expense on US Public Debt rose to $857 billion over the past year, another record high.
And with 75% of outstanding Treasury securities maturing within the next 5 years, this trend is likely to continue. Why? Because the new bonds that are being issued in their place are at significantly higher yields.
The CBO is forecasting rising government interest payments over the next few years, but they are assuming an average interest rate of just 3%. If interest rates instead average 4%, payments will be significantly higher.
6) Higher Rates, Higher Valuations?
10 years ago the 10-year Treasury yield was at 2.7% and the Fed Funds Rate was at 0%. Today, the 10-year yield is above 4% and Fed Funds Rate is above 5%.
Have higher interest rates led to lower valuations, as many said with certainty would happen?
Not exactly.
Case in point: Apple, the largest US company. Its price to earnings ratio has moved from 12x a decade ago to 30x today while its price to sales ratio has moved from 2.5x to 7.5x.
How is this possible given the surge in interest rates?
Interest rates are just one of a multitude of factors that can influence valuations. Vastly more important are changes in investor sentiment and investors are simply much more optimistic today than they were a decade ago. That’s true for Apple as well as the S&P 500 as a whole.
7) A Big Shift in Trade
13.3% of US goods were imported from China during the first six months of 2023, the smallest percentage in 20 years.
Mexico is now the #1 trading partner with the US, followed by Canada. China, which held the top spot from 2015-2018 and again in 2020, has dropped down to third place.
8) Refilling the Reserves?
After hitting its lowest level since 1983, the US Strategic Petroleum Reserve is being replenished. The 142k barrel increase over the last week was the biggest since June 2020. At this pace, though, it’s going to take quite a while to refill. For the decline in reserves over the past 2 years was 273 million barrels.
9) New Housing High
The total value of US residential real estate hit a record $46.8 trillion in June 2023, surpassing the prior all-time high of $46.6 trillion set in June 2022.
10) Some Interesting Stats
a) Apple has bought back $588 billion in stock over the past 10 years, which is greater than the market cap of 492 companies in the S&P 500. Its shares outstanding have moved from over 25 billion to under 16 billion during this time.
b) The equity risk premium in the US is at its lowest level in decades.
c) The share of US autos that are being leased has moved down from almost a third of the market in 2019 to 20% today. Driving forces: higher interest rates and lower inventory levels.
d) There has been a boom in self-storage over the past few decades, driving up the deal prices paid for storage companies and the share prices of self-storage REITs.
e) How much American families have saved for retirement…
And that’s it for this week. Have a great week!
-Charlie
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