Violating The First Law Of Holes: 2019 Q1 Advance GDP Report

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by: Trading Places Research

The top line number was very sexy at 3.17% annualized, but 92% of that went into non-farm inventories.

This continues a trend that began in 2018 Q3. In the last three quarters, 83% of all real GDP growth went into non-farm inventories.

While disposable income remains strong, demand for goods, especially durables, is tanking. The savings rate is rising.

March looks like a big reversal of much of this in the monthly data.

The elevator pitch: Everyone took their Christmas bonus and put it into the stock market instead of buying a light truck they could afford.

The First Law of Holes

I think they stopped digging. Chris Wimbush

When you are in a hole, stop digging.

- The First Law of Holes

Are You Sick of Me Yet?

CGP Grey

If you’ve been reading my macro articles since last Q3, you're probably very tired of hearing me whine about inventories, but I got more for you.

Once again, a healthy top line GDP number has been undercut by a buildup in non-farm inventories, and there does not seem to be sufficient goods demand since December to warrant it. Real annualized GDP:

BEA Table 1.5.6

Not annualized, in the three quarters real GDP grew by $100 billion. $83 billion went into increased non-farm inventories. The net growth for everything else in the entire US economy was only $17 billion, $10 billion less than just added light truck inventories.

Another way to think about it: if in Q2 US companies were to clear out all the inventories they added in the previous three quarters, the rest of the economy would have to grow at 7.26% in the quarter, just to get the top line to 0.00%.

Demand for goods has been cratering since a huge surge in Q3-Q4 that ended with a bang in December. Real core PCE goods, annualized QoQ growth:

BEA Table 2.4.6U

The problem is particularly acute in durables, especially light trucks, another thing you’re probably tired of hearing me whine about. Annualized QoQ real PCE growth:

BEA Table 2.4.6U

Also, clothing, the only non-durable category seeing the same sort of demand shortage as durables, was down -5.61% annualized.

We are already seeing the effect on prices. Annualized QoQ PCE chained-price inflation:

BEA Table 2.4.4U

When you add it all up, the growth in private inventories is not warranted by demand in many categories and it’s starting to show up in reduced retail prices which will thin margins all around. I’m not sure what corporate purchasers are thinking, but they seem to be unable to keep up with wild monthly swings in demand.

In addition, while inventory investment grows, fixed investment growth is shrinking. QoQ annualized growth rates:

BEA Table 1.5.6

The best news in the report comes in the form of a dramatic recovery of the trade picture, which had been dirt in H2 2018. A big quarter for farm exports, which is a lot of it, and vehicle exports. The overall effect is that the trade deficit down marginally YoY.

I will be discussing this three-quarter period of July 2018 to March 2019 a lot. When I saw the 2018 Q2 report, it looked like the top of the cycle. Not only was the top line huge, but in looking at it again now, every one of the splits had good news, except for residential investment, and we’ll get to that in a bit. But it’s been downhill from there, except...

March looks like a reversal of much of this, and maybe April too.

Why The GDP Report Is So Darn Important

GDP Print Day is a pretty big deal around here. Universal Pictures

Even in its preliminary form, the GDP report is an incredible snapshot of the US economy, and how we connect to the world through trade. Moreover, the underlying tables contain a level of detail that is not found elsewhere in government data. It is an especially unrivaled high-resolution photo of income, consumption and investment.

But I am not the only one who spends days downloading Excel tables and pouring over the 398 rows of data in the PCE underlying details table (it is also the most fun table). Some other people who raised an eyebrow as they scrolled past Line 125:

  • The Fed
  • The Treasury Department
  • The Council of Economic Advisors
  • Congressional staffers
  • Academic, bank, and business economists

I think you get my point.

Why Inventories Are So Darn Important


Inventories, like prices, sit at the nexus of supply and demand. Supply and demand are fuzzy concepts, but inventories together with prices give us ways to measure how supply and demand are interacting. We can easily strip out price effects with PCE deflators, which leaves us with inventories.

In the imaginary world of purely theoretical economics, where information is perfect all the time, and all transactions are frictionless, there would be no inventories. Every day, whatever inputs every company needed for that day — no more and no less — would appear magically at the loading dock in the morning and be depleted by day’s end. Everything would forever be at the market-clearing price, and peace will reign over all corporate entities.

But of course this is not the real world. Information is far from perfect, and transactions have plenty of friction. Companies must project forward and many things can affect that. Sometimes they overshoot, sometimes they undershoot — both are dangerous and it’s important to quickly correct the error. So in a healthy economy, changes in inventories should always be trending toward net zero in the long term. Eventually they have to get there, or the market cannot clear.

On the micro level, inventories are a measure of operational efficiency. Companies with regularly high inventories are having trouble projecting demand, and are shrinking margins as a result.

On the macro level, it tells us how well companies economy-wide or in different sectors are projecting demand. The worse they do, and the more correlated their bad decisions are, the more the danger to the economy becomes.

Most post-war recessions revolve around highly correlated inventories. Of course the Ur-bubble, the Dutch tulip craze, was all about high inventories of tulips. But let’s talk about the last recession, since it’s a little fresher than the 17th Century.

Housing was booming in America, and it didn’t seem like it was going to ever end. Homebuilders couldn’t open up new subdivisions in the middle of nowhere fast enough. Prices were rising so fast, that it attracted speculators, who increased “demand” for housing, but not the actual demand for homes in the places they were being built. Many of these subdivisions were in fact empty, with houses owned by speculators. Inventory kept rising, but speculators masked the problem. Until they didn’t.

Eventually, as housing inventory kept growing, speculators were unable to sell these houses at any price. They defaulted on their mortgages and took total losses. The banks that held the debt were also unable to sell the houses, because of inventory that had way overshot demand. And that debt had been securitized...

Oh, you know the rest. But it all began with high inventories of housing hiding in plain sight.

