Personal Incomes – The Daily Tearsheet

Morning Report: QE portfolio drops below $4 trillion

Vital Statistics:

	Last	Change
S&P futures	2909	-10.5
Eurostoxx index	382	-4.4
Oil (WTI)	72.1	0.02
10 year government bond yield		3.03%
30 year fixed rate mortgage		4.74%

Stocks are lower this morning on overseas weakness. Bonds and MBS are up.

Personal incomes rose 0.3% in August, as did personal spending. The inflation numbers came in a little tamer than expected, with the headline number up 2.2% and the core number up 2%, right in line with the Fed’s target.

The Fed’s holding of Treasuries and MBS (relics of the QE and Operation Twist days) have dropped below $4 trillion. Total Assets at the Fed are still around $4.2 trillion, compared to pre-crisis levels below $1 trillion.

Jerome Powell suggested that the Fed is going to return to its more typical opaque posture with respect to the markets. In the aftermath of the crisis, the Fed became very open about its intentions and policies, and often seemed to follow the markets. This is a sensible posture when the economy is fragile, but the financial crisis is probably far enough in the rear view mirror that the Fed can start returning to normalcy. If Janet Yellen’s handholding of the markets was one extreme, Alan Greenspan’s Fed raising the Fed Funds rate 50 basis points at a surprise Saturday meeting was the other.

The SEC has is suing Elon Musk for issuing “false and misleading statements” and failing to notify regulators of material company changes relating to the ill-fated 420 tweet. On August 7, Elon tweeted “Am considering taking Tesla private at $420. Funding secured.” Tesla stock rallied on the announcement and then sold off as investors figured out it wasn’t as solid as it initially appeared. The SEC complaint is fascinating reading – the Board of Directors was blindsided by this, and I think it never dawned on Elon what the implications of that tweet would be. Essentially, he had initial talks with a large Middle Eastern investor who was interested in taking a strategic stake in Tesla. No price, percentage stake or other specifics were mentioned. Elon arrived at the $420 price by applying a 20% takeover premium to Tesla’s existing share price (which came to $419) and then rounded up to $420.

From the complaint: “According to Musk, he calculated the $420 price per share based on a 20% premium over that day’s closing share price because he thought 20% was a “standard premium” in going-private transactions. This calculation resulted in a price of $419, and Musk stated that he rounded the price up to $420 because he had recently learned about the number’s significance in marijuana culture and thought his girlfriend “would find it funny, which admittedly is not a great reason to pick a price.”

Elon never thought through any of the regulatory conditions, financing conditions, legal issues, how retail investors would have to be treated, etc before making the tweet, which was probably meant to stick it to short sellers. Tesla’s stock is down about 30% from its peak, and is a classic example of what happens when cult stocks stumble. As an aside, when company CEOs get into public wars with short sellers, that is generally not a bullish sign.

One of the remedies will be to ban Musk from ever serving on the Board of Directors of a public company, and he will certainly face civil suits from people who bought TSLA in the aftermath of the tweet, before the relevant information came out. Suffice it to say, this is one of the biggest corporate brain farts I have seen since Martha Stewart went to the big house (and lost about $1 billion in wealth from MSO’s stock decline) in order to prevent $60,000 in losses on IMCL stock.

In the aftermath of the US housing bubble, massive coordinated central bank easing has led to bubble conditions in six large cities: Hong Kong, Munich, Toronto, Vancouver, London and Amsterdam. Extreme overvaluation exists in Stockholm, Paris, San Francisco, Frankfurt and Sydney. Who knows when these bubbles will burst, but when they do, it will tend to pull rates lower, despite what the Fed is doing to short rates.

Morning Report: New Down Payment Assistance programs

Vital Statistics:

	Last	Change
S&P futures	2728.75	9.5
Eurostoxx index	379.91	3.04
Oil (WTI)	73.39	-0.06
10 Year Government Bond Yield		2.84%
30 Year fixed rate mortgage		4.52%

Stocks are higher this morning on end-of-quarter window dressing. Bonds and MBS are flat.

