by Jim Welsh
Macro Tides Monthly Report 01 March 2021
Traditional Sources of Pent-Up Demand
GDP estimates for 2021 keep climbing with the majority of economists expect a Roaring Twenties type of Boom kicking into gear in the second half of this year. Economists expect the successful vaccination of the majority of Americans to be completed by mid year which will unleash a torrent of pent-up demand. This concept is easy to grasp after a year of being careful, postponing vacations, not being able to enjoy frequent visits with family and friends around the dinner table, or catching a good movie and eating buttered popcorn, and spontaneously dining in at a favorite restaurant.
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A return to a normal life and being able to partake in all the ordinary activities that amount to a busy day and full life. There will be a surge in activity once it appears it is safe but are the high expectations for pent up demand beyond what is likely. Growing up I remember looking forward to an event for weeks and weeks and when the day finally arrived being left with the sense the day failed to measure up to what I was expecting. The second half of 2021 and early 2022 could provide that experience, if the level of pent up demand is weaker than expected.
Historically pent up demand was temporarily created when the Federal Reserve increased the federal funds rate causing the cost of financing the purchase of a car, home, and anything on credit to increase too much. As demand fell for cars, houses, and most consumer products, inventories would build up, manufacturers cut production laid off workers and a recession materialized. Once a recession became obvious, the Federal Reserve realized it had tightened credit too much and lowered the federal funds rate. Every post World War II recession (shaded areas in the chart above) was preceded by an increase in the federal funds rate. The lone exception was the 2020 recession which was preceded by a decline in the federal funds rate from 2.4% in July 2019 to 1.6% in November 2019 and before the Pandemic hit in March 2020.
The Unemployment Rate peaked at 9.0% in May 1975, 10.8% in December 1982, and 10.0% in October 2009 before beginning a slow descent after the recessions ended. The Unemployment rate topped 14.8% in April 2020 and by January was down to 6.3%. In the other 8 recessions the Unemployment rate never rose above 7.5%. In the majority of the 12 recessions since World War II the Employment Rate was 92% or higher so the vast majority of workers had a job.
The one thing that kept them from buying a new car, moving into a new home, buying furniture or a new appliance was the cost of financing. Having a job gave the majority of workers the capacity to be able to buy a car, house, and anything else they may have wanted once interest rates fell. This is true pent up demand which was triggered once the cost of financing declined. With demand improving companies rehired workers to rebuild inventories, the Unemployment Rate fell, Consumer Confidence improved and GDP growth accelerated.
Vehicle Sales Set to Slow
After prior recessions vehicle sales experienced a slow gradual recovery after an initial surge. The one exception was after the recession in 2001 which was not accompanied by a large drop in sales. As you may remember the U.S. car makers offered 0% financing for the first time in their history after the 9-11 terrorist attack. The auto companies took this step as their union employees would receive 90% of their pay whether they were making cars or not. It simply made sense to have them keep working which is why car sales held steady.
In 2020 after a plunge similar to what took place after the financial crisis, the recovery was extraordinary, with Total Vehicle Sales regaining almost all of the losses in six months rather than six years. The recovery in U.S. vehicle production has completely recovered with vehicle assemblies back to where they were in 2017, 2018, and 2019.
It is difficult to make the case that there is a pool of pent up demand for vehicles that will accelerate sales in the second half of 2021. The rate of improvement will slow in coming months and could turn negative in early 2022.
Demand for Housing Will Moderate in Second Half of 2021
The cyclicality in housing activity suggests it may be the most interest sensitive sector within the U.S. economy. With the modest exception of the 2001 recession, Single Family Home Sales fell significantly prior to every recession. Even prior to and during the 2001 recession housing activity dipped about 20%, but the Federal Reserve ameliorated the decline by slashing the federal funds rate to 1.0% so the real after inflation funds rate was below zero percent. This period also saw the onset and proliferation of exotic mortgages that boosted demand and eventually led to Liar Loans and the housing bubble.
Housing was still recovering from the financial crisis when the Pandemic hit which initially caused a two month drop in housing activity. The rebound in housing has been nothing short of amazing with a surge in demand from those wanting to move out of major urban areas, and those needing more space after transitioning to working remotely. Record low mortgage rates made this possible but the Pandemic induced surge in demand has likely peaked for those who were renting an apartment or wanting a larger home.
