Citi: "Be Careful Of The Big Con"
Despite rising gas prices, rising mortgage rates, slowing income growth and the rise of 'low-quality' part-time jobs, 'con'sumer 'con'fidence 'con'tinues to rise to post-recession highs. However, as Citi's FX Technicals group notes, for the 3rd time in the last 17 year period we may be looking at a 4-year-4-month rise in consumer confidence before a turn lower again; and in spite of the Fed's rosy forecasts (and the market's expectations), we should be careful being too quick to believe that the sluggish economic dynamic that has 'dogged us' for the last 6 years is yet fully behind us.
Via Citi FX Technicals,
In our chart of the week we start with what we think is one of the most forward looking and influential Techamental charts we look at - CONsumer CONfidence.
– It has been pivotal in the last 17 years or so in giving a guide to the overall backdrop when it comes to the US economy and financial markets. In addition it has been a leading guide for equity markets (In 2000 and 20007 in particular.)
– In addition we will look at some of our other favored Techamental indicators and market charts
– Our conclusion: Be careful about being too quick to believe that the sluggish economic dynamic that has “dogged us” for the last 6 years is yet fully behind us. If we are correct then the Fed is likely going to have to agonize in the 4th quarter whether to stick with its implicit guidance and taper and even if they go ahead with that decision they may find themselves having to reverse it later.
For the 3rd time in this 17 year period we MAY be looking at a 4 year 4 month rise in consumer confidence before a turn lower again.
The peak in June followed by the subsequent fall away in July IF followed by lower levels in the months ahead would set up a picture very similar to that seen in both 2000 and 2007.
With this in mind it is important to look at 2 things:
– The factors that feed into how the path of consumer confidence is likely to evolve
– The “leading indicator” status of consumer confidence as a feedback loop into financial markets/the economy.
The move this time in mortgage rates is nearly twice as large as that seen into the 2000 and 2007 peaks in a timeframe that was 50% longer but at 9 weeks still very rapid.
In addition we got this 124 basis point move off a 3.40% low (36% change) versus at 7.86% level and 52 basis point move in 2000 (7% change ) and a 5.67% level and 67 basis point move in 2007 (12% change)
Into July 2008 we did see mortgage rates rise by 126 basis points – but that was
– Over a period of 6 months, not 9 weeks
– After consumer confidence had already turned sharply lower after the 2007 peak. Despite this consumer confidence did collapse nearly another 40 points in this 6 month period.
On a basis of speed, magnitude and starting point this is by far the most aggressive surge seen in the last 15 years. In addition we have seen a sharp widening in the spread between 30 year fixed mortgages and 10 year yields. A the peak in the 30 year fixed rate in 2000 that spread was about 188 basis points and 120 basis points in 2007.Now on a much lower rate structure it was at 197 basis points by end May and today still sits at 175 basis points compared to around 130-140 basis points in early 2010 and early 2011 when rates also pushed higher (Albeit much less aggressively than today). In fact in both those instances the spread actually dropped as mortgage rates went up much less than the rise in 10 year yields
As of today the rise in mortgage rates off the May low has been identical to that seen in 10 year yields.
So what else does the consumer care about?
The prior moves down in consumer confidence in 2000 and 2007 both came as an existing rally in Oil extended and accelerated (Too far relative to the economic backdrop)
The break higher in Oil at the end of 1999 / early 2000 also saw a peak in consumer confidence
The 2007 break higher on Oil came just after the peak in confidence but as Oil continued to rally, confidence fell.
This time we have so far broken through short term levels on Oil but not the more important ones yet.
Next good resistance stands at $115 (The 2011 high) above which we would expect an acceleration (possibly back to the all-time high above $147 posted in 2008.)
There is no doubt in our mind that such a move would be near impossible to justify from a fundamental basis and therefore would expect it to come from a supply shock dynamic. The resulting rapid rise, if seen, would act as a sharp “fiscal drag” effect on the economy.
We are already 25% higher from the lows of April this year and 16% higher in just the last 5-6 weeks coming straight after the surge in yields
During the rise into consumer confidence into 2000 and again in 2007 we saw initial claims fall sharply hitting lows below 300k in both instances.
As consumer confidence peaked initial claims in those 2 instances was averaging around just under 300k compared to the present number of 326k
In the following months as consumer confidence rolled over we started to see initial claims rise once again and continue to rise for the next 18 months+
As consumer confidence peak in 2000 and 2007 unemployment was at 4% and 4.7% respectively while second quarter GDP in those years was 8% and 3.6% respectively. Today’s numbers do not have anything close to those robust numbers to buffer this potential drag.(Yields, Oil, underemployment, fiscal tightening etc). ISM was also well above the 50 level in June-July those years as it is now…but moved back into contraction (Sub 50 ) before the year was out.