Personal incomes rose 0.4% in May while personal spending rose 0.2%. Incomes were in line with estimates, while spending was lower. The June FOMC statement said that consumer spending was accelerating – no evidence of that in this report. Services spending drove the decline, and we could be seeing evidence that higher gasoline prices is affecting discretionary expenditures. Inflation was in line with expectations at the MOM level, and a hair above expectations on an annual basis. The core PCE index ex-food and energy came in at 2%, which is right where the Fed wants it. April’s income and spending numbers were revised downward. Don’t be surprised if strategists take down some of their Q2 GDP forecasts on these numbers.

The Chicago PMI improved to 64 from 62, which is a 5 month high. New Orders and order backlog drove the increase. We are seeing some signs of inflation brewing, with extended lead times, and a 7 year high on the prices paid index. Businesses were asked about how trade was affecting their operations. About 25% said they were having a significant impact, 40% said there was a minimal impact, and the rest were either unsure or insulated from trade issues.

KB Home reported strong numbers, with a 170 basis point increase in gross margins, 10% revenue growth, and a 50% increase in operating income. ASPs were up 4% to 401,800, and order growth was 3%. Backlog was the second highest on record. The stock is up 7% pre-open.

Interesting theory about the lack of construction workers: opiods. Between users and those that have been convicted of crimes related to usage, many workers are shut out of the work force. 80% of homebuilders report shortages in subcontractors.

The Senate will hold hearings on July 12 and 19th for Kathy Kraninger’s nomination to run the CFPB. The conventional wisdom is that she is not intended to be confirmed, but is to be an excuse to keep Mick Mulvaney in charge of the agency.

Deutsche Bank failed its stress test, while State Street, Goldman and Morgan Stanley got dinged.

Many Millennials are struggling to get a down payment for a home, and now some companies are working to help them get it. One company will supply up to a $50,000 downpayment if the borrower rents out a room on Air B&B and shares the income with the company. These loans are appealing to borrowers who might qualify for a FHA or 3% down Fannie loan but don’t want to pay the MI and other costs. While there are fears that we are bringing back the bad old days of the real estate bubble, here is the MBA’s mortgage credit availability index. We are a long way away from the days of the pick-a-pay mortgage.

Morning Report: Job cuts fall again

Vital Statistics:

	Last	Change
S&P futures	2725	1
Eurostoxx index	386.51	1
Oil (WTI)	67.49	-0.72
10 Year Government Bond Yield		2.86%
30 Year fixed rate mortgage		4.47%

Stocks are flat this morning after personal incomes came in as expected. Bonds and MBS are flat.

Personal Incomes rose 0.3% in April, in line with expectations. Personal Spending rose 0.6%, higher than the 0.4% estimate and inflation was tame at 2% YOY, with the core rate up 1.8% YOY. The big jump in consumer spending will probably have some strategists taking up their estimates for Q2 GDP. March and February spending numbers were revised upward. Inflation remains in check, which will give the Fed the leeway to hold off on hiking rates if the European situation with Italy escalates.

Pending Ho me Sales fell 13% in April, according to NAR. The supply / demand imbalance remains the story: Lawrence Yun, NAR chief economist, says the housing market this spring is hindered because of the severe housing shortages in much of the country. “Pending sales slipped in April and continued to stay within the same narrow range with little signs of breaking out,” he said. “Feedback from Realtors®, as well as the underlying sales data, reveal that the demand for buying a home is very robust. Listings are typically going under contract in under a month1, and instances of multiple offers are increasingly common and pushing prices higher.”

Initial Jobless Claims fell to 221,000 last week. We are still at exceptionally low levels.

Mortgage rates fell 10 basis points last week, and this is even before the huge bond market rally on Tuesday.

Deutsche Bank was put on the troubled bank list last year. This was obviously a big impetus behind its decision to reduce its US footprint. The German regulators have been on top of the bank as well. With credit default spreads widening in the Euro banking market, expect to see the European Central Bank tread extremely cautiously with policy normalization, and for the Fed to adopt a wait and see attitude after hiking in June. Separately, if Deutsche Bank decides to exit the US entirely, wouldn’t it be wild to see them spin off Bankers Trust?

Job Cuts fell to 31,517 in May, according to outplacement firm Challenger, Gray, and Christmas. This is the seasonally slow period for job cuts, as most companies concentrate them in Jan-Feb time frame. The cuts are mainly coming in retail, although things are picking up in the financial sector. Regionally, they are concentrated in the Northeast, particularly NY and NJ.