Existing home sales are significantly higher than in the five years prior to the Pandemic, so much of the pent up demand released by the Pandemic has already been satisfied. (Chart of Existing Home Sales compliments of Doug Short Advisor Perspectives)
In January 2021 Existing Home Sales were 6.69 million up 23.7% from the prior January, and the highest since 2006, according to the National Association of Realtors. Existing home sales are likely to hold up during the prime summer selling season but not increase much from current levels through the end of the year.
The lessening in demand from the Pandemic isn’t the only reason why the growth rate for moving out of the city or to a larger home will slow in coming months. The arrival of vaccines reduces the threat of the virus so the fear factor will be less in driving renters to move out of the city. Most the shift to remote working has already occurred and over time some portion of workers will begin to spend more time in a central office, whether it is 1 day a week or more.
According to the Labor Department this shift started in June as the percent of workers who ‘teleworked’ fell from 35% to just over 20% in October where it has held relatively steady. Unless another surge from the virus occurs this percentage is unlikely to rise in coming months. This will make it easier for those who haven’t moved to tolerate staying put. The factor that will affect a greater number of potential buyers is the price of housing, which has soared in the past year and lower affordability.
In January 2021 the median home price was $303,900 up 14.1% from January 2020. As this is an average it masks the larger price increases that have occurred in many suburbs surrounding major cities, but home prices are rising everywhere.
The median sales price for existing homes in the 180 metro areas tracked by the National Association of Realtors (NAR) rose in the fourth quarter from a year earlier. That is the second consecutive quarter that every metro area tracked by NAR posted an annual price increase, marking the first time this milestone has been achieved in back-to-back quarters since the NAR has been tracking data since 1980.
The surge in home buying has lifted the Homeownership Rate to 67.4%, not far below the all time high of 69.4% in October 2004 and 68.9% at the end of 2006. The large increase since the second quarter of 2019 when it was 64.1% has pulled some portion of pent up demand.
The home ownership rate between October 2004 and December 2006 was sustained by a collapse in lending standards and a level of speculation that will not be repeated, so any additional increase will be dependent mortgage rates remaining low since prices have risen so much and so broadly.
The time the average home is on the market has plunged from 43 days in January 2020 to 21 days in January 2021. This is primarily due to there being so little inventory of homes on the market for sale. In January 2020 there were 731,901 homes for sale and only 354,900 in January 2021.
This has created an environment where there are too many buyers for each home for sale. In January our daughter and son-in-law put their home up for sale and booked 36 showings in less than two hours, received 9 offers in four days, and accepted one that was 5% above their asking price. The whole process took less than a week. I expect the inventory of homes for sale to increase in coming months which should bring housing off the boil and slow the rate of appreciation.
There is feverish buying today but it is coming from buyers who are far more qualified than during the housing bubble. From 2004 through 2007 less than 25% of home buyers had a FICA score over 760 compared to more than 70% now.
Home prices have been rising faster than incomes for years. Since 2013 annual home price appreciation has never been less than 4% and in most years averaged more than 6%, while wages have never grown more than 3%.
The net result is that median home prices are far above median income, with the gap now almost as large as it was before the housing crash.
Even if the rate of price appreciation slows, for many reasons another housing crash is not going to happen. This doesn’t mean housing prices won’t fall at some point but today’s buyer is more qualified and banks are not as leveraged to home prices as they were in 2007. The affordability gap does mean fewer buyers can afford to buy a house, unless they already own a home with equity. Housing activity is not likely to incrementally add as much as it has to GDP growth in coming quarters as it has during the past year.
The Federal Reserve has been buying $40 billion of mortgage backed securities every month which has helped mortgage rates resist the increase in the 10-year Treasury yield, which has jumped from 0.50% on August 8 to 1.44% on February 26. During the same period the 30-year Fixed Rate mortgage has increased from 2.88% to 3.27%, and up from the record low of 2.65% on January 7 and 3.01% on February 18. Mortgage rates are likely to trend higher in coming months which will make buying a home more expensive and further lower affordability.