The “value” of inventories are just a number on a balance sheet — we think our inventories are worth this much. But when prices plummet due to oversupply, the actual value is somewhere between what’s on the balance sheet and zero, and it can leave a giant hole. If many companies or banks have highly correlated balance sheets, then systemic liquidity collapses, and we wind up bailing everyone out, because the alternative is worse.

High inventories are a virus.

GDP in Plain English

Story time. Provincial Archives of Alberta

I apologize in advance for the length of this article, but in 25 years of reading these things, this has to be one of the weirdest, especially in combination with the previous three. Strange things are afoot, and there are many threads to pull together to get a complete picture of what happened in the last 9 months. I’m an econ geek, so this is all fascinating to me. Your milage may vary.

I’m going to start off with Jerome Powell’s “plain English,” and tell the story of the last 9 months with as little jargon and as few numbers as I can manage. I hope I am more successful with it than Jerome was. The data, and I came with binders full of them, will come after, but first I want to tell you this story in the simplest way possible.

We begin in the halcyon days of Q2 2018. We were just 3 months into the corporate tax cuts, and the trade war had not heated up yet, though everyone was anticipating that it would soon. Outside of residential construction, a sore spot all year, the US economy was firing on all cylinders the way it hadn’t since Q3 of 2014. Woo hoo! U-S-A!

Coming out of June, companies that make and sell consumer products had to be feeling pretty good. They were still on a tax-cut sugar high, demand was strong all around, consumer confidence was sky-high, and disposable income was growing. Their inventories were going down because they couldn’t maintain the pace. Even exports were growing! Everything was looking like a setup for a massive Christmas season, one of the best of all time. I certainly thought so.

But tariffs loomed, so companies began front-loading their Christmas inventories in July. If you believed that wholesale and retail trade in November and December would blow out, what’s a few months in a warehouse if you save a 10% tariff? Margins, bruh.

The buildup was particularly large in light trucks and SUVs, both new and used, large appliances, furniture, machinery and clothing. At the time, this all made perfect sense. No one knew they were digging themselves into a hole.

Demand remained strong through the summer, a little off the Q2 heights, but not enough for anyone to worry too much. Companies continued pile up more and more stuff before tariffs hit in September.

As companies were spending more and more on inventories, they began cutting back on fixed investments. Equipment investment remained strong in most categories, but new construction began to fall quickly. Both imports and exports of industrial and capital goods began to fall. But who cares? Christmas is coming!

September brought the first real signs of trouble to come. People decided they had enough clothing, furniture and large appliances — and demand cratered there and in many categories. But they most definitely decided they needed a used light truck or SUV in their driveway.

Another thing that took away from those dishwasher purchases: prescription drug spending began an epic run in September that has continued at least through March.

As used truck demand skyrocketed, dealers gave great trade-in value to get people into a new truck. No one cared too much, because margins were really fat on used trucks, so a little more on the trade-in was a win-win for the dealer and customer, not to mention the auto makers. Dealers piled up more and more new and used light truck inventory to keep up. They even started importing used trucks.

October brought a huge recovery in new light truck sales, as trade-in deals became too sweet to pass up and 2019 models started hitting showrooms. Used truck purchases cratered as buyers chose these great deals over the used stock, which was increasing in price. All this up and down was making it impossible for buyers to project future demand.

All this time, housing, health care and transportation services were costing people more and more, and becoming a much larger part of everyone’s monthly bills. Despite rising disposable incomes, much of it is going into these three things. Did I mention prescription drugs? Them, too.

And the inventories kept rising, many from imports.

November. Ah, November.

Give the people what they want, when they want it, and they wants it all the time.

George Clinton and Parliament Funkadelic

That was November. Everybody wanted everything all the time and credit cards were melting from the friction of sliding in and out of chip readers. It culminated with the Mother of All Black Friday Weekends. Everything was moving fast, and wholesalers and retailers scrambled to get the people what they wanted, when they wanted it all the time. Wholesalers were salivating, and piled up more inventories. If November is like this, can you imagine what December’s going to be like?

Best. Christmas. Ever.

Or not. December rolled around and people decided their Christmas stockings were full up. Despite a huge Christmas bonus season, everyone saved that money, and socked it away in savings accounts and the like, and paid off some credit card debt they accumulated in November. With the exception of used light trucks (have I mentioned people like used light trucks?), the money they did spend went to air travel, much of it abroad, taking advantage of cheap airfares. With a lot of people out of the country, that did not help domestic demand. Even small business owners, who had been having a great year, saw their businesses stymied.

Inventories exploded. It was too late to cut them off; the orders were already in and being delivered. Wholesalers were in the middle, getting screwed. When December wholesale inventories came out, they lit my hair on fire.

The best spin I can put on the report is that drugs were not completely awful, and alcohol sales were strong and drew down inventories, so we were all too drunk and stoned to notice what was going on.

The US consumer turned off the spigot in December in a big way. They even took a month off from buying TVs, which hadn’t happened in quite some time. It was not just credit market liquidity and the stock market that stalled. Everything did.

The new year brings new hope, though not for wholesalers in 2019. They had dug themselves into a giant hole. But for some reason, many of them kept violating the First Law of Holes and wholesale inventories continued their steep incline.

But some wholesalers, like lumber yard owners, had enough, slashed prices, and did stop digging. The problem began to spread to durables manufacturers and clothing retailers, who were now stuck with a bunch of stuff that was proving hard to sell.

The US consumer was a different story. Everyone got back from their trip abroad, and looked at their swollen bank accounts. Feeling pretty good, consumers went out bought a ton of news cars, but left all those new light trucks to sit on lots. Despite high prices from tariffs, they bought some of the furniture and appliances no one bought over Christmas, even at tariff-inflated prices, and dipped into their fat savings for those.

But mostly what they did in January was empty out their savings accounts and put it into the stock market, just as hedge funders were into high levels of cash. But they stayed away from casinos in a big way in January, because they were getting plenty of risk in the stock market.

And we saw the result.

Chart Data by YCharts

The low-volume retail rally was ready to rock.

