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Good morning. Friday was a terrible day for the stock market. But defensive stocks — healthcare, consumers staples — held firm, like they are supposed to do on terrible days. Among them was Apple, which edged up while the rest of big tech was getting knocked around. Apple is a defensive stock now, even if Warren Buffett is selling down his stake. Send your thoughts: [email protected] and [email protected].  

Deep breath time

You know the story by now. Friday’s July jobs report was softer than expected. The market had a tantrum. This inspired both speculation that the inverted yield curve might have been right all along, and a lot of back-seat driving from would-be members of the FOMC.

It was all a bit overdone. Deep breath time:

• There is some reason to think the very low number of jobs added (114,000) was anomalous. In July there was an unusually high number of people with a job but not at work due to weather, and an unusually high number of people on temporary lay-off. These might mean revert. One month is just one month. 

• Over at The Overshoot (which you should subscribe to if you want to understand the US economy) Matt Klein makes another important point about the July jobs numbers. The number of what he calls “permanent” unemployed people — those who have lost their jobs and do not expect to be rehired — has been flat for more than a year. The increase in the unemployment rate in recent months is almost entirely down to new entrants to the job market, re-entrants, and (this month) those people temporarily away from work.   

• This is not the first month of 2024 when job creation was this low. April’s number was initially 165,000 but was revised down to 108,000. We didn’t panic then, and in May the number of jobs added doubled. Again, one month is just one month (OMIJOM). 

  

• Wage growth softened to an annualised rate of 3.6 per cent. But we had weaker readings than that in April, February, and last August. OMIJOM.

• Second quarter GDP growth was 2.8 per cent. And while it is early days, Atlanta’s GDPNow tracker is at 2.5 per cent for the third quarter.  

• As Torsten Slok of Apollo points out, a slew of high frequency data (airline passengers, restaurant bookings, bank lending, tax withholding, bankruptcy filings, card spending) are showing a solid economy. 

• Earnings in general have been strong. According to FactSet, with three-quarters of the S&P 500 reporting, the number of companies beating earnings estimates is above historical averages (though the size of the beats is lower than average). Earnings growth is the highest since 2021. Revenue growth is solid. Margins are strong. 

• Much has been made of soft earnings reports from consumer companies. McDonald’s is clearly having a hard time, as indeed are fast-food chains generally. People are not building many swimming pools (or much else). Amazon’s ecommerce business growth slowed to 9 per cent from 11 per cent a year before. Pepsi’s second quarter was not great. These are all important data points. But, slightly up the price ladder from fast food, Chipotle continues to see great growth. Coca-Cola continues to raise prices without facing much resistance. Colgate is cutting prices in the US, but volume is responding nicely. Royal Caribbean and Carnival report strong cruise demand. The picture is not all bad.

The US economy is undoubtedly slowing down. The most important measure of the slowdown is employment, and we’ve had a notably soft reading of that measure. So the growth outlook has weakened, and the probability of a recession in the medium term looks a bit higher. But there are other good measures that look just fine. The question of whether we are experiencing post-pandemic normalisation or something more worrisome is still open.

What is credit growth telling us?

Last week we observed that growth in personal consumption expenditure recently overtook growth in personal disposable income, suggesting that a slowdown in aggregate demand may be approaching, as consumers exhaust their pandemic savings.

Another key input to aggregate demand is household credit.

On one interpretation, if credit utilisation is rising, that supports demand. Access to and use of credit means people can buy more stuff. Conversely, if Americans either can’t get credit or are hesitant to use it, or are defaulting on the loans they have, that suggests demand is weakening. Ominously, perhaps, the credit data fits the latter picture. Credit growth up to the end of Q1 was still positive, but had slowed and defaults were ticking up:

More timely consumer credit data tells a similar picture. Revolving consumer credit growth was still positive as of May, but had been decelerating since 2023:

But there is another reading. Consumers at different income levels use credit differently. So an increase in credit utilisation can be a sign of a weakening economy, as lower income households take out more credit to delay defaulting on their existing loans. From Eric Winograd at AllianceBernstein:

What you are seeing is that credit card borrowing has increased. That is a sign that lower income households have eroded the financial cushion and are more reliant on credit. If the global market were to weaken, a lot more households would see their financial situations weaken, as banks would clamp down on credit creation.

That interpretation also broadly aligns with the data we are seeing. Though it is not accelerating as it did during the peak of inflation, household credit is still growing, while delinquency rates have been going up. Are a growing subset of households using credit to make ends meet?

Both interpretations are consistent with a consumer slowdown. And if the trend goes on too long, we may indeed see a further pick-up in unemployment, as cautious consumers can engender an “unvirtuous cycle” of slowing demand leading to higher unemployment.

But there is a third way to read the data. What we are seeing may not necessarily be a slowdown, but a broad normalisation after the pandemic altered the credit market. From Kay Herr, US chief investment officer for fixed income at JPMorgan Asset Management:

During the pandemic, you had transfer payments from the government and moratoriums on student debt and rent payments. All the while large swaths of the US economy were closed. This put household finances in a better place, which translated into lower income consumers getting increased access to credit and improved FICO scores.

Around 2021, after a year of high saving and low spending, the majority of US banks and credit card providers lowered their standards, resulting in an acceleration in total US consumer loans.

Household credit, on this reading, is just returning to its pre-Covid trend. And the default rate seems to be lining up with the 2019 growth trajectory, too.

Readers may be able to argue for which interpretation is the right one. For now, Unhedged just isn’t sure.

(Reiter)

One good read

Books.

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