Retail Sales Dependent on Fiscal Stimulus
Retail Sales typically fall during a recession as unemployment rises and consumer confidence falls so even those with a job spend less. Auto sales are in retail sales, and although housing isn’t, all the stuff a new owner purchases i.e. furniture, appliances, etc are included.
The rebound in auto sales has been solid and housing activity has been extraordinary, so the fact that Retail Sales have been setting new highs shouldn’t come as a complete surprise. The main driver has been the stimulus checks consumers have received which more than offset the loss of personal income due to unemployment.
Consumer spending rebounded sharply last spring after consumers received the first round of stimulus checks. After receiving another $600 in January 2021, Personal income rose 10.0% and spending soared 2.4% M-O-M.
Retail sales slumped in the fourth quarter, but the receipt of more stimulus money lifted retail sales 5.3% in January. Electronics and appliances saw the biggest increase, up 14.7% for the month, while furniture and home furnishing sales were up 12%. After the financial crisis it took 30 months for personal income to get back to its prerecession level, which is why the rebound in auto sales, housing, and retail sales was so muted.
In 2020 personal income not only recovered what was lost within three months but zoomed to a much higher level. This provided consumers with cash to spend even after paying down credit cards and boosting savings. The comparison with 2008 is striking.
A breakdown of components within retail sales comparing the changes from a year ago and their five year average is instructive. Home improvement sales were up 30.0% from last year compared to its 5-year average of 1.1%, while furniture sales soared 31.7% versus a historical increase of just 0.7%. Even department stores registered an increase of 13.3% compared to an annual drop of -2.9%.
These sectors are not going to continue to grow at this pace. If housing activity growth slows as seems likely in coming months, the Y-O-Y rate may approach their historical averages later in 2021 or early 2022. The sectors that have fared the worst are no surprise, travel (Airlines -68.2%), Lodging (-39.6%), and Restaurants (Food & Drinks (-11.1%).
Travel and lodging represents less than 3.0% of GDP, Restaurants and Bars generate less than 5% of GDP, Arts i.e. movies, concerts, theatres comprise less than 5% of GDP, while Hair Salons and Barbershops account for 0.25%. The sectors that have been hit the hardest represent a relatively small proportion of GDP compared to the sectors that have held up well or actually benefited from the Pandemic.
Setting aside any difficulties with vaccinating enough people to reach herd immunity or the arrival of variants that make existing vaccines less effective, the sectors that have been in a depression could easily experience a huge surge from pent up demand. Millions of Americans can’t wait to go on a real vacation or travel to spend time with family and friends. Who doesn’t want to go to a movie, or a concert, or a sporting event and whoop and holler for the home team. Just about everyone will be happy to get rid of their COVID-19 hairdo and many women would relish sitting back as they get a pedicure and their nails done. And going out to eat at a favorite restaurant is high on everyone’s wish list.
Consumers have plenty of money to indulge in all of these activities after paying down their credit card debt during the last year by $114 billion and increasing their savings rate from 7.6% in January 2020 to 20.5% in January 2021.
There can be little doubt that the economy will experience a burst of activity in the second half of 2021 if the vaccination process goes well.
Sustained or Just a Growth Spurt?
The key question is how long will the pent up demand from the weakest sectors persist after the initial surge? Will the majority of people change long term habits to make up for all the experiences that were lost due to the Pandemic? Will those who used to go on one or two vacations a year decide that going forward they will go on three or more vacations each year? Will people who previously went to a movie or a concert once a month take in a bunch of movies and concerts for a few months and then revert back to their old habit?
After a month or two of hitting all the favorite restaurants, how many people will cut back and enjoy eating at home again as they learned to do because of the Pandemic? Even those in their twenties may temper their bar hopping indulgence after a few months of frequent blowouts.
According to a 2009 study of 96 people by researchers from the University College in London, it took an average of 66 days for a new habit to stick, although the range for all the participants was 18 days to 254 days. The Pandemic has gone on long enough for a lot of people to acquire new habits and learn that the new habits are OK, so the need to do everything they did prePandemic isn’t as necessary.
The pattern of human behavior suggests the surge in activity won’t be sustained and in 2022 the year over year comparisons won’t look good, especially in the second half of 2022. Since the second quarter of 2020 was the weakest, the best Y-O-Y numbers may occur in the second quarter of 2021, hold up in the third quarter, and then gradually fade.