Incomes remained strong in February except for small business owners, who continued to take it on the chin. While consumers dove in as 4K TV prices declined sharply, they only had money for housing, health care, prescription drugs, and skyrocketing transportation costs. And have you seen the market?

Stock market indexes surged and the retail risk rally continued, while hedge funders stuck with large cash positions.

Chart Data by YCharts

More wholesalers were beginning to realize the deep hole they had dug, and they tried to stop digging, but that didn’t stem the rise in inventories. The problem continued to seep outward to retailers and manufacturers. Despite huge discounts across a huge range of items, nothing was moving (except 4K TVs). Everyone was too busy watching their brokerage accounts soaring.

Fixed investment continued its slowing growth, but there was bright spot in the new year: new warehouse construction was booming! There was so much extra stuff, they ran out places to put it all. I wish this were a joke, but it isn't.

Rising inventories were continuing to outpace sales, and many wholesalers were at this point desperate to unload. New manufacturing orders dried up as they decided to let retail and manufacturing absorb some of the burden, and they did, especially retail clothing.

If you asked a retail sales associate, “do you have more in the back?” in February, the answer was yes, and it’s on sale, too. There were huge discounts, but this did not seem to stir anyone...


March rolled around, and it was as dramatic a swing as December. Retailers and wholesalers were desperate to unload inventory, and prices plunged across a wide range of products.

Consumers were feeling extra good. Outside of small business owners, disposable income continued to grow. But more to the point, they saw this every time they logged into Schwab:

Chart Data by YCharts

Do you feel wealthy now? I sure do! And oh my God, everything is on sale! Let’s go spend some money!

What did they buy? Everything. Furniture, appliances, cars, trucks, clothes — everything, all the time. Spurred by their new stock market wealth and lower prices, the US consumer went on a November-like binge.

But they didn’t pull money out of the stock market to do it; they just saved less money. People kept their money in the market, but didn’t add to it, and opted instead for that insane deal on a 2016 F-150 with low miles. The retail rally stalled.

Chart Data by YCharts

Yet somehow, inventories kept growing through all of it, right to the end.

So that’s where we stood at the end of March. We don’t have a ton of April data yet, but what we do have is mostly positive, though I don’t think as strong as March. This is a 9 month period, with 3 giant inflections and huge monthly swings. I’m not about to try and predict where it goes next.

Binders Full of Data

TPR interns busy at work with the new report. NPS

Yes, I came with binders full of data, and this is the long part. The issue here is that we can view the economy from many angles, and by putting them together, we get to form simple conclusions. For example, when in plain English I said:

What money they did spend was on air travel, much of it abroad, at cheap airfares.

That’s actually 7 different data points spread out over 3 tables, plus I checked inflation on jet fuel. So this is a very complex thing.

This is going to mostly be of interest to econ and data geeks, but I tried to keep the jargon at a minimum, so I encourage everyone to give it a go. If it’s too boring for you, scroll down to the photo of the fortune cookie for conclusions and market implications.

A Quick Note on Data Choices

Feel free to skip this if you don’t care, but someone has to.

The GDP report is actually around 100 tables, some of them huge. It is important to choose the right ones, or else the conclusions can be radically different. Unless otherwise noted, all the data is:

  • Real: Because, inflation. Beginning in 1997, BEA has used PCE chained-price deflators which is far superior to traditional CPI deflation. Chained-pricing uses a continually changing basket of goods that reflects inflation in each individual subcategory on the PCE table (and there are many). So it accounts for changing consumer tastes, spending patterns, and also substitution effects. By the final report we get a highly accurate inflation number for total consumption, and also in the excruciating detail of the PCE table.
  • Seasonally Adjusted: Because, seasonality. By the final report, these are also very accurate.
  • Annualized: This allows for easy comparison between monthly, quarterly and annual numbers, whether levels or rates-of-change. Just be aware that annualized rates-of-change are compounded, so large changes over short periods get amplified once annualized. This is especially acute with the annualized monthly growth numbers.

Starting At The Top

Let’s start with the main categories in the report. The percentages are the contribution to real top line growth.

Percentages don’t add to 100; there is also a “residual” category, which is typically a negative number and is highly volatile QoQ. BEA Table 1.5.6

So, from ten thousand feet, this looks really good, especially when paired with the strong 3.17% annualized top line. But PCE is dominated by services, primarily health care, housing and transportation. Other than IP investment which continues to blow out, and investment in warehouse construction, fixed investment growth is weak.

So there’s some good news on the right side of that pie, mostly for farmers, but the left side is actually pretty bad once you dig down. So let’s do that.

Personal Income, Wages and Savings

Personal income and wages are the only data we will be using that are nominal and not seasonally adjusted, and BEA has their reasons for not releasing adjusted real data here. Ask in the comments if you care. They do, however, give us real disposable income.

We’ve see strong growth here for some time, but Q1 saw this fade a bit:

BEA Table 2.1

As you can see, the wages/salaries category continue to grow at a fast clip, and disposable income per capita also grows nicely (the lower rate is because this is real and per capita), and we can see it was a blowout Christmas bonus year in Q4 disposable income.

The drop in the top line growth rate in Q1 is almost entirely due to non-farm proprietorships, which are the small business “pass-throughs.”

I’ve highlighted a few things that are small items, but are part of our overall story.

  • Farmers have had an insane up and down year — much more than just the usual seasonal variance here. In the end, they wound up +2.56% YoY, so certainly not awful, but it’s been a wild ride getting there.
  • The next thing I want to highlight is the big jump in unemployment insurance benefits which matches the rise in continuing claims from November through mid-March. This is the first blip we’ve seen in employment in 10 years.
  • Finally, we see a big downward movement in interest income. This is interesting, because the savings rate had been going up, and I was assuming people were taking advantage of relatively high rates on savings accounts and cash equivalents. As we will see, it was going into the stock market.

BEA also publishes monthly tables for these series, which gives us an added level of resolution on the trends here (annualized MoM):

BEA Table 2.1

First off, December bonuses for the win! November was hardly a easy comp, but income and DPI per capita were both up close to 13% annualized in December. January saw the inevitable decline off of bonus season, but has not picked up considerably since.

