Consumer Cracks With No More Snacks
Consumers continue to cut budgets, even when it comes to snacking
Highlights
Consumers continue to cut budgets, even when it comes to snacking
The rally in value yesterday lacks fundamental support
Build-up of economic slack means interest rates are heading lower
Productivity gains from AI (for now) do not match the hype
While We Were Sleeping
Global equities are set to finish with a sixth consecutive weekly winning streak, with Europe staging a third straight session in the green (+0.5%). U.S. futures are mixed — Dow up but Nasdaq down as this value over growth trade extended into the overnight session. Asia was mixed — Japan’s Nikkei 225 this time was the laggard (-2.5%) with Taiwan (-1.9%) and Korea (-1.2%) also suffering steep losses and China’s Shanghai Composite was flat. But there were gains to be had in Hong Kong (+2.6%), India (+0.9%), and Singapore (+0.7%). Bond yields are steady in the U.S. but up +3 to +5 basis points across the Atlantic. It was a completely different picture in Asia where the 10-year JGB rate dropped -2.5 basis points to 1.05% and by -5 basis points in Australia to 4.32% (and -6.5 basis points in New Zealand to 4.48%).
The 10-year T-note has faced stiff technical resistance below 4.2%, notwithstanding yesterday’s excellent CPI report. Oil climbed for the third day in a row, with WTI firming 1% to $83.43 per barrel (even with the IEA cutting its 2025 global oil demand growth forecast to 980,000 barrels per day from just over 1 million barrels per day) though gold (-0.5% to $2,404 per ounce — it closed in on a record yesterday) and Bitcoin (-0.8% to $57,086) have seen a round of profit taking. Bonds are trading a tad defensively even though France’s CPI came in lame and tame at +0.1% MoM in June (+2.2% on a YoY basis). All market quotes are time-stamped to 4:45 a.m. (ET).
A word on yesterday’s bizarre market action. First, the Magnificent Seven collectively shed $598 billion of market value in the steepest one-day loss since February 2022. Nvidia’s stock fell -5.6% (but is still up slightly for the week), Meta stumbled -4.1% and the rest of the group dropped between -2% and -3%. Tesla saw its run end with a stunning -8.4% slide. The headlines scream “rotation!” as the small-cap Russell 2000 gapped up +3.6%, hitting over a two-year high in the process. The S&P 400 Mid Cap jumped +2.5%, and is back above its 50-day trendline. The S&P 500 Equal Weight index popped +1.2% to the best levels since late May. And even with the falloff in the Nasdaq, it is still overextended, being +6.5% above its 50-day moving average. The bizarre thing is that it typically is longer duration growth stocks that benefit most from lower inflation and lower bond yields. So-called value stocks, the ones that ripped yesterday, typically respond much better to higher inflation and higher rates because they are inherently cyclically-oriented.
Not just that, but the segments of the stock market that did best yesterday were the same ones that deflated the most in the CPI report — as in, the areas seeing the weakest pricing power. So, this smacks more of a value trade built on technical and short-covering as opposed to anything durable. Growth stocks are generally where you want to be in this environment, but they are too pricey, especially in the Tech space — but to be going long “value” stocks despite their more alluring valuations in a 1%+ GDP growth backdrop with declining pricing power makes absolutely zero sense.
Quote of the day:
“Excess supply has led to heavy discounting, like everyone, you get impacted.”
— Delta CEO Ed Bastian in an interview yesterday following the airline’s earnings release
Price cuts have been “particularly acute” for June through August, Bastian said, estimating that industry capacity is exceeding demand by three to four percent. Carriers have already taken steps to resolve the issue by pulling down capacity starting in September (prompting both American Airlines and Southwest to cut their forecasts for the June quarter).
Indeed, as we saw yesterday, CPI airfares are down four months in a row (-5.1% YoY) and look set to deflate further in the coming months. And it’s not just the air carriers — have a look at Pepsico Results Indicate Shoppers Are Cutting Back Their Spending on page B3 of the WSJ and Cheetos Are the Latest Economic Red Flag on page B10. The opening line of the first piece just about said it all: “Inflation-weary shoppers are finally cutting back on potato chips” (as the Frito Lay business deflated -4% YoY in the latest quarter). Come on — once consumers stop snacking, you know a recession is on its way.
Feeling “confident” yet, Jay?
Second best quote goes to Chicago Fed President Goolsbee with his “profoundly encouraging” depiction of yesterday’s CPI report. Better late than never, as the saying goes.
The Fed is way behind the growth curve, as much as it was behind the inflation curve in 2021. By staying on hold as inflation fell, the Fed has actually embarked on a backdoor tightening since July 2023 with the real funds rate climbing an additional +40 basis points — the interest rate shock has been so massive that the inflation-adjusted funds rate has soared 10,600 basis points since the tightening cycle commenced in March 2022. This actually is unprecedented, having taken out the 1980-1981 punishing cycle unveiled by Paul Volcker when the real funds rate soared 10,200 basis points over a comparable time frame.
Such is the nature of the beast… the central bank is always slow to react to shifting economic circumstances and in both directions. This is the reason we have business cycles. The question is not so much timing the meetings though I do think we will see rate cuts at the September, November, and December meetings, but whether the Fed goes -50 basis points at one or two of these. But what is important is the destination and it is 2% for the funds rate, and this is important because the markets are priced for a 4% terminal rate. I come to this conclusion by the pattern of the historical record. The Fed always brings the funds rate to or below the five-year average when the easing cycle commences, with or without a recession. The average of the past five years is 2.2%, and the current rate is 5.3%. Not since the spring of 1982 has the gap been this wide — and it will close if the past is prescient.
Even under the Fed’s assumption that the R-star is 2.75%, that means that just getting rid of the excess restraint, before it even provides the economy with the stimulus it will be begging for, will mean cumulative rate relief of 250 basis points. Do the yield curve calculations off a 2% funds rate, and you get to 2.25% for the 2-year note, 2.75% for the 10-year, and 3.5% for the long bond. If that manages to happen in the coming twelve months, the total return for the long bond will be +22% (versus +16% for the 10-year T-note). The power of convexity.
It’s not just the funds rate. The spot interest rate for the small-business sector is also 300 basis points above the five-year average and 250 basis points for both auto loans and residential mortgages. For investment grade credit, try a near-175 basis point spread between the current rate and the average of the past half-decade. Unwinding this 2022-2023 rate shock is going to be fun to watch if you are bullish on rates. Within the equity market, the large banks, select REITs, defensive growth like Staples and Health Care, as well as Utilities should like this prospect. If Big Tech weren’t so wildly over-owned and overvalued, they too could be included… but for another time. A weaker dollar should be good news for the precious metals complex to be sure.
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