More Fiscal Stimulus Coming
President Biden has proposed a $1.9 trillion spending package entitled the “American Rescue Plan Act of 2021″. There is a bit of irony in this title since 36% of the funds won’t be spent until 2022 or later, according to a recent analysis by the Congressional Budget Office (CBO). The bill would provide K-12 schools $129 billion in new funds but only 4% of the total will be spent in 2021. The CBO estimates that $32.1 billion will be spent in fiscal 2022, $32.1 billion in 2023, $25.7 billion in 2024, $19.3 billion in 2025, $9 billion in 2026, $2.6 billion in 2027, and $1.3 billion in 2028.
If the money isn’t being used to open schools up for in person education in 2021, what will school districts spend the balance of allocated funds on, if the vaccines are successful in containing the virus by the end of 2022? This has the potential of being a real boondoggle for the teacher unions. The $129 billion is on top of the $13.2 billion in the Cares Act and the $54.3 billion in the December stimulus bill. Teachers unions increased their political donations from $4.3 million in 2004 to more than $32 million in 2016, and more than $50 million in 2020. According to Open Secrets.org, teachers unions have given at least 94% of their political contributions to Democrats since 1990. Democrats are merely doing what politicians always do after an election – rewarding constituents for their support.
The bill includes $350 billion for states and local governments even though 21 states experienced an increase in revenues in 2020. According to the National Conference of State Legislatures only 24 states used Rainy Day Funds and only a few states used all of their Rainy Day Funds. On average state revenues were down by a miniscule -0.01% and almost $50 billion of the $150 billion Congress authorized in the Cares Act last spring hasn’t been spent.
Research outfit Wirepoints recently estimated that 44 states are running surpluses for fiscal years 2020 and 2021, when previous Covid relief and budget reserves are included. The six states that aren’t running a surplus are New York, New Jersey, Illinois, Maryland, Hawaii, and Nevada. They have pre-existing spending problems or rely heavily on tourism. Of these six states Illinois, New Jersey, and Hawaii’s pension funds were less than 60% funded in 2018 according to Pew Research.
Some states and local governments will certainly use a small portion of the funds to rehire 1 million government workers who lost their job. If the economy can regain a normal footing and tax revenue rebounds further, it will interesting to see how much of the $350 billion is used by states to fund underfunded public pensions, rather than providing support for private sector workers and businesses most impacted in 2020 and 2021.
Of the 10 million workers who are still out of work, nearly 4 million of them are in the leisure and hospitality sector, according to the Bureau of Labor Statistics. During the 3-day President’s Day weekend, which is normally a good weekend for movie attendance, only 38% of movie theatres were open, according to Comscore. According to the New York Hospitality Alliance only 80% of restaurants were able to pay rent last June, but that increased to 92% in December. These statistics underscore that a small portion of the U.S. economy is in a depression, while most of the economy is doing OK and some sectors are booming.
The “American Rescue Plan Act of 2021″ would extend the eviction and foreclosure moratoriums until Sept. 30, and provide $30 billion in rental assistance for renters and small landlords. Hopefully this is enough assistance to prevent a wave of evictions and foreclosures in the future.
The Federal Reserve of Atlanta conducted their Survey of Business Uncertainty in May 2020 and in January 2021 and the results are informative. Prior to the Pandemic 5.5% of employee time was spent working from home and jumped to 14.6% in January 2021, with 35% working at least one day a week from home.
An analysis by the University of Chicago’s Booth School of Business found that nearly 40% of U.S. jobs can be done at home, which suggests the results of the Atlanta Fed’s January survey are in the ballpark and not likely to increase much more. The ability to work from home is largely dependent on the industry. A far higher percent are working from home in Business Services (43.1%) compared to Retail (15.7%). These changes will for the most part become permanent, which means rental income and valuations for many office properties will fall.
The shift to working from home will become a bigger problem for office building owners as time goes on. Whether it is a looming crisis for a few commercial real estate firms and over exposed banks won’t be known until 2022 or later. According to a survey conducted by Deloitte and Fortune of 171 CEOs across the US, 76% of the CEOs plan to downsize their office space in the near future, while 28% noted that they will require significantly less corporate space.