The Trump Administration is set to push for tariffs on European steel and aluminum. A German magazine said that Trump told French President Emannuel Macron that he wanted to “stick to his trade policy long enough until no Mercedes-Benz cars were cruising through New York.” The deadline for negotiations is this Friday.

US regulators are set to sand off some of the harder edges on Dodd-Frank and the Volcker Rule. The biggest change requested from the industry is the rebuttable presumption that any position held for less than 60 days is considered a proprietary trade. Essentially, this is a “innocent until proven guilty” scenario. The Fed also intends to clarify the liquidity management exception, which is meant to distinguish between market-making and proprietary trading. At the end of the day, falling commissions and tightening bid/ask spreads have made market-making an unprofitable business for the most part anyway. I suspect investors and regulators are in for an unpleasant surprise the next time we have a crash and the only bids in the market are retail GTC orders.

The number of underwater homes fell below 10% in the fourth quarter for the first time since the crisis. Torrid home price appreciation has cut the percentage down to 9.1%, or about 4.4 million homes. “For much of the country the Great Recession is an increasingly distant memory – the American economy is booming once again and markets are now shifting their gaze to future downturn risks,” said Zillow senior economist Aaron Terrazas. “But scattered in neighborhoods across the country, the legacy of the mid-2000s housing bubble and bust lingers among the millions of Americans still underwater on their mortgages, trapped in their homes with no easy options to regain equity other than waiting.” The worst areas? Chicago, Virginia Beach, and Baltimore.

Morning Report: Spending / Incomes up, PCE inflation at target

Vital Statistics:

	Last	Change
S&P futures	2679	7.6
Eurostoxx index	385.1	0.46
Oil (WTI)	67.48	-0.62
10 Year Government Bond Yield		2.96%
30 Year fixed rate mortgage		4.56%

Stocks are higher after a slew of new mergers were announced. Bonds and MBS are up small.

We have a big week ahead with the FOMC meeting starting tomorrow and the jobs report on Friday. The Street isn’t looking for any changes in interest rates at the May meeting, but will focus as usual on the language of the statement. For the jobs report, the expectation is 190k new payrolls and 2.7% annual wage inflation.

Pending Home Sales were up marginally from February, but were still down on an annual basis, according to NAR’s Pending Home Sales Index. Bad weather in the Northeast pushed down pending sales, however all parts of the country were down. Again, blame low inventory and falling affordability.

Personal Incomes rose 0.3% in March, while personal spending rose 0.4%, in line with expectations. The PCE index was up 2% YOY and the core PCE index was up 1.9%. This is the Fed’s preferred measure of inflation and it is right where they are targeting. Income growth was the weakest since last Fall, however.

The big debate right now is whether there is any slack in the labor market. Anecdotal evidence abounds that companies are struggling to find qualified workers. However, Econ 101 says that we should be seeing higher wage inflation as a result and that isn’t happening (at least not yet). Some theories are claiming this is a market failure and that employers are artificially holding down wages (which is then used as an argument for more government intervention in the labor market). I suspect the issue is that there are three big forces holding back wage growth. First, inflation is low – if companies cannot pass along price increases to their customers, they aren’t going to be raising wages. Second, lower wage jobs are competing with technology which is only getting better and cheaper. And finally, the long-term unemployed represent a reservoir of slack that companies know they can tap if needed. FWIW, I think the first and third explanations explain it, and find the idea that employers are somehow colluding to keep wages low to be wholly unconvincing. Take a look at the chart below, which shows wage increases versus inflation. You are seeing actual wage growth.

For now it looks like the 3% level in the 10 year has held. What drove the sell-off – it wasn’t like there was anything data-wise to support it. JP Morgan blames CTAs using momentum strategies to short the 10-year. Chinese selling has also been rumored to be a factor. We won’t be able to confirm or deny that theory for a couple of months. CTA funds have been net short Treasuries since September, however a momentum signal in mid-April caused people to pile into the trade and that apparently drove the late month sell-off.

Steve Mnuchin is “cautiously optimistic” on trade talks with China. The subject will include intellectual property and joint ventures.

Defect risk decreased on a MOM basis but was up on a YOY basis, according to the First American Loan Defect Index. The biggest risk was in the sand states, while the lowest risk was in the Rust Belt.