The yield on the 10-year Treasury note plummeted over 50 basis points during November and expectations for a fed funds rate cut shifted from late in 2024 to the first quarter of the new year. This sentiment shift supported a rally in US equities and in gold since gold tends to move inversely to interest rates. In other words, the market has been pricing in a Goldilocks scenario that consists of lower inflation, a soft landing or non-recession, Fed easing early in 2023, and a rebound in corporate earnings in 2024. However, as Mohamed El-Erian noted on CNBC this week, believing this scenario is possible in the current complicated environment is the equivalent of believing a pilot could land a jumbo jet without any passenger feeling any landing at all. The risks are therefore high, that the consensus will be proven wrong.

China/Debt/Gold

Perhaps if the US were functioning on its own, a soft landing might be possible. But there are risks on the horizon. The largest of these could be China. We have often written about the problems facing the Chinese economy in terms of its property crisis, but this week Moody’s lowered its rating on China’s A1 debt rating from stable to negative. This was the first rating shift on Chinese debt by Moody’s since 2017 and the company commented that the costs to bail out local governments and state firms while controlling its property crisis would weigh heavily on China’s massive economy. China’s total outstanding off-balance sheet debt is estimated to be somewhere between $7 trillion and $11 trillion, according to the International Monetary Fund. This figure would include corporate bonds issued by thousands of local government financing vehicles which borrowed money to build roads, bridges, and other infrastructure. According to a senior economist at UBS, most local government financing vehicles currently depend on capital injections from local governments, government subsidies, and external funding because they do not generate enough cash from their operations to cover the interest payments. The longer-term risk is that this massive debt problem becomes systemic to the Chinese banking system and becomes a global banking problem.

Meanwhile, China’s CSI 300 Index (000300.SS – 3,394.26 CNY) is trading at its lowest level in nearly five years. This backdrop of falling real estate prices, risk of debt defaults, falling stock market prices, and a weakening currency, explains why Chinese consumers are actively buying gold (GC=F $2038.30). According to the latest Chinese retail sales data, gold and silver jewelry have been among the best-performing consumer goods in China this year, with a 12% rise in value year-on-year in January-October and outpaced only by garments. A Chinese consumer survey released in late October found that 70% of consumers between the ages of 18 and 40 intend to purchase pure gold jewelry. Together, China and India, the world’s two biggest gold buyers, account for more than half of total global demand. And according to commodity analysts, China is the world’s top buyer of physical gold has been an increasingly important driver behind this year’s rally in global spot gold prices. Gold has clearly become the safe haven trade for Chinese investors. Perhaps the rally in bitcoin (BTC – $43,886.05) is also a result of Chinese investors looking to protect themselves from a weakening currency and falling stock and property prices.

Pivotal Points in Technical Indicators

As we noted last week, the technical charts of the popular equity indices remain bullish with the first level of resistance encountered at the July highs and the second, and most important resistance, found at the all-time highs. Only the DJIA has exceeded its July high on the recent advance, touted by many to be the start of a new multi-year bull market. The July highs of 4600 in the SPX and 14,500 In the Nasdaq Composite have not been bettered and stock prices retreated as they tested those levels. The Russell 2000 index, which is our personal favorite for defining the broad marketplace, broke above its 100-day and 200-day moving averages last week, but the index remains neutral in its long-standing trading range between 1650 and 2000. In sum, the recent uptrend is unconfirmed. See page 8.

The 25-day up/down volume oscillator is at a positive 3.49 reading this week and has been in overbought territory of 3.0 or higher for four consecutive trading days. This is a positive development, but to confirm the recent advance this indicator should remain in overbought territory for a minimum of five consecutive trading sessions. In short, this indicator is close, but has not yet corroborated the recent uptrend as a significant trend. To date, both downtrends and uptrends have failed to sustain oversold or overbought readings for a minimum of five consecutive trading sessions. See page 9. However, this is in line with our long-held view that the stock market is in a broad trading range, which is a substitute for a bear market. We expect this range, best seen in the Russell 2000 index, to remain in force until inflation has been clearly brought under control.