The Greater Boston region has experienced a doubling of sublease space since the onset of the pandemic, with more than 3.5 million square feet of prime office space coming on the market. In Manhattan the vacancy rate has jumped by more than 40% climbing from 10% in 2019 to 14.2%, and is up to 16.7% in San Francisco.
The “American Rescue Plan Act of 2021” would send another round of $1400 checks to those with Adjust Gross Income (AGI) – individuals making less than $75,000 and couples with less than $150,000 of AGI. The $2.2 trillion Cares Act passed in March 2020 and the additional $900 billion spending program approved on December 27 have enabled Americans to pay down their credit card debt by $114 billion and increase their savings rate from 7.6% in January 2020 to 20.5% in January 2021.
These federal spending programs were intended to help those who lost their jobs so they could pay their mortgage, rent, and put food on the table. The $3.1 trillion in spending was also intended to support small businesses that were forced to close during lockdowns, and fund the distribution of the vaccines. Although welcome, the increase in the savings rate and decline in credit card debt suggests a good portion of the funds distributed went to people who hadn’t lost their job and didn’t need the money. The next of round of checks represents more of the same.
Another indication that money was sent to those who didn’t need it can be seen in the number of investment accounts that were opened after money was distributed in March. JMP Securities estimates individual investors opened a record 10 million new brokerage accounts in 2020.
A large portion of the accounts were opened at Robinhood, which experienced an increase from 5.4 million accounts to 10 million new accounts. After the $600 stimulus checks were distributed in January 2021, the number of Robinhood accounts jumped to 13 million.
The average age of a Robinhood client is 32 and has little or no investment experience. Last spring Robinhood ‘investors’ became infatuated with Call options, which allowed them to leverage their small asset base. They can’t afford to buy many shares of Apple, Netflix, Amazon, and Tesla, but they can buy 5 options that allow them to control 500 shares of these stocks for a fraction of the cost to buy 500 shares. After averaging 10 million Call option for many years, the average daily volume has tripled to 30 million in the past year.
This surge has forced the dealers who sell the Call options to purchase the underlying shares, lifting the price of the stock and the value of the Call options. I have no doubt that when Robinhood traders receive their next stimulus check of $1400 they will be aggressively buying Call options. The surge in Call buying by this cohort is likely to lift the S&P 500 comfortably above 4000 by mid-year, but has little to do with expected 2022 earnings growth for the stocks in the S&P 500 or the economy as a whole.
Congress is expected to pass the next stimulus bill before the end of March. The Congressional Budget Office estimates the federal budget deficit will be $2.4 trillion this year under current law, and the Biden Administration’s $1.9 trillion spending bill would push it past $4 trillion. Clearly some of the spending in this package is misguided and politically driven but more of the new spending will help people and small businesses who need the support. Aided by a recovery in the most depressed sectors the economy will get a lift in the short term while the hot sectors of the past year cool off.
Another Treasury Market Tantrum Tests the Fed
The Federal Reserve adopted its Core PCE 2.0% inflation goal in 2012 and since then it has averaged 1.3% annual growth.
As noted in the February Macro Tides, headline inflation is likely to jump above 3.0% in April and May based on higher input costs and how the annual CPI is calculated. Even the Core PCE rate could make a run at the Fed’s target of 2.0%. Chair Powell emphasized that any surge in inflation in coming months was likely to be temporary:
“The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved. Inflation dynamics do change over time, but they don’t change on a dime. So we don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.”
After decades of believing that low unemployment would lead to higher inflation (Phillips curve), the Fed now believes the connection between low unemployment and inflation is broken:
“We’ve shown that we can, over the course of a long expansion, we can get to low levels of unemployment, and that the benefits to society – including particularly to lower and moderate-income people– are very substantial.”
Inflation remained muted even after the Unemployment Rate fell below 4.0% in 2018 and 2019 and the bottom quintile of workers experienced the largest increase of wage growth of any group in those years. This is one way the Fed feels it can partially address income inequality.
The Fed is clearly committed to look through any burst in inflation in coming months, dedicated to maintain their accommodative policy to help lower the unemployment rate, increase the labor force participation rate, and boost wage growth for lower income workers. The potential problem is that the bond market may view the Fed’s commitment as increasing the risk that the Fed will befall behind the inflation curve and be forced at some point in 2022 to increase rates more aggressively. I discussed this risk in the February Macro Tides.
