In Japan, they are trying to reverse years of deflation. Rates have been low for a long period. Pension funds recently dropped bond holdings from 58% on average to 55%. They are attempting to reflate. Can they drive inflation, will consumers consume now because of the fear of higher prices later? Recent Japanese economic numbers show some acceleration however this may simply be a reaction to the impending consumption tax, buying before taxes increase.
It’s too early to tell but I’m thinking in the simplest, personal terms, I’m not overly cash rich right now and if I have the capacity, sure I’ll buy what I need/want now to avoid paying more in the future. However, I don’t foresee my financial position changing much and I’m not going to spend funds I don’t have.
The core problem in the U.S. is that we are not seeing strong job growth and wage growth is sparse. On the macro scale, I think it is difficult to foresee a period of rising wages. We’d need to eliminate the slack first. Plus, on a global scale, companies are still very able to move resources to lowest cost countries. This certainly puts a cap on upside potential to the extent we are not the most competitive producer/manufacturer. On the flip side, we have mentioned that the vast reserves of energy which are now accessible will aid U.S. companies competitive position. This is however a longer term theme and not a cause of inflation any time soon.
Can we consume? Household debt rose by $241B in Q4. This is the largest increase since Q3 2008. Consumer balance sheets on average have been continuously improving post Great Recession. However, the U.S. consumer is still historically more leveraged than in prior years. Hence, what is the longer term capacity of the U.S. consumer to spend? It is probably limited. Slow growth is the most likely scenario and this does not raise the prospect for inflationary forces.
In fact, we can see in the past minutes from the Fed a growing concern about persistently low inflation as they noted “several factors that cast doubt” on the baseline view that inflation will revert back toward the mean or their target of 2.5%. It is something they have agreed must be “monitored carefully”.
While prices may not be dropping, they don’t seem to be increasing dramatically either. If you do happen to be cash rich or willing to leverage a bit, the weather seems to have impacted auto inventory. At the end of January, auto inventories were equivalent to 72 days’ supply or 10% above normal. February isn’t likely to have helped. Delayed buyers might come back to the market in the spring. Now might be a good time to bargain hunt before buyers come back when the weather breaks. This apparently is not happening soon as another winter storm bears down on the east coast.
One area we would have thought most impacted by current weather is housing. Numbers in this market segment are mixed. New home sales rose 9.6% in January versus a consensus of -3.4%. December U.S. Case Shiller home price index was up 13.4% versus consensus at 13%. Home prices continue to increase the rate of increase has slowed. On the other hand, existing home sales declined 5.1%, slightly below expectations with the largest declines in the West and Midwest. Affordability and tighter credit may be holding back activity along with weather as it does not appear to be a weather alone issue. Housing starts also fell to 880,000 in January from 1,048,000 in December. Contrary to what we’d think, regional data showed the Northeast north of 60%. Midwest was the worst down 67%.
There are some interesting points with housing and if you didn’t notice above, the student loan part of household debt has grown. Personally, my oldest is a college senior. He doesn’t have a job as of yet. I’m not sure if he’s coming back home or if he will decide to live with a roommate in an apartment at this point but I’d give both a high probability. I think this has been the standard over the past few years. As the newly graduated and employed, these add to potential home buyers as the economy improves. In 2009 we added just 400,000 new units. If we look at the estimated number of new households each year (increase in population divided by average household size) we need around 900,000 new housing units, not much different than the recent print. Factoring in a backlog created of the past years and reduced forward supply; we certainly have room for favorable surprises, even if it is a slow growth situation.
This brings me to the final review, are U.S. corporations on solid footing? (My son does after all need a job) We know they have larger cash balances. Earnings are difficult to sort through. Recent 4Q earnings seem to have been weaker with nearly 10% less of companies beating estimates than the long term averages would imply. Yes, while the number of companies may have been less, the ones who did beat added more to the bottom line than in the last two quarters.
Low rates are enabling companies to float bonds and use funds to buy back shares. AAPL and ORCL are prime examples. Low rates should provide ongoing affordability for housing. Improving economy should build on itself as employment continues to grow and more people are able to improve their finances and purchase homes. While we are not off to the races, we are on the right track. Numbers are likely to remain mixed through the first half of 2014. Low rates favor growth and we think growth will remain slow. Higher rates would indicate faster growth or inflation and we don’t see signs supporting either scenario. Low rates may be persistent.
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