The reason is that red line, small business owners who have had a tough 6 months, and a rough start to 2019.

The savings rate is also on a wild ride:

BEA Table 2.1

People took their outsized December bonuses and put it not into consumption. Some went to pay off credit card debt accumulated in the October and November retail frenzies. Much of it got dumped into savings and similar. But December was jumping off point for the low volume retail rally of 2019. Just as hedge funders were upping their cash positions, consumers started dumping their savings accounts, and plowing it into the market. Interest income tumbled.

BEA Table 2.1, Fed G.19

However, it looks like the wealth effect is doing its effecting. As we will see, March consumption spiked off the December to February lows, and the savings rate plummeted as a result. We’ll get to the bottom of all this as we proceed through the report.

Wages and salaries have remained strong, but the one trend is that manufacturing wages have lagged the growth in every other category. This is not a new trend.

Personal Consumption

My favorite table in the report is Table 2.4.6U "Real Personal Consumption Expenditures, Underlying Detail.” There’s a really fine level of detail here, and a lot to learn about the US consumer, including some fun conundrums like: how exactly did “games, toys and hobbies,” less than 1% of all consumption, account for 14% of top line consumption growth? Sampling error? Non-sampling error? I really hope D&D is making a massive comeback, and is driving the economy.

When you build your dungeon out of Lego, you’ve not only reached Peak Geek, but are also the engine of global economic growth. wiredforlego

The first thing is to start stripping things out, which BEA mostly takes care of for us. The prices for food and energy are highly volatile, and respond more to commodities prices than they do consumer demand, which is fairly inelastic, and distort underlying trends in the economy, so they are commonly stripped out of PCE and inflation. PCE for only food and energy was down -1.23% annualized this quarter, and pulled -13.2% out of top line PCE growth. Big swings are typical in these numbers, which is why they are stripped out for “core” numbers.

Core PCE was up 1.50% annualized in the quarter, which certainly is not terrible, but well below recent quarters as well as the YOY at 2.62%. But digging down, the details reveal continuations of troubling tends since December. Services dominate the growth in this table, and really it’s the three highly inelastic categories that are the whole report: housing, health care (plus prescription drugs) and transportation services.

First, the annualized QoQ and YoY growth rates of some aggregates:

BEA Table 2.4.6U

The first thing is that the YoY numbers remain strong. This is an issue that began in December. If we look at the QoQ numbers, we can see that, stripping out the three inelastic categories (2nd row), core PCE was down this quarter -0.24% annualized. Those three categories account for 81% of all PCE growth this quarter.

Core PCE goods was down -0.31% annualized in Q1, and when we strip out prescription drugs, down a whopping -2.03%. The weakness is mostly in durables, and we’ll drill down in a moment.

Services still have healthy growth, though below recent quarters and the YoY. This is dominated by housing, health care and transportation. Without them, the growth rate of services is less than half.

This was a period of rapid changes so let’s look at the monthly numbers. Remember, these are annualized rates-of-change, so big moves in a monthly window are exaggerated. As you can see, there are many big moves in monthly windows, particularly December and March.

BEA Table 2.4.6U

This is one of our first big indications that like December was in Q4, March is a reversal of trends in the rest of Q1. This surge in consumption was not the result of increased disposable income, but rather goods price deflation and a reduced savings rate, which leads me to believe the wealth effect is effecting.

January was a mild recovery from December, and February was down sharply. As you can see, the 4-month result of all this up and down is pretty much the same as the annualized quarterly numbers in the previous table. For core PCE goods, what a way to get to zero.

Often, when the last month of a quarter is this different, we see big quarterly revisions, in this case upward. Standard disclaimer: only time will tell!

PCE Goods: Not Good

This is where the trouble is mostly, and it is concentrated in durables, especially light trucks.

BEA Table 2.4.6U

We’ll get to the disaster that is light trucks in a moment because that requires special attention. The household durables number is being driven by big year-long declines in large appliances and especially furniture. Those giant recreational goods numbers are TVs, software, and computers/tablets, in order of giantness. Also, pleasure boats have been killing it all year, and are having an outsized effect on PCE. Who knew? Finally, the “Other” decline is being driven by jewelry. I don’t know if the Apple (AAPL) Watch is counted as a watch or electronics, but the watch category held up exceptionally well in contrast.

Switching to the monthly numbers, we can see the wild ride.

BEA Table 2.4.6U

For Pete’s sake. But despite the huge March turnaround in durables consumption, there’s still a lot of red in that last column. With these giant monthly swings in demand, is it any wonder that companies are having trouble managing inventories?

Moving to non-durables:

BEA Table 2.4.6U

Core non-durables looks like a bright spot in the PCE report, but it’s mostly prescription drugs driving that number. When we strip out the exploding expenses of prescription drugs, non-durables are down QoQ and YoY. Clothing sales have taken a nose-dive since December after what had been a strong 2018.

The “Other” category in non-durables is actually very large, as it contains all drugs and medical devices. But even stripping out all drugs and medical products, it is still 5% of all consumption, and as you can see has been growing very nicely in both windows. The big driver in Other, accounting for 13.71% of all real PCE growth, is games, toys and hobbies. OK, maybe I’m a little obsessed, but this is a tiny category, 0.88% of all PCE. It was up 21% annualized QoQ and 9% YoY. D&D for the win? Please let it be so.

Switching to the monthlies, we can see that, except in clothing, the picture was not nearly as volatile as durables.

BEA Table 2.4.6U

My favored look here is the core non-durable ex-drugs row. While this strips out most of non-durables — food, gas and prescription drugs — those three categories reposed to other things besides consumer demand. In any event, that measure winds up only +0.48% in this bizarre 4-month window, so not so good, but better than durables

PCE Services: Also Not That Good

In services, the main splits:

BEA Table 2.4.6U

I’ve added two columns: percent of all PCE in the quarter, and also its percentage influence on the top line PCE growth. I want you to get a sense of how much the services categories are driving the top line, a trend that is pretty long in the tooth by now.