“The question is how will financial markets react, irrespective of FOMC member statements, if the headline CPI climbs comfortably above 3.0% for a few months? Few will suggest the Fed will increase the federal funds rate in 2021 but strategists will begin to discuss the potential that the Fed could move sooner than the end of 2022 to raise the funds rate.”
The only surprise is that market participants didn’t even wait for less benign inflation data to react. The outlook for inflation and chart analysis led me to expect higher Treasury yields in coming months as noted in several Weekly Technical Reviews during January:
“The 10- year yield will test and likely breakout above 1.266%. At some point in 2021, more likely in the second half of the year, the 10-year Treasury yield could spike up to 1.75% to 1.95%, and the 30- year has the potential to rise to 2.15% to 2.35%.”
As outlined in the February 22 Weekly Technical Review:
“The 30-year Treasury bond may retrace 61.8% of the decline in the 30-year yield from its high of 3.455% in November 2018 to 0.837% in March 2020 which would target 2.455%. The 30-year closed at 2.18% on February 22 so it may reach 2.30% – 2.45% soon.”
The 30-year Treasury yield spiked to 2.402% on February 25.
“The 50% retracement of the decline in the 10-year yield from its high of 3.248% in November 2018 to 0.40% in March 2020 would allow for the 10-year yield to rise to 1.82%.”
On February 25 the 10-year Treasury yield spiked to 1.614%. Higher yields for the 30-year and 10- year are likely. The highs on February 25 were likely the end of wave 3, which suggests they will 15 be exceeded in wave 5, after a modest drop in yields for wave 4. It appears wave 4 began after yields spiked on February 25, so wave 5 could happen in March.
In his February 23 testimony to the Committee on Banking, Housing, and Urban Affairs, Chair Powell was asked if he saw a link between elevated asset prices and the Fed’s easy money policies:
“There’s certainly a link. I would say, though, that if you look at what markets are looking at, it’s a reopening economy with vaccination, it’s fiscal stimulus, it’s highly accommodative monetary policy, it’s savings accumulated on people’s balance sheets, it’s expectations of much higher corporate profits…So there are many factors that are contributing.”
A comparison of GDP growth and the change in Household Net Worth indicates that monetary policy has been far more effective to boosting asset values (home and stock prices) than GDP growth. In 2002 the Federal Reserve lowered the federal funds rate to 1.0% and below the rate of inflation. In doing so the Fed pushed the ‘real’ after inflation funds rate below 0%. The real funds rate remained below 0% until 2005 as the Fed began belatedly to increase the funds rate from 1.0% in June 2004 to 5.25% in September 2005.
The Fed pushed the real funds rate below 0% in 2008 where it remained until 2018. By the end of 2019 the funds rate was again below 0% as the Fed lowered the funds rate from 2.40% in July 2019 to 1.55% in December 2019 and before the Pandemic crippled the economy in March 2020.
Leading up to the financial crisis in 2008 GDP rose 31.3% from the fourth quarter of 2002 to the third quarter of 2007. During the same period asset values rose 53.5%, 70% more than GDP. Net Worth suffered severely during the financial crisis falling -15.4% versus just -1.0% for GDP as the S&P 500 plummeted 57% and home prices tanked.
After the financial crisis ended GDP grew 47% from the fourth quarter of 2009 to the third quarter of 2020. Since the fourth quarter of 2009 Net Worth has soared 105.3% or 123% more than the increase in GDP. The ‘link’ between monetary policy and assets prices cited by Chair Powell has been more like a propellant.
From 1960 through 2001 the median home price was less than 3 times median income as banks wouldn’t extend a mortgage if the payments were more than 33% of a home buyer’s income. The housing bubble was fed by low mortgage rates, lax lending standards, and mortgage loans that represented more than 43% or more of a buyer’s income. The current housing bubble is supported by record low mortgage rates, record low inventories, and 3% down payments for government agency mortgage loans.
By almost any measure the stock market is at one of the highest valuations in history. Investors cite low interest rates, extraordinary accommodative monetary and fiscal policy. Jay Powell is right that there are a number of factors goosing asset values but the largest influence since 2002 has been monetary policy.
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