By:
Tom WernerThe Bureau of Economic Analysis, or BEA, has just released its estimate for April 2024 US Personal Consumption Expenditures (“PCE”). Also known as “Personal Spending,” PCE directly accounts for over 60% of total US Gross Domestic Product (“GDP”), marking it a crucial indicator for assessing changing rates of expansion, contraction, and momentum in US economic activity. According to the BEA, Real PCE (adjusted for inflation) contracted by -0.05% — a downside surprise compared to the median forecast of professional economists, which expected -0.05% growth. The question now is: Based on a thorough analysis of the PCE data, and the initial market reactions to it, should investors make any adjustments to their economic forecasts, and/or to their investment strategies? The right answer is never an obvious one. Success in investing largely depends on finding difficult-to-obtain information and/or insights that supply an informational and/or analytical edge. This requires both diligence and skill. Our method, focused on five key questions, helps us generate an edge from analyses of just-released economic reports: Was there any surprise? What caused the surprise? Did the surprise alter the macroeconomic outlook? Is anything in this report being misunderstood or overlooked? Has the initial market reaction given rise to any actionable opportunities? In this article, these questions will be addressed as we walk readers through a four-step process. First, we will perform a comprehensive analysis of the just-released report. Second, we will update macroeconomic forecasts, based on this analysis. Third, we will adjust our investment assessments of major asset classes. Finally, we will deliver actionable insights that will enable readers to capitalize on our analysis. Headline Data & Analysis We begin our analysis with a review of headline data that is summarized in Figure 1. We recommend that readers make note of the percentile rank of the rate of change (growth or contraction), and sequential momentum (acceleration or deceleration). Most importantly, readers should identify any surprises (i.e., deviations from forecasted values), as these tend to drive the initial reactions in the market. Figure 1: Change, Acceleration, Expectations, and Surprise PCE Summary Data & Analysis (BEA & Investor Acumen) Current dollar PCE surprised to the downside. As can be seen in Figure 1, the nominal dollar value of PCE (not adjusted for inflation) for April 2024 totaled $19,340.61 billion at a monthly annualized rate, a record. The 0.20% MoM rate of change was below the historical median, ranking in the 22nd percentile. Relative to the median estimate of professional economists of 0.30% growth, this month’s PCE represented a downside surprise of -0.10%. PCEPI inflation surprised to the downside. The PCE Price Index (“PCEPI”), a measure of consumer prices which is closely followed by the U.S. Fed, indicated inflation of 0.26% during April 2024, accelerating by -0.08% compared to the inflation of 0.34% in January 2024. The PCEPI inflation in April represented a downside surprise of -0.04% compared to the median estimate of professional economists of 0.30%. Some sources cited the median estimate as +0.2%. Therefore, the surprise factor on the PCEPI is relatively ambiguous. Real PCE also surprised to the downside. By combining both of the factors above – the current dollar value of personal spending adjusted by consumer price inflation – we can see that Real PCE totaled $15,714.36 billion (at a monthly annualized rate). This month’s rate of change of Real PCE (-0.05%) was below the historical median rate of change, ranking in the 22nd percentile. Relative to the 0.00% growth expected by the median forecast of professional economists, the reported MoM change surprised to the downside by -0.05%. It should be noted that the prior month’s real PCE data was also revised downward from +0.5% to +0.4%. A Deep Dive Into The BEA’S PCE Data In this section of our report, we will walk our readers through a comprehensive analysis of the latest PCE data. The analysis is broken down into three subsections: 1) Analysis of the impacts of inflation; 2) Rates of change and momentum of Real PCE components; 3) Attribution analysis. Our goal in this section is to pinpoint the specific causes of any deviations from forecasts (i.e., surprises) and to uncover anything which may have been misunderstood or overlooked by market participants. Prices Matter: The Impact of Inflation and Deflation on Personal Consumption Expenditures In this subsection, we highlight the impacts of price changes (inflation or deflation) on personal spending data. Any serious analysis of PCE must seriously consider this matter because price changes directly affect the quantity of goods and/or services that a given amount of money can purchase. In Figure 2, we show Personal Consumption Expenditures in both “current dollars” and in “real” terms. The “real” figures adjust the nominal current dollar figures for the changes in purchasing power caused by inflation/(deflation). The purchasing power adjustments to the PCE consumer spending data are made by applying the appropriate PCE price indexes, published on the same day as the report on Personal Income and Outlays. It is important to note that the PCEPI is the US Federal Reserve’s favored consumer price inflation. Figure 2: Personal Consumption Spending in Current Dollars and Adjusted for Inflation PCE Inflation Adjustment (BEA & Investor Acumen) As can be seen in Figure 2, personal spending in current dollars during April was estimated to have grown by 0.20% MoM. However, consumer prices, as measured by the PCE price index, “inflated” by 0.26% during the month. Real PCE, which adjusts the current dollar spending figures for inflation, is estimated to have contracted by -0.05% during the month of April. It is important to note any divergences between the Goods and Services categories. When analyzing changes in consumer prices and real personal spending. Price divergences. Goods prices during April inflated by 0.22% MoM, compared to a 0.27% change in prices of services. Prices of services tend to be stickier than the prices of goods. If goods prices, which have until recently been a drag on overall inflation, merely revert to normal levels of inflation (around +0.1% per month) before services prices do, then overall PCE inflation could become very high. This would be very problematic for interest rates and Fed policy and, ultimately, for economic growth. Spending divergences. Real personal spending on Goods (inflation-adjusted) in April was estimated to have contracted by -0.38%, compared to growth of 0.10% in real consumer expenditures on services. Please note that for the remainder of this article, all Personal Consumption Expenditures (i.e., personal spending) figures will be presented in “real” (inflation adjusted) terms. For the remainder