Core PCE services rose at 2.08% annualized in the quarter, which is a healthy number, though below recent quarters and also the YoY.

But if we strip out the low elasticity categories — housing, health care and transportation services — we can see that the quarterly numbers are pretty bad in comparison to the previous quarters.

Most of the growth in the more discretionary categories is being driven by — good news for y’all — tremendous growth in portfolio management fees. Annualized growth rates:

BEA Table 2.4.6U

This is our second clue regarding the Q1 retail risk rally. Pros stayed away, and thus the collapse of commissions. But consumers were looking for wealth management in January, and they got it. As you can see, they were ready for risk, not mutual funds.

But… Is that FOMO’s music I hear in March? Look at that jump in commissions (though still way down for the quarter). Some pros got tired of underperforming.

The three big services categories were 37% of all PCE in Q1, and accounted for 89% of the growth. That’s the giant sucking sound you hear in our monthly expenses.

Finally, before we get to vehicles, I just want to dial PCE services back to December, when overall demand fell through the floor. But air travel expenses were up 51% annualized in December — remember, these are real and seasonally adjusted, so this was an unusually busy Christmas season for air travel.

But we should also expect to see big jumps in hotels and restaurants, and just the opposite is true — sharp declines of -6.54% and -4.22% respectively. People were out of the country, and this was part of the reason domestic goods demand cratered so hard in December. We’ll look at this from some other angles later in the report.

PCE Motor Vehicles: Good God!

Holy smokes, what a disaster, and I say this as a Tesla (TSLA), GM (GM), and Ford (F) bull, though maybe not for long if this keeps up. So bad, they get their own section. Fortunately for us, BEA publishes fine detail on the auto business, because, America.

BEA Table 2.4.6U, BEA Table 7.2.6U

Do you like the color red? Welcome to new vehicles PCE. You see all the large negative numbers there, but to boil it down, the giant shortfall in durables demand in Q1 is 110% new light trucks. Had new light trucks just remained flat, durables were actually up in the quarter, not a giant hole in PCE. Do you think light trucks may come up again when we talk about inventories? If you do, you have good instincts.

But we can also see the continuation of something that is starting to turn into a long term trend: there is higher demand for used vehicles at the same time that demand for new vehicles is doing so poorly. PCE for new vehicles has been slacking for a couple of years now, but used vehicle consumption continues to grow at a steady clip, and our friend the light truck is leading the convoy.

BEA Table 2.4.6U, BEA Table 7.2.6U

As you can see, even new light trucks have been selling poorly of the last two years, and both used and new autos are down. Demand for used light trucks is pushing the trend here.

But, March. Even though they are still in a huge hole, they were able to fill it a bit in March. The monthlies:

BEA Table 2.4.6U, BEA Table 7.2.6U

Like saw in all the durables subcategories, the March surge was not enough to overcome the deep holes dug in December through February. We’ll just have to wait to see where this goes.

Inflation: It's Fallen, And Can’t Get Up

Prices contain a lot of information about supply and demand — sort of the nexus between consumption and production/inventories as discussed before. When prices rise, it’s a signal to companies to produce more, and for consumers to hold off purchases. When prices fall, it’s a signal for companies to produce less, and for consumers to start dipping into disposable income or their credit. The relationship goes both ways: lower prices will increase demand, but higher demand will increase prices — at some point theoretically reaching equilibrium at the market clearing price.

But since 2001, we live in an era of relative low growth, low interest rates and low inflation. Despite all the fiscal and monetary stimulus of the the past 18 years, inflation remains below the Fed’s target rate of 2% Core PCE inflation. It only rose above that for one quarter since the last recession, though we grazed up against it last Q3.

BEA Table 2.4.4U via FRED

I believe this has more to do with demographic trends than anything else, but that’s beyond the purview of this already very long article, so let’s move on.

How did the wild swings in consumption over the last four months affect prices and vice versa? Starting with the core aggregates.

BEA Table 2.4.4U

The blue line is the main line the Fed looks at. As you can see, we grazed up against their target, but now we are well below, driven by accelerating goods deflation and a reduced inflation rate in services, both in response, generally, to decreased consumption.

Digging deeper on durables, where we saw all those wild swings:

BEA Table 2.4.4U

As you can see, the overall durables inflation is negative in the entire window. In household furnishings we are seeing huge price jumps in furniture and large appliances, the two main components of the category. These are very weak areas of consumption, so I have to image higher prices are being driven by exogenous factors like tariffs, and consumers don’t want to eat it.

Motor vehicles need their own chart, and I’m just going to boil it down to light trucks (including SUVs), because that’s where all the action is.

BEA Table 7.2.6U

So two things happened that drove the March surge in light truck sales. Wholesalers and dealers got tired of looking at the same used light trucks and SUVs on their lots, dropped prices, and consumers responded in a big way. However, after at first dropping during the December collapse in demand, new truck prices began rising in February and March. Consumers also responded in a big way, just not the way we’d expect. But new or used, both inflation rates are very low.

If anyone out there who covers the auto industry wants to jump in here, I’m all ears. That blue line doesn’t make a ton of sense to me, unless that’s the effect of new model-year sales.

Moving on to non-durables:

BEA Table 2.4.4U

The non-durables aggregate has responded pretty quickly to demand, declining after the December collapse, and picking up in March. I included prescription drug prices, which though a still a big chunk of consumption, has very muted inflation due to the increased use of generic drugs — prices for branded drugs with no generic competition or biosimilars continue to inflate at a rapid pace.

Apparel is a demand disaster similar to light trucks, and prices have continued to decline there, even with the March surge. Prices will likely continue to drop until they can empty out all the warehouses.

What about games, toys and hobbies? Oh, just humor me. Prices in this category are deflating at near double-digits. PCE price indexes respond to changing consumer tastes, so often something like this is because a very low-priced item has become wildly popular. Are pogs back? Help an old man out.