The American Association of Individual Investors (AAII) survey showed a 3.5% increase in bullishness (48.8%), and a 4.0% decrease in bearishness (19.6%) last week. Bullish sentiment remains above average for the fourth consecutive week and bearishness is also below average for the fourth consecutive week. But more importantly, bearishness is at its lowest level since the January 3, 2018 reading of 15.6%. This extreme bearish reading in 2018 was followed by a 10% decline in the S&P 500 by February 8, a 13.6% advance by September 20, and a 19.8% decline by December 24. For the full year, the S&P 500 fell 6.2% in 2018. This too supports a view of a volatile trading range marketplace.

An Economic Mix

The headline ISM manufacturing index was unchanged in November, but six of the 10 components fell. The backlog of orders component declined to 39.3, its lowest reading since May 2020. The non-manufacturing index rose from 51.8 to 52.7, but the rise was mostly due to a buildup in inventories to 55.4. Order backlog also fell from 50.9 to 49.1. Readings below 50 indicate a contraction. See page 3.

The 5.2% GDP pace in the third quarter was the fastest rate recorded in nearly two years. Inventory build was a big contributor, consumption rebounded from a weak second quarter, and trade was a drag. However, this was the fourth consecutive quarter of negative real retail sales, which is typically associated with a recession. The key risk factor for the 2024 economy will be the strength of the consumer. See page 4.

Personal income rose 4.5% YOY in October, down from 4.8%. Disposable income rose nearly 7% YOY, down from 7.4%. Real disposable income increased 3.85% YOY, unchanged from September. Personal savings were $768.6 billion, up $19.6 billion, and the savings rate rose from 3.7% to 3.8%. But this remains well below the average long-term savings rate of 5.7%. See page 5.

Personal consumption expenditures rose 5.3% YOY in October and personal disposable income rose nearly 7% YOY. This marked the tenth consecutive month in which income exceeded consumption and it follows 21 consecutive months of consumption exceeding disposable income. Note that wage growth is decelerating for most employee sectors of the economy, except government, where wage growth was 8% YOY in October. See page 6.

Gail Dudack

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Media Hyperbole

It is widely known that there is political bias in the mass media, but we continually see signs of bias in the financial press as well. The bias tends to be bullish or optimistic, which may seem constructive and comforting, but it can also be dangerous if it is misleading to the public and/or investors. We have pointed out several situations in the past and there was more this week. In particular, we just read a headline from an international news source that shouted in bold letters “US consumer confidence rebounds, house prices maintain upward trend.” We had just finished writing the back pages of this report, so we knew what these economic releases contained, and this headline did not match what we learned from the data.

This headline sounded like the economy was on the verge of an economic rebound. However, within the article it did state that “the Conference Board said its consumer confidence index increased to 102.0 this month from a downwardly revised 99.1 in October. Economists polled by Reuters had forecast the index dipping to 101.0. The improvement in confidence was concentrated mostly among households aged 55 and up. Consumers in the 35-54 age group were less optimistic about their prospects.”

The fact that the 35-54 age group was less optimistic than those over 55 is noteworthy since this age group is of prime working age and has children in school, a combination that makes them core consumers and important drivers of the economy.

What was not made transparent in this article was that October’s index had initially been reported to be 102.6. This means the consensus estimate for November was 101.0 implying a decline in sentiment. And the only reason November’s index of 102.0 was better than forecasted was the large negative revision in October’s index, to 99.1. In our opinion, there is a bit of a sleight of hand to say that November’s confidence was a positive surprise and/or represented a rebound. Plus, the University of Michigan consumer sentiment index for November showed consumers were clearly worried, especially about higher inflation. The main index fell 2.5 to 61.3, present conditions were 2.3 lower to 68.3, and expectations fell 2.5 to 56.8. All in all, none of this supports a headline that says consumer confidence is rebounding, in our opinion. See page 6.