of this article, all figures will be presented in “real” (inflation adjusted) terms. Rates of Change and Momentum of Real PCE Components In this subsection, we present the major components of Real Personal Consumption Expenditures (PCE), scrutinizing their annualized growth rates over various time frames (1m, 3m, 6m and 12m). The purpose of this analysis is two-fold. Our first purpose is to identify the relative growth of various components of PCE compared to each other, and to the overall aggregates. Our second purpose is to determine whether, and to what extent, growth rates are accelerating or decelerating over various time frames. We will mostly focus on the 3-month rate of change, which is generally the best indicator of current strength and trends. However, the 1-month, 6-month and 12-month data are important reference points. Figure 3: Annualized Growth Rates of Major Components of Real PCE PCE Inflation Adjustment (BEA & Investor Acumen) Strength and momentum of overall growth. As can be seen in Figure 3, overall real spending growth, on a 3-month annualized basis (2.73%), remained below the historical median (43rd percentile), with an even weaker rate of change in data (22nd percentile) for the most recent month. Divergences in rates of change between categories. During the past 3 months the growth of Real PCE Goods was in the 38th percentile while the real PCE Services was in the 49th percentile. On a one-month basis, this divergence continues, with Goods actually turning negative (-4.46% annualized). Attribution Analysis: Change and Acceleration of Real PCE In this subsection, our analysis is focused on identifying the contributions that various categories make to the MoM Change and MoM Acceleration of Total PCE. Figure 4: Contributions to Change and Acceleration Attributable to Major Components Real PCE Annualized Growth (BEA & Investor Acumen) As can be seen in Figure 4, the MoM rate of change in total real PCE in April (-0.05%) decelerated by -0.46% compared to March (+0.41%). This momentum is attributable to a -0.43% contribution to deceleration in Goods and a -0.03% contribution to deceleration in services. Within Goods, Durable Goods contributed to deceleration by -0.03% while Nondurable Goods contributed to -0.39% deceleration. It should be noted that the largest source of the contribution to deceleration was from Gasoline and other energy goods (-0.18%), contributing to nearly 40% of the total deceleration of Real PCE. However, the breadth of deceleration in the report was notably strong. US Economy Outlook: Implications of the PCE Data In this section, we address the following question: Based on our comprehensive analysis of the just-released PCE data, what (if any) changes should we make to our macroeconomic forecasts and/or our overall outlook for the US economy? Updates to US Economic Forecasts Let’s begin with a brief review of forecasters’ expectations leading into this report. The median forecast of professional economists expects the BEA to report that personal spending grew at +0.30% percent during the most recent month (31st percentile). Assuming that this forecast had been entirely correct, and that there were no revisions to prior data, the 3-month annualized change of Real Personal Spending would have been a +4.05% growth rate, ranking in the 64th percentile historically. As it turns out, reported data (including the figures for the most recent month and revisions to prior months) indicate that real PCE grew at a weaker 3-month annualized rate of 2.73%, a rate of change which ranks in the 43rd percentile historically. Thus, the downside surprise in the personal spending data was equivalent to 21 percentages points in terms of percentile rank – a significant figure. Update of Overall Outlook for US Economy How do these updates to our forecasts for the above macroeconomic conditions affect our overall outlook for the US economy? Currently, the overall outlook for the US economy is dominated by whether the US economy will achieve a “soft-landing.” How does our thorough analysis of the just-released PCE data impact the analysis of this question? PCE grew at a weak rate in April – in fact, PCE actually declined after adjusting for inflation. This disappointing result represents a confirmation – supported by a slew of other data – that the U.S. economy experienced a significant slowdown during the month of April 2024. The question that is raised is: Will the “landing” for economic growth in the US economy be “soft” or “hard”? Among economic analysts, opinions are varied, but it will take several more months of data to gain any clarity. While the path of future growth hangs in the balance, we believe overall macro risk is rising substantially. Our view is that there are under-appreciated risks to the inflation outlook which could severely restrict the Fed’s ability to lower interest rates in 2024, even if the economy is slowing. The most important of these risks is a potential oil price shock due to instability in the Middle East. We believe that financial markets are not prepared for the risk that financial conditions could remain tight (or even tighten), while the economy is slowing. Market Outlook U.S. Treasury yields declined after release of the report. Bond markets were relieved by the PCEPI inflation number, while welcoming the slowdown in personal spending. Going forward, US treasury yields – particularly TIPS yields – could decline substantially if growth continues to decelerate. Immediately after the report, the S&P 500 (SP500) rose slightly, based mostly on relief regarding inflation. However, the enthusiasm was muted by the realization that personal spending growth was quite weak, thereby negatively impacting expectations for corporate earnings. The S&P 500 had reversed initial gains as of the writing of this article. Overall, we think that the implications of this report are bearish for equities. The report increases the risk of stagflation. Indeed, the report increases the risk of a “nightmare” scenario whereby the U.S. economy slows down at an alarming rate, while the Fed may not be able to “come to the rescue” due to stubbornly high inflation. We are not yet prepared to forecast a major decline in the U.S. equity market, but believe that the risk of such a decline has risen materially. Concluding Thoughts Our Investing Group team has been positioning our portfolios in a manner that accounts for various risks. First and foremost, we are positioning our portfolios for the risks of severe oil price shocks, particularly in the second half of 2024. Second, we think that the risk of a severe slowdown in U.S. economic growth – and potentially even a recession – is rising. In this context, we believe that very extraordinary opportunities are going to emerge in the second half of 2024, starting sometime between June and August.
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