Moving on to services, for a couple of decades demand has been higher than in goods. Also, many services cannot be off-shored or automated (yet). The net effect is a much higher inflation rate than goods, which have from cheap imports driving down prices.

BEA Table 2.4.4U

As you can see, inflation for the services aggregate (blue) remains above the Fed’s overall target, but like all the main aggregates, it had been dropping since the December collapse. The Big Three swallow everything, so let’s stick with them.

For many reasons, which we will get into below, supply of housing has lagged demand in the places people actually want to live. The result of that is prices there keep inflating above the trend of the rest of the economy, while lagging elsewhere. We will return to this in the sectoral analysis.

Health care inflation is the lowest of the Big Three, and the reason is the cost-cutting measures in the Affordable Care Act, that began in 2011.

BEA Table 2.4.4U

For years we saw high health care inflation until the ACA. But when the GOP began to eat into the ACA with court victories and executive orders, and you can see the result. Last year’s inflation rate was the highest in the post-ACA period.

In transportation, what we are looking at is fuel prices, especially jet kerosine this quarter. Inflation in this sector responds almost entirely to fuel prices.


But to return to December, we can see that jet fuel prices were very low, and people took advantage of the -22.34% annualized inflation rate in air travel that month to head out of the country. Fiji sounds nice.

Investment: It’s All Inventories Nowadays

Did you find the wild swings in consumption and prices disorienting? I have little comfort from fixed investment. The trend for three quarters now is strong investment top line growth that is mostly coming from changes to non-farm inventories, not private fixed investment as we would prefer.

BEA Table 5.3.6, BEA Table 1.5.6

Over the 9 months, fixed investment growth, though certainly not terrible, is less than a quarter of the gross number. While fixed investment grew by $12 billion (real, not annualized dollars), $83 billion was added to inventories. About a third of that inventory growth is light trucks, split fairly evenly between new and used. The growth in just new light truck inventory exceeded all fixed investment growth by 42%. That’s after the March surge in light trucks consumption.

Fixed Investment: Meh

Before we get to inventories, let’s look at the areas of strength and weakness in fixed investment. The main splits:

BEA Table 5.3.6

Starting with top line fixed investment growth, this has had a strong 12-months, mostly due to a blowout 2018 Q2. The last three quarters have been much more tepid, with an annualized growth rate of 1.92%, 1.51% in the last quarter.

In the three non-residential categories, there’s some divergence. Structures and equipment have been fading since the big 2018 Q2. But investment in IP is strong in all subcategories, especially software, which is just killing it. Software investment accounted for 46% of fixed investment growth in the year window, and 109% of Q1 investment growth. This, I believe, is partially the result of the “everything is a tech company now” mentality. All sorts of non-tech companies are making significant investment in customer apps and backend software. I expect this trend to continue. Insert your own “Learn To Code!” joke here.

After several years of strong growth, structures investment is declining. Equipment is a more complex story. Boeing (BA) may come up in that discussion.

The movers from the structures splits:

BEA Table 5.4.6U

Neither the quarter nor 3-quarter windows are too impressive here. What is impressive?

Warehouses. Seriously. Inventory growth has spurred growth in warehouse construction to the extent that it was the number one contributor to all structures investment growth in both windows.

Maybe you need a refresher course? It’s all inventories nowadays.

The big movers in the equipment splits:

BEA Table 5.5.6U

The Q1 drop in the top-line growth rate was largely due to Boeing’s issues. I’ve stripped out aircraft investment for the “ex-Boeing” line, and we can see that growth is still quite healthy outside of it.

  • Computer investment reversed a big slide in Q1
  • Communications investment is super strong
  • “Special industry machinery, nec” is likely driven by semiconductor equipment.
  • Not just light trucks, but 18-wheelers, buses, Mystery Mobiles, all of it. The growth in corporate light truck investment has saved the auto companies from an even worse year.
  • Putting together structures and equipment, it has not been a good year for farm investment.

Inventories “Investment"

Remember, investments can also fail, and if you have around $27 billion in extra light trucks on car lots that no one wants to buy, their actual value at market is somewhere between $27 billion and zero. But probably not $27 billion. And the value of the other trucks that were already there is also at risk.

So inventories are the Big Kahuna of this report and the last two as well. Inventories are divided into the three stages of the supply chain: manufacturing, wholesale and retail. We’re going to start in the middle with wholesale where the problems were more acute and began earlier, and work our way out.

Unfortunately, the inventories and sales data is a month behind the rest, so we only have until February. I had to make estimates based on changes to inventories in the March GDP table. In any event, you should consider March inventories more of an estimate, but I think a pretty good one.

The annualized growth rates of the main aggregates (there is no core retail as they do not split out grocery stores and gas stations in inventories):

BEA Table 1BU, BEA Table 5.7.6BM

As you can see, after a strong April retail month cleared them out, wholesalers (green) began to raise their inventories and kept going, even through the ups and downs of October through December. After the December collapse, the rate of change shrunk, but inventories continued to grow through the end of March in all categories.

Wholesale Inventories: Autos, Then Durables, Then Everything

This is what that section heading looks like on a chart:

BEA Table 1BU, BEA Table 5.7.6BM

Inventories grew dramatically for vehicles (green) in August, then durables (red) followed in its wake, and then everything else was growing at a huge rate. The November consumption surge brought growth down, but it surged right back up in December. All the growth rates are still positive — inventories continue to be added to through March, even with the surge in consumption.

Switching to the inventory-sales ratio, which, uncharacteristically for economics, is exactly what it sounds like. It is sort of like days inventory outstanding data for companies, but expressed as a percentage instead of a number of days. It is an indicator of how companies are managing their inventories. A rising ratio means that either low inventories are being filled up, or that companies have over-produced. A declining ratio means either high inventories are being emptied, or that demand is outstripping supply.