In terms of suggesting there is an upward trend in house prices, it is more of the same. The article was referencing housing data from the Federal Housing Finance Agency (FHFA) which does not measure home prices but calculates an index (1991=100) which is defined as a weighted repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. It is a broad-based index but does not represent actual home prices. We doubt that the journalist understood this. Moreover, the FHFA index is released a month later than most other home price data, i.e., the article was referencing September data when data for October and surveys for November had already been released. See page 5.

As for the trend in new home sales and prices, according to data from the Census Bureau, sales were lower in October versus September, but up 17.7% YOY. New house inventories were at their highest level since January and the total months of supply of housing was 7.8, back to August’s level. But in terms of home prices, Census data showed that the average new single-family home price fell 10.4% YOY to $487,000 while the median price fell nearly 18% YOY to $409,300. This data does not support the international news article, but it does support the negative NAHB survey results reported for October and November. See page 4. In sum, do not believe everything you read.

Media Neglect

Not getting much attention by the media are the risks appearing in the Chinese economy. Most investors know about China’s property crisis and its impact across China is immense and ongoing. However, foreign investors have been souring on China for most of this year, and recent data shows strong evidence that the global trend of diversifying supply chains and other de-risking strategies are having a negative impact on the world’s second-largest economy. In the July-September period, China recorded its first-ever quarterly deficit in foreign direct investment, a sign of capital outflow pressure. See page 7. According to Rhodium Group (www.rhg.com), the value of announced US and European greenfield investment into China dropped to less than $20 billion last year, from a peak of $120 billion in 2018, while investment into India shot up by some $65 billion or 400% between 2021 and 2022.

Given this backdrop, it is not surprising that Chinese President Xi Jinping recently met with President Biden at the Asia-Pacific-Economic-Cooperation (APEC) Summit in San Francisco. Investment in China has dropped to historic lows, and President Xi attended the Summit in San Francisco to promote China’s economy. However, the data suggests that foreign firms are not only refusing to reinvest their earnings in China but are selling existing investments and repatriating funds. This trend could put further pressure on the yuan and dampen China’s economic growth in the long run. It also reduces China’s need to invest dollar inflows, which helps explain China’s decreasing demand for US Treasury bonds.

In terms of China’s economic activity, a survey released by The Conference Board showed that more than two-thirds of responding CEOs indicated that China’s demand has not returned to pre-COVID levels. Forty percent of respondents are expecting a decrease in capital investments in China and a similar proportion are expecting to cut jobs. In sum, corporations will become more dependent upon US consumers for top-line growth in the future.

Market Update

Not much has changed this week. The charts of the popular equity indices remain bullish with the first level of resistance seen at the July highs and the most important resistance found at the all-time highs. The near-term levels to monitor are 4600 in the SPX (July high) and the 1820-1827 area of the Russell 2000 index where the 100-day and 200-day moving averages merge. These short-term challenges are yet to be tested. However, while moves above these levels would be favorable for a year-end rally, the all-time highs are the real source of resistance. In our view, the longer-term trading ranges remain intact. See page 10.

Beware What You Wish For The consensus believes rate hikes are over and rate cuts, accompanied by a soft landing are in store for 2024. Yet, today’s rapid Fed tightening cycle would be most comparable to the early 1950s or the early 1980s. In both cases, Fed tightening led to multiple recessions. And while the stock market is currently rallying based upon the view that rates have peaked and will soon decline, the decline in interest rates following a tightening cycle has usually appeared in tandem with a recession. In short, the current stock market rally appears to be celebrating the onset of a recession, whether it is aware of it or not.

Gail Dudack

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Happy Thanksgiving to all! We are grateful for many things, but most of all the friendship and loyalty of our clients. Wishing you the best that Thanksgiving represents gratitude, family, friendship, and great food!!

Momentum Shift

After a strong four-week advance off the October lows, US equities retreated this week. Part of the retreat was due to a string of weak earnings reports from retail companies, but stocks also stalled from a lack of news that could move stocks higher. Even a positive earnings report from chip designer, Nvidia Corp. (NVDA – $499.44), failed to impress, and the stock traded lower in after-market trading. Nvidia noted in its earnings report that it faces challenges in both Israel, where employees are being called up for active duty, and in China, where sales will be affected by US export controls. The release of FOMC minutes confirmed the consensus view that the Fed is apt to be on hold, barring any bad news on the inflation front. This is a positive factor, but it has already been discounted by rising stock prices.

