Consumers Block Bears From Earnings Recession

Every week we receive an email from Credit Karma telling us how great we are that our credit rating keeps improving. Apparently, we are not alone as the average credit score has moved higher since Covid to 716 today. This week Trans Union CEO Chris Cartwright shared that consumer debt service to income is near historic lows, credit scores have been rising and lending remains elevated. Credit delinquency rates are at a healthy normal level, and the Consumer remains resilient. Add into the mix the full employment and a record summer travel season and it’s hard to conclude that our nation of profligate spenders is anywhere close to cutting up their credit cards. With 60% of our economic output accounted for by consumers, corporate earnings are also healthy since they pulled back from their Covid sugar highs. FactSet reports that for Q1 2023, 79% of companies show earnings above consensus expectations and 74% have Sales beating consensus. While 78% of the economy is tied to our consumer happy Service Sector, even moribund Durable Goods and manufacturing are holding strong since consumers shifted toward travel and away from stockpiling toilet paper. US Q2 GDP estimates are being revised higher to 3%+ as consumers are increasing their spend. This is bad news for inflation and interest rates, but good news in holding back the Bears hoping for an earnings recession. As seen below (green line), stock market company earnings fell modestly this past year and are forecasted to begin rising as the year progresses. Restrictive levels of interest rates to slow the economy are a necessity to bring inflation down, so analysts are waiting for clues that may alter this sanguine profit outlook. Thus far, the resilient consumer led economy favors high interest rates and economic slowdown being strung out over a much longer period than most currently expect.

Money managers and economists focus on proxies of historic patterns to forecast the future. The majority have maintained a pessimistic outlook this year despite surprisingly robust data to the contrary. As we often discuss, it’s challenging to experience a “bad” economy if you have full employment and an ongoing worker shortage.  Construction employment just hit new all-time record highs. The Auto and Manufacturing industries are touching new 15-year highs in their labor force. Homebuilders have been an excellent place to invest, despite 7% mortgage rates. Hotels, travel and restaurants are still desperate for workers despite near record levels of employment. There may be a plethora of historical proxies that have been screaming for the past year to watch out below, but can we say the sky is about to fall when these major industries continue to lack the capacity to meet demand? Low inventories and heavy backlogs will also provide a warning buffer when these strong trends finally roll over. 

Looking a bit closer at the $104 billion Auto industry we see that despite almost 15-year highs in their workforce, production supply remains well below demand with perhaps the lowest inventory levels relative to sales in history. High interest rates and rising loan delinquencies should temporarily slow the elevated pent-up demand for cars and trucks, but full employment and strong consumer balance sheets should buffer any downturns this year.

An interesting report this month shows that along with strong demand for cars, Class 7 and 8 Heavy Duty truck sales have shot up towards record levels. If trade and commerce is slowing, then it has yet to be reflected in the concern over the shortage of trucks and drivers needed to meet order flows. Another fascinating observation about Heavy Weight truck sales cycles is that they tend to fall off sharply well before an economic recession begins. In fact, commercial trucks always begin a sales downtrend before the stock market heads south into a Bear market. The equity Bear market of 2022 was a “stimulus” recession, removing the Covid free money premium from stock valuations. Any new downturn – Bear market – will be about true economic woes and throwing million out of their jobs. Truck sales may be peaking soon, but there are no signs of a downturn, which typically leads the economy and the stock market by months.

Looking at one more measure of US activity using Business Sales, it’s easy to see the Government handouts and easy money policy of the Fed that powered an enormous Covid sales surge that needs to be worked off in time or by reduced demand. While a 5 to 10% decline is warranted to bring down inflation and find an equilibrium for supply and demand, it would cause a deeper than forecast recession if sales fell too quickly. Current trends support a mild down to sideways pattern over a longer period without considerable damage to our economy, until inflation falls much further.

With full employment and strong income growth, consumers continue to show they can handle even higher debt loads. Interest costs should keep pushing debt service higher, but thus far consumer credit is strong and consumer utilization of their credit limits is healthy.

The problem for the markets may be a matter of perspective that eventually impairs consumers and the stock market. The Fed incorporates services, housing and owner equivalent rent into its measure of inflation progress. Unfortunately, almost all of the elevated inflation left for the Fed to fight is in these two areas where prices are very sticky. Even if the Fed can inflict enough monetary pain to curtail consumer travel and leisure, housing inflation has been very resilient and unlikely to fall sharply unless the rest of the economy has tanked.

When we view inflation without housing (purple line), the inflation fighting progress looks great. However, housing inflation (blue line) is a whopping 8%+ with no hint of a housing collapse to deflate, despite 20-year high mortgage rates. Millennials are forming families in high numbers and continue to snap up inflated homes with costly borrowing rates. Low inventories and limited building capacity have kept home inflation near record levels and boosted Apartment building boom while buyers wait for homes to come onto the market. This sticky inflation will keep Fed interest rates and core inflation at higher levels than the market is expecting. There will be a slowdown over the next year, but for now there is still too much money chasing too few goods, which keeps the stock market in a subdued trading range – ex Nvidia and mega tech.

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