The BEA’s numbers only go through February on inventory-sales, but we just got advance numbers on March from the Census Bureau. These are preliminary survey data, which in the first place come with high errors intervals, and in the second place, are not comparable to the BEA’s non-survey data, so we will have to look at March separately.

The annualized rates of change in the wholesale ratios:

BEA Table 3BU

The columns are based on the two inflection points for the ratio: the beginning of August, and the start of 2019 after the December collapse. The best way to look at this table: all those large green numbers in the Aug-Feb column are companies digging very large holes for themselves. But the red in Jan-Feb column are those industries where they have stopped digging and are beginning to fill up the hole, however they can, but mostly with steep price cuts as we saw in the inflation section. But where you see green in that rightmost column are industries where they were flagrantly violating the First Law of Holes.

While inventories in many key categories continued to rise, the March retail frenzy grew sales faster, and the wholesale inventory-sales ratios of many categories dropped in the Census Bureau March advance survey.

US Census Bureau, Advance Wholesale Inventories

Clothing. Still. But those red numbers in the MoM column are all good news.

Spreading Like The Borg: Manufacturing and Retail

Resistance is futile. Paramount Pictures

Of course, a problem like this that goes on for so long is not going to remain confined to the middle of the supply chain. Manufacturing inventories have jumped this year as wholesalers have tried to slow down and empty their giant inventories. The industries where we would expect the rising inventory-sales ratios:

BEA Table 3BU

With the exception of textile mills, everyone did OK in at first, and you can see the aggregates are down in the longer period. But in January-February the tide has risen up from the wholesalers, and it is flooding durables and apparel manufacturers with all that green in the rightmost column. Textile mills saw the problem the earliest, and are also trying to unload now like some wholesalers.

The inventory tables are a little thin on detail with retail, but the rising ratios are exactly where we would expect them.

BEA Table 3BU


So How Much Inventory Are We Talking About?

Let’s switch over to nominal unadjusted numbers and try and figure out the “value” of what is sitting in warehouses and car lots, and how much of that may never sell, or only sell at reduced margins.

* BEA does not publish inventory levels on the vehicles splits, just changes to inventories. Small truck total inventories was estimated at 75% of all vehicle inventories. BEA Table 1BUC, BEA Table 5.7.5BU1, BEA Table 7.2.5U

The first column is the nominal value of the 3-quarter change in inventories. Companies added $86 billion to inventories from July 1, 2018 to March 31, 2019, over half that with wholesalers and over a third with retailers. As you can see, auto companies and dealers added $27 billion of light trucks and SUVs to their lots (wholesale + retail). This is split pretty evenly between new and used.

The second column is the total “value” of all inventories, $2.2 trillion all together. I put value in quotes, because this is a sum of figures on companies’ balance sheets, not their actual value at market — how much cash someone is willing to exchange for it. In situations like this, it is usually less than what is on the balance sheet. The biggest nut that is at high risk of devaluation is the $400 billion in wholesale durables.

The rightmost column is the annualized growth rate, and I would imagine that the ones with very high growth rates, highlighted in red, are going to have the most trouble filling up their holes. As you can see, it pretty closely matches the trouble spots in the inventory-sales ratios. Even though it’s the smallest on our list, apparel wholesales have the largest problem. and it is similar to the problem in vehicles.

But to circle back to real GDP. Since July 1 2018, GDP grew by $100.18 billion (seasonally adjusted, but not annualized). 83% of all that growth came from additions to inventories. 27% of all real growth in the US economy in that 9 months was just increased inventories of light trucks.

This is not a picture of a healthy economy.

Trade: Filling a Giant Hole

Another hole being dug since July is the one in trade. A combination of tariffs and a strong dollar (they are not unrelated), caused the trade deficit to spike in Q3 and Q4. The big reduction in the deficit in Q1 did not fill that hole, but at least we’ve stopped digging.

The trade tables in the GDP report are not nearly as detailed as consumption and investment, and contain large aggregates groups with names like "Other other nondurable goods, not elsewhere classified.” That’s not a typo.

So there isn’t as much to read into it, but enough to form some conclusions about what was driving the quarter. For starters, in Q3 and Q4, the trade deficit increased by $115 billion, or 29% annualized. In Q1, it decreased by $56 billion, or 26% annualized. So the annualized rates of change are similar, but we were two quarters into the trend once it reversed. The trade deficit is still up $58 billion real annualized dollars since the monster Q2, back almost exactly to the level of Q4 2017. Let’s look at the splits and see what’s driving this. Do you think light trucks may come up?

Starting with exports, I always like to split out food and petroleum, which respond to more to commodities prices, not as much as consumer demand and corporate decision-making. Those two make up over 17% of all exports in the last year, and 32% of all growth in Q1, so it is an important part of the picture, never more so than this quarter.

US farmers finally got some relief in a big way, to the tune of a 46% annualized rise in exports after two dreadful quarters. They are still down 16% annualized in the 3-quarter window, but the picture is much improved, and they still have a little room to run. In any event, the dramatic rise of $15 billion annualized accounted for 27% of the entire growth in exports. Farmers for the win. For once.

Petroleum exports were up slightly, but much less than previous quarters. In any other recent window you care to choose, oil exports are way up. Fracking for the win. Together, food and petroleum accounted for almost a third of all export growth in the quarter.

Turning to core exports, they were up only 1% annualized as opposed 18% for food and petroleum. Both top line exports and core exports are basically flat in the 3-quarter window.

Details from the splits:

* Computer prices change so rapidly that BEA advises against making your own calculations on that line item, so these are BEA’s (very) rough estimates. BEA Table 4.2.6U

The table is sorted by the second column so we can see where the big shovels filling this hole are.

As you can see, Boeing’s troubles extend throughout the report. Assuming the losses in the aircraft categories are all theirs, they pulled $2.25 billion out of real GDP QoQ. If Boeing was flat in the quarter, top line GDP growth would have been 3.37%, not 3.17%.

The big winner is motor vehicle and parts exports — ⅔ of the growth in core exports, and now up moderately in the 9-month window. Zeroing on just the vehicles:

BEA Table 7.2.6U

Strong numbers all around for US automaker exports. Their problems are in the US. Maybe they will start exporting their inventories?

