Posted by Jeffrey J. Roach, PhD, Chief Economist
Friday, October 27, 2023
Key Takeaways:
- Adjusted for inflation, consumers increased spending in each of the last four months while real disposable income fell over the same period. Clearly, this can’t last much longer.
- Auto incentives brought in buyers last month as real spending on goods was driven by spending on autos, both new and used. The use of incentives obviously has implications for profit margins in the near future.
- Not surprisingly, international travel was the largest contributor to the increase in real services spending in September. Airlines should not expect this level of spending in coming months.
- The annual core inflation metric decelerated to 3.7% from 3.8% in August and 4.3% in July.
- Markets will likely struggle with processing the sharp 0.8% monthly rise in restaurant and hotel prices, the highest rate since October.
- Bottom Line: Although consumer prices rose faster than expected from a month ago, core inflation continues to lose speed and this report will not likely change the Fed’s view that inflation will slow in coming months as demand slows. Eventually, spending will moderate after consumers spend more than they earn for several more months.
Where is Inflation Most Nagging?
The Federal Reserve’s (Fed) preferred inflation metric taken from the personal income and spending report is decelerating but some components seem to defy the odds. The price deflator for both headline and subcomponents are definitely improving. The headline deflator rose 0.4% month over month and kept the annual rate at 3.4% in September.
But, restaurant and hotel prices seem to be the most nagging, especially hotel prices. Given the incredible demand for travel and the accompanying rise in hotel occupancy rates, markets see inflation as sticky in this sector.
For context, total hotel occupancy in September was 66.2%, higher than occupancy rates in 2019. Investors should know that hotel companies are reaping the benefits—revenue per available room (RevPAR) is up roughly 3% from a year ago.
Auto Incentives Drove Sales
Auto incentives brought in buyers last month as real spending on goods was driven by spending on autos, both new and used. The use of incentives obviously has implications for profit margins in the near future so expect to see some chatter in the markets on this topic.
Incentives averaged over $2,000 in September, the highest in over two years and close to 5% of the average transaction price. As a side note, this morning’s report is important for several reasons. It provides a snapshot on consumer spending, consumer income, and consumer prices. All three topics are worth digesting.
How Sustainable is This?
For several months now, spending grew faster than disposable income which is clearly not sustainable in the long run. As shown in this second chart, investors have seen a few recent periods when real monthly spending grew faster than real income. From yesterday’s GDP report, we saw that consumer spending contributed over half of the quarterly growth but it looks like consumers are starting to wind down their spending splurge as they head into the end of the year.
Bottom Line
Investors should not be surprised that the consumer was spending in the final months of the summer. The real question is if the trend can continue in coming quarters and we think not. Markets are still expecting no change in target rates at the upcoming Fed policy meetings. Yields on the 2-year Treasury fell on the recent news in the last few days. It’s too early to be dogmatic about the final quarter of the year but investors should expect some deceleration in momentum. Although consumer prices rose faster than expected from a month ago, core inflation continues to lose speed and this report will not likely change the Fed’s view that inflation will slow in the coming months as demand slows. Eventually, spending will moderate after several months of consumers spending more than they earn.
Investment Takeaway
LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its recommended neutral equities allocation as the Committee views the risk-reward trade-off between stocks and bonds as relatively balanced. The Committee continues to favor the energy and industrials sectors and rates consumer discretionary and communication services as neutral, but with a positive bias toward the latter. A combination of generally favorable technical analysis trends, a solid earnings growth outlook, and quite reasonable valuations are some of the reasons why the STAAC is warming up to the sector even as the mixed reception to results from Alphabet/Google (GOOG/L) and Meta (META) creates a tougher path to outperformance in the near term. On the flip side, STAAC suggest caution toward consumer staples and real estate and maintains negative views of those sectors.
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