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2023 – A year of infinite possibilities: Part 1 – The world’s biggest consumer

By Macrodesiac

12:15, 28 December 2022

Macrodesiac
Macrodesiac’s Tim Vollans on the likelihood of the US economy avoiding recession in 2023

As we knock on the door of 2023, infinite possibilities await the global economy and financial markets. Until recently, the bearish consensus was dominating the narrative: war, imminent recession, profits will fall, the stock market will plummet.

Then US inflation slowed by 1.1% in just two months. The imminent recession chatter is being challenged by persistently resilient economic data and a few contrarians who still think a soft landing is possible. The only certainty is uncertainty.

As the story unfolds, perhaps the path will become clearer. This three-part series is an attempt at mapping that path, or better said, possible paths. The optimal route is unlikely to be known until the ever-reliable 20/20 hindsight kicks in (around this time next year).

In part one below, we'll cover, forecasts, wages and the world's biggest consumer, followed, in part two by a summary of the rising rates environment and the effect on the economic cycle and potential for a company earnings recession to drag stock valuations lower. In the final part we'll move on to central banks, China and commodities markets.

Part one: Forecasts, wages and the world’s biggest consumer

It’s not likely to be a good year for anyone ignoring the many possible, viable routes and focusing solely on the destination (eg, stock market crash or new bull market). The path always matters at least as much as the end point. With that in mind, let’s start with the sell side S&P 500 (US500) price targets: 

2023 S&P 500 forecasts (via Jonathan Ferro):

  • Deutsche Bank 4500
  • Oppenheimer 4400
  • BMO 4300
  • JPMorgan 4200
  • Jefferies 4200
  • Wells 4200
  • Evercore 4150
  • RBC 4100
  • Credit Suisse 4050
  • Goldman Sachs 4000
  • HSBC 4000
  • Citi 4000
  • BofA 4000
  • UBS 3900
  • Morgan Stanley 3900
  • Barclays 3725
  • SocGen 3650
  • BNP Paribas 3400

1100 points between the high and low. That’s a wide distribution. Some will be more right than others, but blind monkeys could throw darts at a board and have a similar success rate. The price targets themselves are almost useless. To reinforce that point, the lowest price target for 2022 was 4400, and we’re all set to close out the year under 4000.

Should we all laugh at the sell side analysts for getting it wrong? Well, nobody’s stopping you, but that’s not the point. The targets are useful, solely as a barometer for sentiment and uncertainty. Two things stand out.

Firstly, the wide range at the extremes. How can two teams of analysts look at the same economic data, the same speeches, the same historical analogues, and come to such opposite conclusions?

Second, the clustering around the current price. Take Credit Suisse’s 4050 as your mid-point and the vast majority are within 150 points either side. So, things are either going to end up pretty much the same or VERY different. Helpful.

When you dig a little deeper, it’s even more baffling. Some think inflation will come down quickly and prove transitory after all. Others think it’s going to be sticky, especially in the 4-5% range. Economists also disagree on inflation-adjusted wages.

For 2022, inflation has been reducing purchasing power. Stimulus savings have cushioned the impact, but wage gains are struggling to keep pace with price rises, implying that people have, on aggregate, been worse off. As inflation falls, that dynamic could reverse, with wage bumps outpacing the current level of price jumps, at least for a while.

Bottom line: Nobody has a clue what’s going to happen. We could be heading back to a world where deflation fears outweigh everything else, especially if inflation continues dropping at the current pace. Or perhaps a world where inflation’s a sticky problem, but at lower levels than in 2022. Or we could even see another wave of inflation as the US economy picks up again and consumers believe the worst is behind them.

On that note…

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How resilient is the US consumer?

The US is the largest economy in the world, and depends on consumer spending for roughly 70% of that economic activity. In simple terms, the US consumer is a key component of global economic health.

The data’s currently painting a murky picture. Let’s start with the amount of cash in US household checking accounts.

chart one

Approaching $5trillion. Loadsa money. The far trickier question to answer is just how much of that is ‘savings’. It’s well-documented that the personal savings rate has plunged to levels not seen since 2005.

chart 2

Which doesn’t mean that people have run out of cash. It just means they’re not really adding to the stash. The rainy-day fund sits largely untouched, or is being drawn down to maintain lifestyles.

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JP Morgan thinks that any ‘excess’ savings will be spent by the middle of next year as households increasingly raid those accounts.

chart 3

Which is a dynamic that potentially suggests a slowdown in overall spending by the second half of 2023. Consumers may shift focus to rebuilding savings or feel less confident about freely spending with a smaller buffer behind them. Either way, spending would likely slow.

Outstanding credit card debt is at record levels, again suggesting that there’s limited headroom to drastically increase consumption:

chart 4

Charge-offs and delinquencies have risen slightly too. In its latest report, Discover, the third largest US card issuer (after Visa & Mastercard), reported a 20% Y/Y rise in outstanding balances, while charge-offs hit 2.46% and delinquencies were at 2.36%.

Not a disaster, but indicative of less consumer resiliency overall. However, a low household debt service ratio suggests that there’s still room for more borrowing before households really feel squeezed.

chart 5

The obvious problem is that all of this is aggregate data. It doesn’t reflect the situation across income bands. Those at the lower end of the pay-scale might be struggling more than those at the top.

However, those on benefits (approximately 70 million Americans) will see their payments boosted by 8.7% due to the Cost-of-Living Adjustment to be implemented by the US government from January 2023, outpacing robust wage growth that was running at 6.4% in November.

chart 6

Overall then, the picture for 2023 consumption isn’t as strong as it was, but it’s far from grim and depressing either.

To top things off, if Goldman’s forecast (mentioned in “if there’s no recession, what happens to inflation?”) is correct, disposable incomes could rise, even after adjusting for (declining) inflation:

“While there are risks on both sides, we think the real income upturn is likely to be the stronger force as we move through 2023, especially because the financial conditions drag will likely diminish assuming Fed officials do not deliver dramatically more tightening than the rates market is currently pricing.”

chart 7

The little red diamonds suggest that disposable incomes could actually be increasing towards the end of the year…

Wage growth will be a key dynamic to monitor in 2023. If wages keep rising then stock market valuations are at risk, especially if the Delta/Spirit Pay Awards become more representative of labour’s bargaining power:

“The agreement includes an 18% increase on the day the contract is signed, then a 5% increase one year later and two 4% raises in each of the following years. It also includes a one-time payment of 4% of 2020 and 2021 pay each, plus 14% of 2022 pay.”

Workers taking a larger share of the revenues could see profits decline, and if the worker is more flush with cash to spend, inflation could surge once more, leading central banks to raise interest rates again, or at a minimum, keep rates higher for longer, quashing hopes of rate cuts and a return to the cheap money regime.

Everything is priced relative to interest rates. If you can earn 5% on cash, why risk putting it into the stock market?

That’s the end of part one. In the next instalment, we’ll take a look at the late stage of the economic cycle and recession odds.

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