The Weekend Edition # 109 - Is the US Economy Overheating?

Welcome to another issue of the Weekend Edition.

Thank you to all who’ve read and welcome to all the new subscribers this week!

Here’s what we cover:

• Market Recap - Weakness Continues

• Macro - US GDP

• Earnings Season Q3 - Warnings abound

• The Week Ahead - Economic & Earnings Calendars

• Closing Thoughts - Overheating Economy?

Let’s dive in ⬇️

Market Recap - Oct 16 - Oct 20, 2023

We were bearish going into the week. When we put out our MacroVisor Dashboard on Sunday evening, we noted that most markets were likely to have bearish momentum out 1-3 weeks. This view for the broader US Markets has not changed. Here’s a free look at our dashboard.

We believe that we will continue to see weakness in the next two weeks, at least until the end of the month and then we have the BoJ meeting on Oct 31 and the Fed meeting on Nov 1.

The S&P 500 closed lower for the day on Friday on higher volume. So there was an active bearish push despite some intraday buying. The major indices have now all closed below their 200-day moving average, which is a major line in the sand for technical analysts. We're not out of the woods here.

The Nasdaq-100 however, still lingers slightly above that 200-day line but, still below the 50-day Moving Average. We have big tech earnings next and that could bring some strength to the Nasdaq, if earnings are better than expected.

Commodities

Oil rebounded higher with news of escalation, as did Gold. Gold is now less than 1% away from touching $2000/oz, and we may see a push towards that number - 2000 being an important psychological level.

Agricultural commodities also saw a positive week and continue to look bullish for the short-term. Base metals have not fared well particularly in light of continuing turmoil in China.

We’re cautious on commodities after these extreme moves but, see some continuation into the week.

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Macro - US GDP

Third quarter US GDP Advance numbers are set to be released this week on Thursday Oct 26, 2023. Ahead of the print, I thought we could look at what's driving the GDP growth from the second quarter and what we're likely to see for the third quarter, particularly given that forecast estimates are trending much higher. 3Q GDP Growth is expected to be 4.1% QoQ vs. actual growth of 2.1% QoQ achieved during 2Q 2023.

Second Quarter Real GDP Growth

In 2Q23, the primary drivers of GDP growth were personal consumption, non-residential investment, and government expenditure. Upward revisions to prior months suggest real consumption growth expanded at a strong 4.0% annual rate last quarter.

In the second quarter of 2023, non-residential fixed investment experienced a significant upswing, largely fueled by substantial growth in expenditure on structures—much of which is attributed to the ongoing effects of the Inflation Reduction Act—equipment, and, to a slightly lesser degree, intellectual property. This resurgence in investment is notably remarkable considering the escalating costs of capital and increased economic ambiguity.

The more unpredictable elements of GDP, such as net exports and inventories, played a minimal role in GDP's overall performance. On the other hand, residential investment saw a decrease for the ninth straight quarter, even though there are indications that the housing market may have reached its lowest point in recent times.

Bottom line for 2Q: We saw a 2.1% increase in real GDP QoQ. What we continue to see is strength in the economy from services spending, government spending and business investments. 

Expectations for Third Quarter Real GDP Growth

As I pointed out earlier, the third quarter estimates are notably stronger with the consensus coming out at 4.1% growth in QoQ Real GDP.

Atlanta Fed runs a model that updates with every data point that comes out. This GDP Nowcast model is estimating a growth of 5.4%, as of Oct 18, 2023. Barclays has the estimate at 5.1% QoQ and JP Morgan revised up their estimate to 4.3% QoQ.

All of these increases were driven by factors that noted the resilience in the US Economy. Here are some of the more notable ones:

Retail Sales and Consumption

One of the major data points was the Retail Sales number that came out on October 17, 2023. The number that we take for the GDP is the Control Group data.

The "retail sales control group", published by US Census Bureau, represents the total industry sales that are used to prepare the estimates of PCE for most goods.

The control group data has been positive for 3 months running now and with the last reading coming out at +0.6% MoM and 3.8% YoY.

Furthermore, sales in restaurants and bars, which are the only components from the report that the BEA incorporates into its calculations of PCE services, quickened to a growth of 0.9% month-over-month, coming after an upward adjustment to a 0.4% increase in August. This progression effectively dispelled previous indications of a slowdown.

Industrial Production

Industrial production data came in stronger than expected with utility production data coming in stronger. Industrial production number came in positive for 3 months running with last month's reading at 0.3% YoY.

However, indications from various capital expenditure trackers suggest a potential standstill in the third quarter of 2023—a prospect that is expected to be underscored by an upcoming decline in US business fixed investment, as per the GDP report due next week.

Exports have also been weaker than imports and that’s something to keep an eye on, as is, the shift in lower levels of inventory. Ultimately however, the strength of consumption and government spending is likely to continue for the third quarter.

Earnings Season - Warnings abound

FactSet Earnings Recap:

We had a number of major earnings this week and despite quite a few beats, we’re behind on Earnings Growth. Guidance remains soft for many of the industrials and we’re seeing signs of a slowing economy.

• Consumer spending - Tesla’s earnings was a washout. They missed on every metric but, what’s more important is that despite all the price cuts, they’re not increasing revenues or margins. In the face of better than expected growth at Netflix, this tells us that the consumer is becoming more discerning. It’s not the time for large-ticket purchases.

• Freight Recession - JB Hunt posted a double miss. But, what was most alarming is that this drop in revenues came on increased volumes. Volumes +3.9% q/q with the last week of September posting the best volume since 1989. The company is seeing lower freight rates and higher costs, leading to lower margins.

• Inflation and Copper Prices - FCX posted better than expected results but discussed that they would be slowing expansion plans due to inflation and slumping prices for copper used across the global economy.

• Logistics - Prologis, one of the largest warehousing companies in the world with customers such as Amazon and Walmart had this to say:

The Week Ahead - Calendars

US Earnings Calendar

US Economic Calendar in Eastern Time (Source: Trading Economics)

Closing Thoughts - Overheating Economy?

The US economy has shown remarkable resilience despite a slowdown in manufacturing growth.

The Fiscal Impulse, i.e., Government Spending has not just directly fueled GDP Growth but, as well has put money into the hands of the consumer through stimulus packages that were bigger than any time in history. Much of that is still driving spending and the cost of Taylor Swift tickets is just one measure that proves it.

While 4Q GDP is set to slow because the stimulus is gone, excess savings are almost gone, student loan repayments have restarted, it's still the case that the US will end the year at quite a high relative Real GDP growth. That slowdown due to the hiking cycle is taking far longer than expected.

Oh but, we have one more issue to contend with though, which will amount to more spending:

But the repercussion of this kind of growth is inevitably inflation remaining higher than expected. As Chair Powell keeps reminding us, the economy will need to be at below trend growth to reach the inflation target of 2%. And if this overheated economy does not cool down, the Fed remains resolute in cooling it down.

Here’s wishing you safe investing.

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.