However, the technical condition of the market did improve in the last week. Trading on November 14 recorded a 91% up day, i.e., volume in advancing stocks represented 91% of total NYSE volume. In addition, the NYSE total volume for the day rose above the 10-day average. This combination displayed a positive shift in conviction. (Note that our indicators use NYSE volume versus composite volume to separate day trading and professional hedging from actual buyers and sellers.) The 10-day average of daily new highs rose to 122, above the 100 benchmark that helps define an uptrend, while the 10-day average of daily new lows fell to 79, below the 100 benchmark. This combination also reversed a negative trend that had been in place since mid-September. See page 12.

Nevertheless, our 25-day up/down volume oscillator is at a negative 0.40 reading this week and neutral. See page 11. This lackluster response, despite several strong days of upward momentum, does not surprise us since it is in line with our view that the market is long-term trendless. Our view that the equity market will remain in a wide trading range, a substitute for a bear market, has not changed.

The charts of the popular equity indices continue to be bullish with the first level of resistance seen at the July highs and the second level of resistance found at the all-time highs. The key levels to watch in coming days are 4600 in the S&P 500, which is roughly the July high and the 1830 area of the Russell 2000 index where the 100-day and 200-day moving averages merge. These levels pose near-term challenges for these equity indices and will help define the strength of the current advance. The favorable seasonality of the November, December, and January months are in the stock market’s favor, but it was disappointing that the Russell 2000 index was the worst performing index in this week’s pullback. We do not expect year-end strength to carry the indices to new highs and this suggests that the long-term trading ranges will remain intact.

The Economy is a Tale of Two Cities

Strategists can be broken down into two distinct groups of those looking for a recession and those looking for a soft landing. However, the underlying data drives this division.

The positive factors include October’s headline CPI showing a 3.2% YOY rise, the PPI for finished goods falling 0.4% YOY, and the price of crude oil down 3.8% YOY. This combination makes a lower inflation outlook seem probable. Some inflation benchmarks are still higher with core CPI at 4% and core PPI at 3.2%, but overall, most inflation benchmarks are now below the long-term CPI average of 3.4% YOY. In short, inflation is lower, and if not yet at 2%, it is still below average. See page 3. This coupled with a job environment that is neither robust, nor weak, makes a soft landing credible.

However, this would be the first time in history that inflation at or approaching a double-digit pace, was not followed by a series of recessions. And it would be the first time that the real fed funds rate did not have to rise to 400 basis points before an inflationary trend was reversed. See page 4. We believe the jury is still out whether the current 200 basis points in the real fed funds rate will cure inflation. See page 4.

Neither the last recession nor economic recovery were normal business cycles. The recession was the result of a mandated shutdown of the economy and the recovery was the result of historic stimulus policies by both the administration and the Fed. Does this mean it will be different this time? It is difficult to tell. Inflation is a cruel tax on the lower end of the income spectrum, and this is what sparks a recession. We can see this in the current economy, which is a tale of two cities, i.e., the wealthy and the poor.

Retail sales were down slightly in October, but up 2.5% YOY. However, if adjusted for inflation, real retail sales fell 0.7% YOY in October and were negative for 10 of the last twelve months. Negative real retail sales is typical of a recessionary economy. See page 6.

Consumer credit growth has been decelerating all year, which is not a surprise given the rise in interest rates and interest costs. However, the most disturbing development is the increase in the number of people taking hardship withdrawals from their 401k plans. Wells Fargo & Co. (WFC – $42.60) reported a rise in such withdrawals last week and Fidelity National Information Services Inc. (FIS – $53.90) reported a similar trend this week. These withdrawals are a sign that many households are in very poor financial shape. Moreover, it suggests that future consumption trends will likely slow in the US. This is in line with weak reports from retailers in the third quarter. See page 7.

