#1: Both regional Federal Reserve automated US GDP models are showing declining economic momentum during Q3 2021.
Here is the Atlanta Fed GDPNow model, where the latest estimate calls for 5.1 percent growth. This is the lowest QTD estimate and differs noticeably from the +7 percent expected by economists.
And here is the NY Fed’s Nowcast model, which shows the same downtrend. This model has been spotty in 2021, getting Q1 basically correct but underestimating Q2. It is the direction of the revisions that is concerning, therefore, not so much the actual 3.8 percent estimate.
Takeaway: there is a link to the data behind these models below, and our read is that supply shortages are one common driver of their diminished expectations. Home sales, manufacturing and employment trends are all contributing to reduced Q3 GDP estimates. Yes, there is still time to turn things around. A strong August Jobs Report on Friday would help – both models use that as an important input.
#2: It has been over 100 days (106, to be precise) since US inflation expectations peaked, as measured by Treasury Inflation Protected Securities prices. As the chart below shows, on May 17th 5-year inflation expectations were 2.7 percent and 10-years were at 2.5 percent. At the time, they looked like they were going right to 3 percent. That would have been a very bad sign indeed. In the entire history of TIPS issuance (2003 – present), inflation expectations have never breached 3 percent. And they still have not …
There is some magic to the mid-May peak in inflation expectations, in that the April CPI report was out on May 12th. It showed a 0.8 percent increase from the prior month. That was the highest reading in over a decade, but markets viewed that sort of increase as unsustainable. The following three months (May, June, July) have averaged 0.67 percent CPI monthly inflation, so that assumption has thus far proved correct.
Takeaway: we focus/fret about inflation as much as anyone, but the market is saying this is wasted energy. We’ve had +100 days with multiple inflation headlines and countless bold-faced names talking about this issue. And yet TIPS spreads go nowhere.
#3: We recently covered long run US house price trends, but today’s Case-Shiller Home Price Index reading is getting a lot of press, so let’s briefly discuss it.
The headlines are “greatest annual increase in home prices ever!”, and that is true. The June index is +18.6 percent over last year. That’s higher than September 2005’s peak comp of 14.5 percent.
Now, here is the headline you won’t read: the compounded annual increase in US home prices since the 2006 top is just 2.3 percent. That is less than half the CAGR from 1991 – 2006 (6.0 percent, as shown in the chart below). It is also right in line with long-run CPI inflation (2.0 pct CAGR since mid-2006).
Takeaway: US home prices are playing some catchup after what was a decade-plus of little to no appreciation. It takes a long time to build up a bubble in the US housing market (as visible in the chart above), and by our reckoning we are not anywhere near there yet.
#4: The latest US office occupancy data from ID card security company Kastle Systems is out (week of August 25th), and it shows a modest uptick despite summer vacations. Every large US city, in fact, saw more office workers in situ rather than working from home. As has been the case for many months, only the Texas cities (Austin, Houston, and Dallas) are anywhere close to 50 percent office occupancy. Still, even RTO laggard like San Francisco (20 pct occupancy) and New York (22 pct) did see modest improvements last week.
Takeaway: the data here is a good reminder that less commutation = lower monthly consumer expenses = higher potential consumer spending. As bad as the August office occupancy data is for urban employment (worth noting ahead of Friday’s Jobs Report), it is potentially good for discretionary spending.
#5: Famed, if somewhat tarnished of late, investment manager AQR was out with a fresh defense of value investing last week. There is a brief webinar that summarizes their perspective (link below), but here are the 2 charts that anchor their argument.
This first one is their analysis of the relative valuation between value and growth stocks for US large caps (darkest blue line), International large caps (lightest blue line) and Emerging Market large caps (blue line). By their estimate, all 3 equity asset classes are in the +90th percentile of historical value stock “cheapness” relative to growth stocks back to 1984.
AQR then asks the question “are value stocks cheap because future earnings growth expectations are below historical averages?” The following chart is their answer: “No”. Five-year forward earnings growth expectations for “cheap stocks” (value, dark blue bars) relative to “expensive stocks” (growth, light blue bars) are not much different now than what Wall Street analysts were forecasting from 1990 – 2017.