The jobs hard to get index is just off the trend lows (As it was in both 2000 and 2007 as consumer confidence peaked)
It is also just above good support at 35.10 which was the break out point in October 2008. However a big difference here is that when this index was at this point in 2008 on the way to breaking higher and also at the peak in 2003 before heading lower the unemployment rate averaged around 6.3% compared to the present 7.6%. At the same time the underemployment rate(U6) was at 10.4% (2003) and 11.8%(2008) respectively compared to the present 14.3% (having bounced from 13.8% in May)
This suggests that while the present level of the unemployment rate at 7.6% is just 0.1% off the trend low it is still higher than it should be at this point. In addition the qualitative nature of this number as measured by the U6 number which takes into account things like
– People who are disillusioned and have left the labour force
– People working part time jobs who would like full time jobs
...suggests that the 7.6% number overstates the improvement
Bottom line it appears that the consumer at this point has been overly optimistic about both the quantitative and qualitative improvement on the jobs front. Further deterioration on the U6 number if seen would further validate this concern.
Given that small business is recognized as the backbone of the US economy and the primary vehicle of private job creation this chart bears watching at this point.
For the third time since 2011 we have moved back towards good resistance around 94.5
– Feb 2011: Peaked at 94.5 and fell back to 88.1 (6 months later)
– April 2012: Peaked at 94.5 and fell back to 87.5 (7 months later)
– May 2013: Peaked at 94.4 and moved lower in June
IF this indicator continues to drop in the coming months it would add another “building block” of concern.
While the NAHB index (National Association of Homebuilders) has just moved into expansion territory (Like the ISM above 50 is expansion) sentiment seems to have “got ahead of itself” relative to actual activity
We are now seeing even greater divergence than that seen in 2010-2011 whereas building permits, new home sales and housing starts corrected lower the NAHB index then also corrected with a lag.
So far the building permits and starts peaked in April-May and have turned lower since while the NAHB has moved to new highs. New home sales at this point are still holding on to their gains
The obvious point this chart makes is that the level of the S&P 500 does not reflect the relative confidence of consumers
While consumer confidence has just posted a trend high, it is significantly below the 2000 and 2007 highs while the S&P 500 made new highs in 2007 and again this year.
The second point is that the Equity market trends down when consumer confidence turns down with a 3-4 month lag.
In 2000, Equities peaked first in March and consumer confidence posted a double top in May. Equities did not trend down aggressively until after Consumer confidence fell away
In 2007, consumer confidence peaked in July and the Equity market made a marginal new high in October. That high was unsustainable and we saw a peak as confidence also collapsed.
In both 2000 and 2007 once the Consumer confidence peaked and turned, the Equity market continued higher for another 3-4 months but was unable to sustain the new highs as confidence continued to fall.If confidence continues lower in the months ahead (after 4 years and 4 months of gains like the last 2 cycles) then we would be careful with the sustainability of an elevated S&P 500. In the short term the trend is your friend and “skeptical participation” seems to be the “order of the day” We would however be careful with this rally from a multi month perspective as we move into Q4.
Rising mortgage rates, an elevated Oil price, sequestration drag, significant underemployment, possible Fed tapering and question marks about who will be the new Fed Chairperson all serve to create a potential drag/uncertainty that could have a negative feedback loop to the economy
The Fed is “data dependent” although it is obvious they are still aiming to taper (Possibly as early as September) There is no doubt however that some comments in the Fed’s statement yesterday were designed to give “wiggle room” just in case
– They stated inflation holding below 2% for an extended period could be a risk. Well, core PCE is at 1.05% (The lowest print ever recorded in its 53 year history) and has been below 2% for 4 ½ years.
The GDP quarterly Personal consumption core price index is not much better. It moved back below 2% in Q2 last year and now stands at 0.8%
The lowest we have seen in this in its 54 year history is 0.7% (Twice in the sixties-1961 and 1962 and again in 2009)
Even core CPI has been trending down
Has been falling since the May 2012 2.3% level and is now down at 1.6%
– They expressed concern about mortgage rates (Not surprising)
– They marginally changed the growth dynamic to modest rather than moderate
If economic data holds up they are still likely to move. However at the same time there is a danger that the yield dynamic and or Oil scenario could get exacerbated and provide an increased negative feedback loop.
Bottom line : The present Fed does not have the robust backdrop that Greenspan had in 1994 or Volcker in the late 1970’s that allowed the economy to absorb (Albeit painfully) the headwinds of higher yields (And in Volcker’s case higher Oil prices)
This increases the danger that it could become a “policy mistake” and/or that the present backdrop deteriorates over the coming months once again causing the Fed to backtrack. At some point in every year since 2007 the Fed has expressed a more positive forward looking outlook on the economy and/or the housing market and every time they ended up having to backtrack.
Our bias is that QE should be wound down, not because we are looking at a robust recovery, but because we are less than convinced of its merits relative to its negatives. However, what we believe does not matter. The present Fed believes it helps.
If, as our charts suggest, we are not yet at that point of “Escape velocity” in the US economy and still have 2-3 years of repair to get through, then there is a small chance they do not taper... but a bigger chance that they do, only to end up reversing course later on.
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