The housing market had been a boost to the economy in the first half of the year, but that has changed in recent months. Existing home sales were 3.79 million in October, the slowest pace in 13 years. Housing affordability is at its lowest level since 1985 and the NAHB survey is at its lowest levels since the start of the year. It is clear that rising rates are taking a toll on housing. See page 8. The 2023 economy has been a division of the haves and the have-nots, and the question is will higher income families keep the economy afloat in 2024, or not? It is an important question since the recent rally has carried the averages back to a relatively rich level. S&P Dow Jones consensus estimates for 2023 and 2024 are $214.65 and $242.73, respectively, down $0.53, and $0.60, respectively, this week. LSEG IBES estimates for 2023 and 2024 are $220.38 and $244.98, down $0.24, and $0.33, respectively. Based upon the IBES EPS estimate of $220.38 for this year, equities remain overvalued with a PE of 20.6 times and inflation of 3.24%. This sum of 23.84 is fractionally above the 23.8 level that defines an overvalued equity market. Note: based upon the S&P estimate of $214.65, the 2023 PE is even higher at 21.1 times.  

Gail Dudack

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Kicking the Can Down the Road

A stopgap spending bill that would extend government funding at current levels into mid-January was passed hours ago. This gives House lawmakers time to craft several detailed spending bills that will cover everything from the military and defense allotments to scientific research. Some Republicans on the party’s right fringe were frustrated that the bill did not include the steep spending cuts and border security measures they sought; nonetheless, the bill was passed with help from the Democratic side of the House, and it pushed the potential of a government shutdown into the New Year.

However, the partisan gridlock seen in Congress is not over and this is what led Moody’s to lower its credit rating on US debt from “stable” to “negative” last week. Moody’s pointed to economic risks including high interest rates, the government’s steadily-growing debt pile, and political polarization in Washington as reasons for the downgrade. Treasury Secretary Janet Yellen voiced disagreement with Moody’s shift, nevertheless, this implies she is blind to the ballooning deficits that now point to long-term fiscal risks. Burgeoning federal debt has recently provoked fresh warnings from economists, politicians, and credit-rating agencies.

Monthly fiscal deficits surged during the COVID shutdown and then fell on a year-over-year basis as stimulus payments began to fade and people went back to work and started paying taxes. However, a 12-month sum of monthly deficits began growing again this year and showed a 135% gain as of July 2023. This declined to a 29% YOY gain in October once Californian individual tax payments came due. Nevertheless, deficit spending is on an ominous trend, and particularly worrisome since the debt ceiling has been suspended until 2025. Not surprisingly, last week’s $24 billion sale of 30-year Treasury bonds (part of the government’s $112 billion debt sale) drew weaker-than-expected demand. This resulted in a yield of 4.769%, or 0.051% higher than the yield in the pre-auction trading in order to entice buyers. Primary dealers, who buy up the supply not taken by investors, had to accept 24.7% of the offering, more than double the 12% average for the past year. All in all, it was considered a bad performance, and it shows how rising debt levels will eventually push interest rates higher.

Moody’s had been the only one of the three main assessors with a top rating for the US. Fitch Ratings downgraded the US government credit rating in August following the latest debt-ceiling battle. S&P Global Ratings stripped the US of its top score in 2011 amid that year’s debt-limit crisis.

Here Comes Goldilocks

The equity market had a muted response to these debt risks, probably due to the fact that the economy has been surprisingly resilient. Yet it had a wildly bullish response to October’s CPI release. October’s headline CPI was unchanged for the month and up 3.2% YOY. This was down from 3.7% YOY in September and better than the consensus expected. However, if you look at the major components of CPI the only segments showing weaker than headline inflation were fuels & utilities, transportation, education & communications, and apparel. See page 3. There is still work to be done to get inflation down to the Fed’s target of 2%.

More importantly, core CPI rose 0.2% in October and was up 4% YOY, down slightly from September’s 4.1% YOY. Service sector inflation was still high at 5.1% YOY in October, down from 5.2% YOY in September. See page 4. What is clear from the history of inflation cycles is that it takes years for inflation to fall back to average or less after a sharp spike in rising prices. Inflation has been decelerating for 13 months and the consensus is declaring victory. This week equity traders began to discount an expectation that the Federal Reserve has not only ended its tightening cycle, but that rate cuts are on the horizon in the first half of 2024.