Here’s what we think AQR misses:
- Let’s use the S&P 500 Value index as a proxy for this investment style.
Almost half (48 pct) of it is in just three sectors: Financials (21 pct), Health Care (15 pct) and Industrials (12 pct).
We like all 3 groups, but we seriously doubt they can increase their earnings power by 11 percent annually over the next 5 years. That estimate, however, is what AQR’s defense of “value” uses to justify its thesis that this style is “cheap”.
- S&P Growth, by contrast, is 42 percent Apple (12 pct), Microsoft (11 pct), Google (8 pct), Amazon (7 pct), and Facebook (4 pct).
It’s a lot easier to believe all these companies can grow earnings by 14 percent a year over the next 5 years (current analysts’ expectations). The just doubled their earnings power from 2019 – 2021, after all.
Takeaway: while we agree “value” is cheap to “growth” just now, we think a clear-eyed take on the fundamentals explain far more of the gap than AQR does.
#6: Since we are at a month end, here is a price performance recap for major global equity indices, fixed income, and commodities for both August and year-to-date.
US Equities versus non-US Regions:
- S&P 500: August: +2.9 percent, YTD +20.4 percent
- Russell 2000: +2.1 pct, +15.1 pct
- MSCI EAFE: +1.4 pct, +10.5 pct
- MSCI Europe: +1.8 pct, +15.7 pct
- MSCI Emerging Markets: +1.6 pct, +1.4 pct
Comment: despite August’s reputation for volatility, every major global equity index was up for the month. Even Emerging Markets managed a late rally, and the index is now back to positive for the year. We’re still cautious there, preferring US large caps and MSCI Europe over EAFE (which includes Japan) and EM.
EAFE Markets (non-US developed economies, all MSCI Indices):
- Japan: August: +1.9 percent, YTD: +1.2 percent
- United Kingdom: +0.7 pct, +12.7 pct
- France: +0.9 pct, +16.3 pct
- Switzerland: +1.2 pct, +13.8 pct
- Germany: +1.2 pct, +10.0 pct
Comment: August’s global equity rally helped every major developed economy’s equity market, although none performed as well as US large caps. Worth noting: Japan did the best but is still barely up for the year. We continue to favor UK equities for their exposure to Financials and Energy.
Emerging Markets (MSCI Indices):
- China: August: -0.7 percent, YTD: -12.6 percent
- Taiwan: +2.2 pct, +22.4 pct
- South Korea: -2.3 pct, +0.7 pct
- India: +8.7 pct, +20.8 pct
Comment: China’s local Big Tech crackdown dinged the country’s equity index in August, but it could have been far worse. Through the 20th, MSCI China was down 7.2 percent on the month. There’s clearly some bottom-feeding interest here, and we are watching to see if 1) it holds and 2) the central government is done issuing fresh regulatory decrees. Also worth noting: India had a great month and is now the only major global equity market (developed or emerging) that is giving US large caps a run for their money.
Fixed Income (price change only) / Commodities:
- Intermediate Treasuries (7-10 years): August: -0.5 percent, YTD: -2.3 percent
- Long dated Treasuries (+20 years): -0.5 pct, -5.5 pct
- US Investment Grade Corporates: -0.2 pct, -2.0 pct
- US High Yield Corporates: +1.2 pct, +0.9 pct
- WTI Crude: August: -7.4 percent, YTD: +41.2 percent
- Gold: +0.2 pct, -4.2 pct
- Silver: -6.4 pct, -9.4 pct
Comment: pull up the August charts for WTI crude and the MSCI China Index (MCHI), and you’ll see they both bottomed on the 20th and rallied thereafter. Concerns about China’s near term economic growth hit both earlier this month, but late August brought some reprieve. We expect that relationship to carry on into September.
Atlanta Fed GDPNow model (complete dataset): https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf
NY Fed Nowcast: https://www.newyorkfed.org/research/policy/nowcast
Kastle Office Occupancy Data: https://www.kastle.com/safety-wellness/getting-america-back-to-work/
AQR webinar (6 minutes): https://www.aqr.com/Insights/Research/Webisode-Are-Value-Stocks-Cheap-for-a-Fundamental-Reason