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Vice Index Nails Retail Forecast AGAIN

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Heads Up: Retail Spending Momentum Turns Negative

 

(Note: The Vice Index is lagged: recent vice spending pullbacks are reflected in the chart above starting June.)

Consumer Spending Slowing Down

Regular readers know the Vice Index is the real way to measure the breadth of the U.S. consumer. It factors in many disposable spending habits like alcohol, marijuana, prostitution and gambling.

Everyone knows consumer spending (including disposable spending) is the lifeblood of the US economy. There are different but related measurements:

  • Disposable Income is personal income minus taxes.
  • Personal Consumption Expenditures (PCE) is disposable income minus savings, interest payments, and transfer payments.  (It runs ~91.5% of Disposable Income)
  • Discretionary Income is PCE minus basic essentials

In other words, discretionary spending is the spending on wants after the needs get covered:  taxes, interest, savings, and basic needs. It includes luxuries like apparel, cars, TVs, vacations and so on.

Discretionary Incomes are directly impacted by changes in incomes and inflation. But the spending of that income is most influenced by the state of the economy and expectations about the future, which affects consumer confidence and the willingness to spend or not.

Retail spending is an incomplete measure of consumer spending because it only follows spending at stores and virtual stores. By definition it excludes major luxury spending like recreation (vacations, sporting events, gambling, air fares, and so on). That’s a significant gap: US gambling is a $240 billion (B) industry.

An Even Higher View Of The Vice Index

Vice spending is broadly representative of the US consumer:

  • Broad-based: Every socioeconomic and demographic group participates
  • High-volume transactions: Over 100 million discrete events per year

And vice spending is highly sensitive to near-term economic conditions:

  • Cash based: depends on free cash flow
  • Luxury spending: wants not needs
  • Significant dollar amount: not pricey but not cheap

That’s why analysts spend so much time crunching the data and spitting out projections and expectations.

Guess what? Moneyball’s Vice Index nailed it again.

Where Consensus expected a solid month in retail expectations, the Vice Index was flashing warning signs.

Retail Retail ex Autos & Gas
Consensus Expectations 0.1% 0.4%
Andrew Zatlin -0.1% 0.1%
Actual -0.2% -0.1%


More concerning is that the Vice Index is flashing rapid deceleration in spending momentum. It’s worth showing the Vice Index chart again.

Spending has clearly downshifted.

Last month I predicted an inflection point – a downshift in retail spending trend. Specifically, I forecasted a drop from the 4%~5% range to a more moderate 3%~4% range. That’s now happened.

Spending growth slowing down is no longer a one-off problem. It is now a trend.

 

Discretionary Spending: Leading Indicator

For Bond & Equity Markets

The impact on the bond and equity markets is both immediate and direct. 

Increased demand for consumer discretionary goods and services is inflationary and boosts the likelihood of interest rate hikes.  

It also leads to higher corporate revenues which in turn boosts the stock market. The opposite is true as well: reduced demand will lead to lower production and services, which means weaker performance by companies in the affected sectors and lower inflation and falling interest rates.

Tracking Consumer Spending: Personal Consumption Expenditures & Retail Spending

The main conventional data points that track consumer spending are Personal Consumption Expenditures (PCE) and Retail Spending.  PCE tracks the ability to spend and Retail tracks the actual spending.

If PCE measures the ability to spend (after-tax money leftover after covering essentials). And Retail measures a portion of the spending… Luxury spending measures the willingness to spend.

As the quintessential non-essential, luxury spending is highly elastic with incomes and that makes it the canary-in-the-coalmine for consumer spending.

Track luxury spending and you gain leading visibility to consumer spending.

Luxury Spending: The Missing Piece of the Puzzle

Traditional definitions of luxury are quite narrow: costly goods purchased by the wealthy to demonstrate affluence.  

As such, measurements are limited in scope and scale: diamond purchases, Tiffany’s and Sotheby’s revenues, and yacht sales, to name the most widely used.  

We want to know whether consumers feel that they have more or less money in their pockets and, therefore, will spend accordingly.  

For that reason, price is irrelevant.  A normal good purchased by a rich person may be a luxury good to a lower income person.

A more useful definition of luxury spending is anything that is (1) truly non-essential, (2) not an ordinary day-to-day purchase, and (3) enjoyed on relatively rare occasions.  In addition, there is a psychological element of satisfaction: the consequence of buying luxury goods and services is that the consumer feels

Vice Spending To The Rescue

Remember, Vice spending tracks U.S. consumer spending on alcohol, marijuana, prostitution and gambling.   