Some optimists suggest that inflation is already at 2% if housing, which lags home prices, is eliminated from the CPI equation. We doubt this is true and we doubt that consumers would agree or that renters are seeing only a mere 2% rise in rents. What is in fact helping to dampen service inflation is the recent decline in medical care services. But note that most medical services, including medical insurance, are repriced in the fourth quarter, so this favorable trend could shift in coming months and push core CPI higher at year end. See page 5. In short, this week’s rally is ushering in a Goldilocks scenario which we believe is unlikely.

Warning Signs

There are warning signs of economic weakening. The NFIB small business optimism index fell 0.1 point in October recording its 22^nd month below the long-term average. A long below-average reading is typically a sign of a recession. What we noticed in the last NFIB survey was that sales fell to their lowest level since July 2020, i.e., during the COVID recession, and earnings fell to their second lowest reading since June 2020. See page 6.

In recent weeks we reported that credit card balances increased to more than $1 trillion and newly delinquent rates on credit cards are at the highest level in over a dozen years. In addition, a Bank of America report indicates that a growing number of “cash-strapped Americans” are using their retirement nest eggs for emergency funds. The number of Bank of America 401(k) plan participants taking hardship distributions in the third quarter was 18,040, an increase of 13% between the second and third quarters and the highest level in the past five quarters since Bank of America began tracking this data. This ominous trend shows that while many financial commentators emphasize the “resiliency of the US economy” there is a growing segment of the population experiencing financial stress. The economy may be weaker than some suspect.

Big Technicals

The charts of the popular equity indices are surprisingly bullish after this week’s big price rise. The first upside resistance in most indices is found at the July highs, and the next resistance would be the all-time highs. This week the Russell 2000 index had it best performance since November 2020, rising 4.5% after October’s inflation report, but the index will encounter important resistance around the 1830 area where the 100-day and 200-day moving averages merge.

We remain cautious. Seasonal factors are usually bullish in November, December, and January, and this dramatic surge in prices could be hedge funds jumping ahead of what is seen as a seasonally strong equity market in order to lock in gains prior to yearend portfolio pricing. It does not appear to be a broad-based demand for equities. Either way, our view of the market is unchanged. The trend is neither bullish, nor bearish, but stuck in a broad trading range which is a substitute for a bear market decline. We have been expecting this trading range to persist until inflation is under control. In short, traders may be jumping the gun.

Gail Dudack

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As we near the end of the calendar year, we know that seasonal factors favor a stronger stock market. However, we also recognize that the outlook for 2024 is clouded by the Ukraine/Russia and Israel/Gaza wars, the uncertainties surrounding the presidential election in November 2024, questions about monetary policy, nagging inflation, rising credit card balances, rising credit card delinquencies, questions about the health of the US consumer, the ability of the US Treasury to fund ever-growing levels of debt, and most importantly, the prospect for corporate earnings.

Yet, what may soon jump to the top of the list of concerns will be the possibility of a government shutdown. This will not be a debt ceiling debate. On June 3, 2023 President Biden signed a bill that suspended the government’s $31.4 trillion debt ceiling until January 2025, in other words, until after the presidential election. Nevertheless, while there is currently no limit to how much the US government can borrow, Congress is required to approve government spending. Historically this has been in the form of a budget proposal originating from the President for the fiscal year (October 1 through September 30). Typically, this budget then goes to the House Ways and Means Committee which creates its own budget, details are debated and negotiated by both houses of Congress and passed. However, Congress has only completed this process in a timely manner three times in the last 47 years. The last time was the budget for the fiscal year ending in 1997.

Continuing Resolutions

The alternative to this process is a continuing resolution (CR). Continuing resolutions are temporary spending bills that allow federal government operations to continue when final appropriations have not been approved by Congress and signed by the President. Without final appropriations or a continuing resolution, there could be a lapse in funding that results in a government shutdown. This is the situation Congress will soon be facing, again. On September 30, House and Senate lawmakers passed a short-term budget extension to avoid a shutdown at the start of the new fiscal year which began on October 1 but that deal will expire on November 17. In short, lawmakers will be back in the same legislative predicaments they faced in mid-September in less than 10 days.

