Personal Incomes & Expenditures: Markets & Economic Analysis

Personal Income & Personal Expenditures were both released this morning.  On a year-over-year basis, the rate of growth of personal incomes is declining less.  For personal expenditures, the rate of growth is declining.  And, within Personal Incomes & Personal Expenditures, the PCE Deflator, the inflation deflator within personal expenditures and, the Federal Reserve’s favorite inflation indicator, there are indications that the peak has printed and inflation growth is waning.  That is good news.  And, the stock market, the broader S&P 500 has taken note of this and is up again today.

Although personal income & personal expenditures do not garner the lion’s share of market driving economic indicators, they are some of the, if not the, biggest drivers of economic indicators.  If you are trying to figure out what actually drives the stock market, personal incomes is an excellent place to start.  The reason is simple: over 70% of the US economy is driven by personal expenditures.

And, if you want to know how much a person is going to spend, all one would need to know is the rate of growth of personal incomes on a year-over-year basis.  If the rate of growth of incomes is increasing, on a year-over-year basis, then the rate of growth of expenditures will increase.

Personal Income & Economic Analysis

For the quarter, personal income increased ~0.41%^[1]BEA.gov statistics.  But, for the year, personal incomes, on a year-over-year basis, improved by 1.3% moving from -8.5% to -7.3% change:

If we were to combine these charts, you would be able to see the strong correlation between personal income and personal expenditures.  However, with the stimulus checks that Americans received to help prop up the economy, the charts are heavily distorted on a visual basis.

Nonetheless, the improvement in personal incomes was important, moving from -8.5% to -7.3%.  The year-over-year changes show the after effects of the stimulus checks.  Americans received free money.  Instantly.  This increased incomes.  Instantly.  Then, Americans promptly spent that money.  Instantly.

The effects of this are still rippling through the economy.

Increased Incomes

First, with the increased incomes showed up in charts above with the sharp spikes upward.  Remember, this chart shows year-over-year increases & decreases on a rate of growth.  With the stimulus checks, Americans received income that was 15% higher than the previous year.

Then, the following year, Americans did not receive stimulus checks on the same scale.  The effect of this was a sharp decline in incomes.

At this stage, since there are no new economic stimulus checks on the horizon, persona incomes are moderating back to normal.  But… we need to define normal.

Personal Expenditures & Economic Analysis

Although not a perfect 100%, there is a direct and strong correlation between income and expenditures.  If the rate of growth of personal incomes increases or decreases, this will drive the rate of growth of personal expenditures:

As I also mentioned, if we were to overlay the two charts, personal incomes and personal expenditures, you would be able to visually see the correlation.

But, and again, COVID and the subsequent stimulus checks has these charts heavily distorted at the moment.  The economy will normalize and the charts will get back to where they are more readable.

In the meantime, personal expenditures, the year-over-year rate of growth, is declining back closer to normal levels just as personal incomes are moving back to normal levels.

What do Personal Incomes & Personal Expenditures tell us?

The normalization process may take several months.  In the meantime, the economy is adjusting.  And, there are some big adjustments that are needed.

Higher Personal Incomes Drove Higher Demand

With the newly-found incomes, Americans shopped.  However, there were limitations to what the economy could handle.  First, COVID sent people home to work (WFH).  Less and less individuals were commuting to work.  This meant less gasoline demanded.

It got so bad, that during the first part of the lockdowns, oil prices plummeted downward to negative: There was effectively zero demand with supply exceeding storage.

Another effect of the initial stage of the lockdown was, of course, the breakdown in the supply chain.  Companies could not maintain 100% of production levels for whatever reason.  This meant that supplies for certain goods & services were in short supply.

And while the supply chain was broken down, many Americans found themselves working from home with their stimulus checks hitting their bank accounts.  And, Amazon shopping carts were filled to the brim quickly.

This depleted existing supply chains from an abrupt, and abnormal, surge of demand.

And then?

Companies started to restock shelves.  But, suppliers were working with dwindling raw goods.  This drove up prices as companies competed more and more for limited raw goods in order to fulfill dwindling supplies.