As a result of this sensitivity, Vice Spending carries a distinct advantage: it leads by 4 months.

Over time, the vice spending correlation to retail spending and Personal Consumption Expenditures has improved significantly.  I think that comes from changes that expanded the reach of vice spending and its consequent representation of overall spending.

  1. Gambling became more accessible:  In the early 1990s, only 2 states had legalized gambling.  Today 48 states have legalized gambling.
  2. Prostitution became more accessible: the internet reduced barriers to participation and created marketplaces that connected clients and providers
  3. Marijuana consumption expanded: Boomers and Millenials smoke pot.  For example, (per the CDC) in 2002, 1% of adults aged 45-54 surveyed said that they smoked marijuana in the previous month.  In 2014, 6% said they did.  For those aged 26-34, the figure went from 8% to 13%

In other words, the end of the 90s saw an accelerating ease of access (and accompanying reduction in social stigma) that led to significantly higher participation by the general population.

 A Reason for Spending Slowdown

Simply put, spending is slowing because income growth is slowing

Compensation received has slipped from 4.5% last year to barely 3% this year.  And the trend is down.  That limits growth in spending: PCE has rolled over again.

KEY TAKEAWAY: There’s nothing signaling a recession. But slower spending is not going to help the stock market.

And if the Vice Index is correct about a major spending slowdown in 4Q, that’s a problem as we head into 2018.

 

Best,

Andrew Zatlin

Editor of Moneyball Economics

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Watch Out Below For Coca-Cola (KO)

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Watch Out Below For Coca-Cola

Coca-Cola (KO) has been under pressure for a few years.  

KO is up roughly 33% since 2012. The S&P 500 is up roughly 88% over the same time frame.

They have sought to streamline their business and have divested a lot of assets. But the clouds are still dark for Coke.

KO has three major problems:

  1. Aggressive competitor: Pepsi (PEP) is very aggressive.  And very diversified: in addition to drinks they offer snack foods (Frito-Lays), granola bars & cereals.  KO does just beverages
  2. Soft drink tax: Cities have begun to tax soft drinks, with the inevitable result that sales are falling. By a lot.  Two months after enacting the tax, Philadelphia saw soda sales drop 30%+. Canada Dry is laying off 20% of its workers.  It’s a few million in losses, but it’s spreading to other cities.
  3. End of Food Stamps Benefits: At the height of the recession, US States waived the requirement that food stamp (SNAP) recipients had to (1) have a job, (2) be in training, or (3) provide some community work.  Food stamp recipients shot up from 27M to 47M.  8 years into the recovery, there are still 41M individuals getting food subsidies.

Most don’t realize, but food stamps are big business: about $71 billion (B) in annual support.  

Food stamp subsidies have more than doubled since 2007 (at $30B.)   

If you really want to get pissed off at program wastage… administrative costs have also doubled – from $2.4B annually to $4.8B.)  

In past economic cycles, Food Stamp participation drops back to pre-recession levels within 2-3 years of the recession. 

That stopped with the 2001 recession. Why? Because big business stepped in.  

A cool $50B per year of government money is being funneled to a handful of companies. These companies spend millions themselves in lobbying to keep the largess going.

Almost half of food stamp money is spent on candy and – wait for it – soft drinks.  

Walmart is the biggest beneficiary. They get 18% of the total.

Amazon sees this big piece of the pie and wants in. Now, Prime members who use their SNAP card get a 45% discount on food and soft drinks.

But changes are coming.  

States like Alabama and Georgia (among others) have reinstated the basic requirements to qualify for food stamps.  

Remember, this isn’t hitting hardship cases. The rules are very gentle. If you are able-bodied, then you don’t get a free ride.

Work, show proof that you are trying to work, or provide the community with 20 hours of monthly public service (one afternoon per week).  Participation has collapsed.  Alabama alone saw 85% drop in participation. Georgia 62%

As a major recipient of the spending, KO is about to face billions in falling sales.

KEY TAKEAWAY: Coca-Cola is in for a rude awakening with the food stamp regulatory changes. Taxes on soft drinks. And competition from Pepsi. All are big negatives for the stock.

