DATA DIVE - Disconnect

While Central Banks are now cancelling their recession forecasts, the underlying economic data continues deteriorating. This is a simple reality.

Euro Area GDP expanded 0.1% QoQ in Q1 which given the positive surprise of lower-than-expected energy prices, the continued sizable government fiscal spending and China’s reopening, can only be described as weak at best.

If we look at the GDP of Holland, this contracted -0.7% QoQ on weak exports and personal consumption, despite a positive contribution of 50bps from increased government spending.

This deterioration is reflected in Economic sentiment surveys.

Euro Area ZEW economic sentiment cratered to a negative -9.4%

Economic sentiment was a solid leading indicator in late 2021 and early 2022 of the material slowdown we saw later that year. The fact that it has been declining again for the past 3 months, does not bode well for the mild rebound we saw at the start of 2023.

The situation is not so different in the US where consumer sentiment has also been declining since February, or in Australia, for that matter, where it just fell by -8% MoM in May.

I will return to the US in a minute, but first I wanted to highlight some data the ECB just released on Credit Conditions. The brief summary is that credit standards continue to tighten, while demand for credit continues to shrink.

In the ECBs own words

“In the April 2023 BLS, euro area banks indicated that their credit standards for loans or credit lines to enterprises tightened further substantially in the first quarter of 2023. From a historical perspective, the pace of net tightening in credit standards remained at the highest level since the euro area sovereign debt crisis in 2011. The tightening was stronger than banks had expected in the previous quarter and points to a persistent weakening of loan dynamics. Risks related to the economic outlook and firm-specific situation remained the main driver of the tightening of credit standards, while banks’ lower risk tolerance also contributed.”

“Banks also reported a further substantial net tightening of credit standards for housing loans in the first quarter of 2023, while the net tightening became less pronounced for consumer credit. The net tightening of credit standards on housing loans was mainly owing to banks’ higher risk perceptions and lower risk tolerance, while the tightening contribution of banks’ cost of funds and balance sheet constraints remained contained.”

And, just as a reminder of how much of a lag it takes for interest rates to start to bite

“Firms’ net demand for loans fell strongly in the first quarter of 2023. The decline in net demand was stronger than expected by banks in the previous quarter and the strongest since the global financial crisis. The general level of interest rates was reported as the main driver of reduced loan demand, in an environment of monetary policy tightening.”

Less credit creation equals less demand in the economy, it really is that simple.

The situation is not so different in the US, as per the Fed’s latest Senior Loan Officers Survey, which showed continued (although not extreme) tightening in credit standards, but a significant decline in loan demand.

The result on final consumer demand is evident if we look at retail sales, which continue to decline.

As well as if we look at S&P earnings, which are down about -4% YoY, or Nasqdaq earnings down almost -8% YoY. Home Depot, which is a good barometer for consumer demand, just reported sales which were down -4.5% YoY, and the question you should be asking yourself is where does it go from here?

Total credit card & debit card spending is declining and is now negative on a year-over-year basis according to Bank of America.

Hedgeye shared an interesting statistic, which showed that for the first time in 13 years, consumers did not pay down their overall credit card debt in the first quarter of this year.

Even travel spending, which has remained resilient due to all of the pent-up covid demand, is starting to show signs of rolling over.

So, what to do with all of this information in the face of market resilience driven by a few AI sector exposure stocks?

It is easy to forget, in the face of so much outright bearish economic data, that Mr Market is a trickster and operates on a clock time all of his own. At any one point in time, there are many factors shaping how it behaves.

A major one this year has been the general understanding of this economic slowdown. Everyone was aware of it, everyone was prepared for it, and hence why it didn’t happen, or play out as many expected, myself included.

Does this change where the ultimate landing will be? I think not, it is just a matter of time. If anything it reinforces Central Banks ability to stay tighter for longer.

I am now seeing many people think that the worst is behind us and that somehow things will magically rebound from here. This narrative is driven more by price action in the markets, than by the economic data, for if you stop and think about it, where will this new surge in demand come from? Has the Fed begun easing? Is the US Government contemplating additional spending? Is the reopening in China what people thought it would be?

The answer to all of those is no of course, and ironically, the US is actually contemplating spending cuts!

One last point I will make on demand for the second half of this year.

Until now, an extraordinary Covid measure has still been in effect. US student loan forbearance program has meant that since March 2020 about 40M people in the US have not had to pay back a single cent of their student loans. This freeze ends at the start of July, and payments resume 60 days later, so by the end of summer, about 40M people will have to find an extra 300-400$ a month to start to make repayments towards their student loans.

How do you think that will impact demand?