At present, House and Senate leaders have not made meaningful progress on a full-year budget deal or short-term compromise plan. The new Speaker of the House, Mike Johnson (Republican – Louisiana), has said that budget cuts or other policy riders will be included in upcoming proposals from his chamber but Senate Majority Leader Chuck Schumer (Democrat – New York), has called those ideas a dead end. Political analysts suggest there are three choices for Speaker Johnson. He could push for a simple funding bill that would move the November 17 deadline into next year without any strings attached. He could pair government funding with GOP priorities linked to immigration or other policies like cutting federal spending. Or Johnson could propose a “laddered CR” that would extend government funding for different agencies for different periods of time. This would allow lawmakers to favor certain parts of the government over others. For example, defense and homeland security spending would be placed ahead of other agencies. Still, without a continuing resolution, active-duty troops will not be paid any salary and hundreds of thousands of federal employees will be furloughed.

We suggested this once before, but we think Congressional salaries should be sacrificed for every day of a government shutdown. It might improve productivity in Washington DC.

Credit Card Woes

Recent data from the New York Federal Reserve revealed distinct pockets of weakness in the consumer sector and this could impact future economic activity. Total household debt balances grew $228 billion in the third quarter across all types of borrowing, particularly for credit cards and student loans. Credit card balances increased $48 billion in the quarter and $154 billion on a year-over-year basis. It was the eighth consecutive quarter of year-over-year increases and the largest increase since the NY Fed began collecting data in 1999.

This expansion in consumer debt helps to explain the surprisingly high GDP growth seen in the quarter, but it is coming at a cost. Credit card delinquencies increased from the historical lows experienced during the pandemic and topped pre-pandemic levels by the end of the quarter. Mortgages, which comprise the largest share of household debt, have delinquency transition rates that are below their pre-pandemic levels; nevertheless, auto loan and credit card delinquencies have surpassed their pre-pandemic levels. The rise in credit card delinquencies is being led by Millennials, whereas Baby Boomers, Generation X, and Generation Z have delinquency rates closer to 2019 levels. Delinquency rates have been increasing in each income quartile but are rising fastest for lower-income credit card holders. Those with combined balances over $20,000 have the highest delinquency transition rate, but fortunately these balances represent only 6% of credit card holders. Not surprisingly, delinquencies are rising most quickly for consumers with auto and student loans.

Haves and Have-Nots

In the second half of the year, the winding down of fiscal stimulus, the rise in interest rates, and the resumption of student loan payments, began to impact households, particularly the lower-income category. Still, the post-pandemic expansion has been an unusual one and continues to be a story of the haves and the have-nots. Seen from one point of view, higher income households have been going to Taylor Swift concerts, enjoying expensive cruises, and traveling the world for fun. Lower-income households have been battered by high inflation and are having trouble paying their mortgage, paying rent, putting gas in their car, and paying for their children’s education. The third quarter GDP of 4.9% did not feel all that special from their perspective.

This week we also review vehicle sales, Conference Board consumer sentiment (seven out of 10 consumers expect a recession in the next 12 months), ISM indices, the employment cost index, and S&P earnings. See pages 3-7.

Technical Update

The Russell 2000 index spent only two trading days below the key 1650 support level, which was too brief to confirm that the breakdown in the index was significant. This is good news since a breakdown would have meant much lower prices for the overall market. In upcoming weeks, the most important index could be the SPX as it trades between its 100- and 200-day moving averages, which represent resistance at 4400 and support at 4251. See page 8. The 25-day up/down volume oscillator is at a positive 0.90 reading this week and neutral, after recording an 89% up day on November 2, on volume that exceeded the 10-day average. See page 9. However, this indicator did not confirm the advance in August nor the weakness in October. This is in line with our long-held view that the equity market remains in a broad neutral trading range.

Gail Dudack

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