Meanwhile, it’s trailing price-to-earnings ratio is 31. Its price-to-sales is just under 5.

Want to pay that much for a company with falling revenue and earnings? Didn’t think so.

Avoid the stock ahead of earnings July 26th.

 

Best,

Andrew Zatlin

Editor of Moneyball Economics

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Yellen Might Want To Check This Industry Before Raising Rates

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Industrial Production & Export Boom Slowing

The economic boom has been underway for several quarters.

Industrial production and exports are up from  Taiwan, Japan, and South Korea. These companies are major semiconductor producers. They are a health gauge for the global economy… as semiconductors are a sign of growth.

You can see Korean and Japanese industrial production in an uptrend through April 2017.

Japanese industrial production and semiconductor billings have also been in an uptrend.

Taiwanese and Korean exports too.

Depending on the sustainability of the boom, central banks in Taiwan, Japan and South Korea can choose to tighten or to wait.  And it’s nice to have those options.

One reason they may want to wait: The boom may start to slow.

You can see semiconductor contract manufacturer growth is now trending down.

The last time foundry billings rolled over was in 2015. Taiwan’s GDP contracted -1.5%. Korea’s annual GDP slowed from 3.5% to 2.5%

In light of the leading qualities of semiconductors, the downtrends indicated by the major Taiwanese producers are reason to wait on any tightening.  

If the semiconductor cycle has peaked – essentially the cause of economic boom for Taiwan/Japan/S. Korea – then the signs will be apparent by the fourth quarter (Q4).

KEY TAKEAWAY: First, the financial risk from Fed rate hikes has been small and another one won’t jostle things too much.  

Second, there are reasons to doubt the sustainability of the current boom.  

Much depends on continued U.S. and Chinese growth, both of which are very much in doubt.  And, if semiconductor signals are right, we are already seeing signs of slower growth on the horizon.

 

Andrew Zatlin

Editor of Moneyball Economics

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Vice Index Shows U.S. Slowdown Ahead

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Slower Spending Growth In Q3

When Vice spending momentum began to slow in February, I blamed near-term noise.  I thought it might be tied to February’s tax refund deferral.

And when it slowed again in March, I blamed Easter.

But vice spending growth continues to slow.  In fact, in the latest month, it points to contraction in 3Q or early 4Q.

And we’re already seeing that slowdown in the latest Retail data. May retail spending downshifted significantly. It dropped from 5.6% year-over-year (yr/yr) growth in January to 3.8% yr/yr growth in May (the lowest of the year).

Recent Macro Data Confirms the Downshift

People spend what they earn.

As income growth slowed, so have Personal Consumption Expenditures (PCE).  And this is after gas price inflation has moderated.

 

Spending could rise if wage inflation picks up. Or if payroll growth accelerates (or both). But that scenario is unlikely in 2017.

Meanwhile, alternative sources of money are slowing. The biggest being student loans.

Student loans are the biggest scam going: money is given but only a fraction goes to tuition.  The rest has been recycled into the consumer economy via cars, vacations, iPhones, and so on.

 

Revolving credit has also rolled over.

Add it all up and conditions are set for slower spending growth.

It’s already showing up in the luxury spending we call vices.

Like in Gambling & Prostitution

Gambling Continues To Slow

 The above chart averages the rates of gambling growth for Detroit, Maryland, Connecticut, Atlantic City, &  Pennsylvania.

While comps play a role in exaggerating some of the contraction, the trend is clear:  less gambling.  And that means less hot money floating around households to play with.

But it’s even more obvious in the middle and upper ends of the market.  Take Las Vegas: the Downtown area caters to more lower-income gamblers.  The Strip is for the middle and upper income gamblers.  In the latest month, Downtown gambling rose 9% while Strip gambling rose 3%.

Prostitution Price Inflation Slows

A sampling of escort prices in major urban markets shows that, after moving up sharply in late 2016 and early 2017, escort prices hikes have leveled off recently.

The reasons are:

  1. Market dynamics: the recent big (~15% on average ) uptick in prices has to be absorbed
  2. No inflation pressure: hotels are the primary cost that escorts pass along. And hotel prices are flat and even down in most major markets (per Trivago’s Hotel Pricing Index)
  3. Opportunity has slowed: Price hikes have been largely opportunistic.  That is, thanks to the surging stock market beginning in 4Q17, customers seemed to have extra disposable income.  The S&P surged ~15% in the 4 months from November to February but only 1.5% in the 2 months since then.