PCE Deflator & Economic Analysis

Because of the abnormal increase in incomes, the subsequent surge in expenditures, and the outsized fulfillment of orders, as companies competed to obtain limited raw materials to stock their shelves, this competitiveness drove up prices.  But, it was not an instantaneous increase in price pressures; this took time to work its way through the system.

Here is the PCE Deflator, the inflation indicator inside the personal Income & Personal Expenditures economic data and the year-over-year change in prices:

As you can see, the big surge in PCE Deflator came well after the initial COVID lockdown.  And, the paragraph above where I pointed out the competitiveness of companies trying to resupply their shelves took time to occur.  As raw material producers started to see their stocks dwindle, prices needed to go higher.  This took time to work its way through the system.

We are now seeing the ripple effects of the stimulus checks pushing outsized demand through the supply chain, the limitations of raw materials, and labor shortages manifesting in the PCE Deflator.  Inflation has not been this high in over 40 years.

The good news about inflation

The good news to this story, and something I have keyed in on consistently, is the fact that the ripple effects are having the effect of demand destruction: When prices get so high, and substitutions are limited, individuals simply stop buying certain things and supplies restock themselves.

First, the PCE Deflator is the Federal Reserve’s favorite inflation indicator.  Second, it has peaked and should start moderating.  Third, and keep this in mind, it is a year-over-year change.  If prices remained exactly the same from today for one solid year, the rate of change would drop down to zero.  That is an important concept to continually keep in mind when you are trying to wrap this around your mind.

If inflation has peaked, there is demand destruction, and workers return back to where they were prior to the pandemic lockdown, this will have the potential to bring prices back downward.  And, this may occur rapidly.  Then, it may even be possible for price increases to go negative.

Another Canary in the Coal Mine With Supply Disruptions

Unfortunately, the other big issue in the world is the war in Ukraine.  Russia’s invasion of Ukraine will have the ripple effect of increasing prices of certain goods such as food coming from a part of the world that produces such a high percentage of exported wheat & sunflower oil, amongst other things, as well as the ban on Russian oil, will have continued pressure on price pressures as the world adjusts and creates the same products in another part of the world.

But, and keep this in mind: Another country can certainly begin to grow sunflowers.  However, the lowest price leaders of growing sunflowers is Ukraine.  Otherwise, those other nations would have already supplanted Ukrainian production.  So, any new sunflower oil hitting the market will first take time while other countries ramp up production, and price will be higher simply because Ukraine is the lower price producer and other countries will have to expend resources to begin production.

Nonetheless, the eventuality si that what Ukraine & Russia would have produced will eventually be swallowed up by the market.

Interest Rates – Personal Incomes, Personal Expenditures & PCE Deflator

All of this begs to ask the question: What will happen with interest rates?

There are approximately 4 more Federal Reserve meetings left for the year.  In each of those meetings the market is expecting a 50-basis point increase in the short-term interest rates targeted by the Federal Reserve.

This will have the effect of pushing short term rates up to approximately 3.25% by the end of this year; seven months from now.  At 3.25%, you could expect more than likely that the long end of the yield curve will be sitting at roughly 5.00% – 5.50%.  This is normal, as this chart shows:

Looking at the chart above, the black line is current whereas the red line is where the US Treasury Yield curve^[2]US Treasury Interest Rate Yield Curve was just prior to the financial crises in 2006.  If the yield curve is any economic indicator, we have a long way to go before we normalize interest rates after the COVID collapse of the economy.  And, even though interest rates are heading higher, the economy is more than capable of handling interest rates at more elevated levels.

If inflation continues to moderate and price increases moderate closer to normal driven by demand destruction and renewed supplies hitting the supply chain, this will mean the Federal Reserve will not have to drive interest rates upward much more, much faster.  The break in the increase with inflation will mean lower increases in interest rates.  That will in turn alleviate any concerns within the stock market and, the overall broader market can resume moving higher.

S&P 500 Markets

In the meantime, with inflation easing, and personal incomes & personal expenditures returning back to normal, the stock market has begun the slow process of recovering:

There is still the remainder of today and Tuesday for the stock market to trade.  It is possible that the market could fully recover the losses it sustained in the interest rate driven scare.

I expect that the bottom is in for the US markets and stocks should start to head back upward from here.  Look for the summer months to see some modest gains.  But, in general, the stock market will proceed upward.