Even more interesting is that mid-tier escorts have begun to offer discounts.  The frequency is limited, but enough to stand out.  And the price deflation is significant – it rolls back most of the recent price hikes.

Why the soft demand?  Affordability.

It’s not that pay-to-play inflation outpaced affordability.  Prices were raised ~9 months and demand remained strong.  Suddenly the phones aren’t ringing off the hook.

And it’s not stiffening competition.

This is a demand problem.  And price cuts are a great way to firm up demand.

If this is trend, we’ll see more discounting through the Summer.

KEY TAKEAWAY: We’re seeing downturns across the board in most of the Vice Index data. I see volatility picking up in the third quarter as the market realizes people are starting to pull back their wallets from vice expenditures like gambling and escort services.

 

Andrew Zatlin

Editor of Moneyball Economics

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Gauging The Economic Impact Of Uber

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Uber has been in the headlines for all the wrong reasons over these past couple months.

I’m sure you’ve seen or heard the headlines.

From sexual harassment, to discrimination, to “Greyball” – software that helped Uber drivers evade law enforcement.

Everything seems to be imploding for Uber. Amidst all the controversy, CEO Travis Kalanick resigned yesterday.

Yet we should not overlook the major economic impact of Uber (and its main competitor Lyft).

According to Uber and Lyft, there are over 400,000(K) registered active drivers in the US.  

An active driver is someone who has provided at least 4 rides per month.

The number of taxi and limo drivers reached 77K in 2013 – an increase of 18% from 2010. Taxi and limo driver payrolls hit 8K in 2015 and 2016. But dropped to 76K this year… essentially leaving payrolls flat for the last 4 years.

You could even argue the 5% decline in payrolls this year were taxi and limo drivers jumping ship to Uber.

But looking from an even higher view,  we now have 400K part-time contractors.

These part-time contractors are not included in the non-farm payrolls numbers.  So any employment upside is being missed in the government data.

Who Wins, Who Loses?

Uber & Lyft will generate $8 billion (bn) in revenue in 2017.  

The U.S. Taxi industry generates $19B annually (per IBIS World).

This hasn’t changed much even with the advent of the ride-sharing economy.  Which means that Uber is not replacing the taxi industry as much as it is augmenting it by releasing pent-up demand.

Understand that the taxi industry is a local monopoly.  New York, LA, Las Vegas, San Francisco – the taxi rights are owned by individual companies.

The origins of the U.S. regulated taxi industry goes back to the Depression.  

To make ends meet… car owners offered ride-sharing. But supply overwhelmed demand and prices plunged.  

To prop up workers, cities began to regulate the industry in order to limit the number of drivers. They created a limited number of licenses (aka medallions) which they sold.  

Eventually a market emerged for those medallions and some smart business people began to scoop them up. Some became billionaires by doing this.

(The fight against Uber is really a fight between billionaire monopolists and a monopoly-busting service. Banks also have a heavy interest in keeping the taxi industry alive because they borrowed a ton of money to buy up the medallions.)

But limiting the number of licensed taxis also capped the number of rides.

If you’ve been to San Francisco, you know hailing a cab is pointless. There aren’t very many.  

As Uber is showing, massive pent-up demand has existed and is generating $8bn of incremental economic activity that is being distributed across hundreds of thousands of workers.

Is Uber Cyclical (part of a booming economy), Counter-cyclical (part of trying to make ends meet), or a bit of both?

There are full-time Uber drivers but most are part-time drivers trying to supplement their income.

An active economy creates the demand for drivers. But when the economy turns down, we’ll likely see even more drivers but less demand. Unlike the Depression, price regulation will be in place because Uber has to make a profit somehow.

KEY TAKEAWAY: Uber has disrupted the ride-sharing economy. However, the government, banks, and taxi monopolists won’t allow Uber to completely put them out of business… at least for the foreseeable future.

When the economy turns, more people will take up driving (increasing supply) as consumers pull back their wallets (decreasing demand). Prices will drop.

Eventually more regulation will be put in place for companies like Uber and Lyft.

Andrew Zatlin

Editor of Moneyball Economics

P.S. Are you struggling to keep up with the huge stock market gains? Then look no further than The Moneyball Trader.

You won’t find it in most mainstream media outlets, but that’s a good thing… it’s why our readers are crushing it so far in 2017.  

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