So the big drivers of the considerable export growth in the quarter were agricultural goods and vehicles, accounting together for 131% of all export growth and 54% of the change in net exports.

On the other side of the coin, imports were down -3.73% annualized in the quarter, matched pretty closely with core imports down -3.51%. Food and petroleum once again lead the way, down -5.00% in the quarter, accounting for 20% of the drop in all imports. But what about the other 80%?

BEA Table 4.2.6U, BEA Table 7.2.6U

Core industrial goods leads the way at over half the reduction. Coupled with a large reduction in exports in the same category, I’m not sure this is good news. The same goes for capital goods, which is down for both imports and exports in both windows.

Did you have a feeling light trucks would show up again? Me too. 15% of the core imports reduction was auto importers deciding that it was time to stop digging.

Interestingly, if we go back a couple of quarters, while the numbers are small, wholesalers increased imports of used vehicles a lot in Q2-Q4. You know, back when they still were worried they did have enough inventory.

One last note on the imports tables relates to December’s big jump in travel abroad. Imports of “Travel,” which is the money spent by US citizens abroad, was up 23% annualized in Q4, and 9% YoY. People were clearly out of the country, and this contributed to the December collapse in demand.

Congratulations! You Made It This Far.

You just made it through 6000+ words and 38 charts and tables of data. Here’s a cookie:

Good fortune. Pexels

Now that we’ve had a repast, let’s look at what it all means.

Sectoral Analysis: Motor Vehicles

As I said, I’m bullish on Ford, Tesla and GM, largely based on leadership, but the picture of the auto industry now is one of tumult. There is added inventory of about $13 billion in new trucks and an equal value of used trucks, so the problem is split between the dealers and the auto companies. All together there is about a quarter trillion dollars of light truck inventory. It is likely not going to be worth a quarter trillion when all is said and done. Demand has been extremely volatile since November, and has made projecting it very difficult.

In the short term, these inventories need to be emptied, and if the prices are reduced, this will not only lower margins, but also in effect shift money from their balance sheets to less money on their income statements. If a $30k car sells for $27k, that’s $30k off the balance sheet and $27k into revenue.

But in vehicles, the problem is bigger. Tastes change, and there’s no accounting for it. Most of the popular light truck and SUV models have rolled over their model lines, and it stands to reason that many of the new trucks in inventory are 2018 model year. They are not used trucks, but they also aren’t “new” trucks in the eyes of consumers. The previous model year will sell at much reduced or even negative margins. Moreover, the longer a used truck sits on a lot, the lower its value — a three-year old SUV just off a lease just became a four-year old SUV.

Finally, the continuing consumer preference for used light trucks over every other category has obvious issues.

Sectoral Analysis: Trees, and Things Made Out of Them

Too many trees. msladyfish

We can see a long supply chain here starting with the lumber, to the lumber wholesalers, to the wood products, paper and furniture manufacturers, to home and furniture wholesale and retail. Of course, the largest part of lumber demand is construction, but we’ll look at that separately.

After a long, high-inflation run which peaked in June 2018 at a YoY inflation rate of 38%, lumber prices collapsed, deflating -24% by the March YoY. Inventories were rising all through 2018, but sales were keeping up, and inventory-sales ratio did not start rising until September — going up 19% annualized through the end of February.

Inventories in the entire supply chain continued to grow, and despite spikes in demand in November and March. The inventory-sales ratios in manufacturing:

BEA Table 3BU

Manufacturers have generally done better than wholesalers. As you can see, at first wood and paper manufacturers dug themselves a small hole, but then started filling it up in 2019. Furniture manufacturers at first did well, but then badly misjudged demand in the new year.

For the wholesalers, the problem also began in September.

BEA Table 3BU

They did very poorly through Q4 with their inventories. Lumber wholesalers have stopped digging, though furniture wholesalers are trying, but are still seeing their ratio grow through February.

Where did the inventories go? Retailers absorbed them.

BEA Table 3BU

Obviously, tree products are only a part of the inventories of furniture stores, and Home Depots of the world, and they are seeing inventory buildup in many products they sell, like hardware and tools.

Adding it all up, the trees sector is not nearly as large a problem as vehicles, partially since it is a smaller sector. Overall, From June to March, total real inventories rose $4.25 billion, raising the total to $168 billion, or about 5% of the total core inventory growth. That $168 billion is likely not worth $168 billion at market.

On interesting side note is that furniture prices have gone up, not down through this, and quite substantially. Since demand is so slack, I have to imagine these are tariff costs they are trying to pass along to customers.

Sectoral Analysis: Household Durables


These are parts of larger aggregates in the inventory tables, so we will have to limit to discussing consumption and prices.

Household appliances saw a steady decline in consumption in the second half of 2018, culminating in the December collapse. They didn’t even get a big retail rush in November like everyone else. Despite a huge March surge that brought consumption back to October levels, it is still down -7.31% annualized in the 8 intervening months.

How’d they turn it around? Big sales, reducing prices by -23% annualized in March. Lower margins, and money off the balance sheet.

On the other side of the coin, TV sales kill it every month, except the dreaded December. This is being driven by steep declines in 4K TV prices. But it’s hard to tell if this is a price war, which thins margins, or just the natural evolution of a new class of product. I’m guessing the later.

Sectoral Analysis: Clothing Supply Chain

Kimberly Vardeman

Though a small part of the economy, the problem is probably worst in clothing, and massive sales in 2019 have failed to clear out inventories. The problem extends all the way from retail back to textile mills and fiber producers.

BEA Table 3BU

As you can see, the problem began at the head and middle of the chain, with textile mills and wholesalers. As they lowered their inventory growth, the problem spread to other parts of the chain. Using cotton prices as a proxy, we can also see it extends to fiber producers


The bump since March is encouraging, and not just for cotton farmers.

‘Member this? Hallux Makenzo

The problem is more acute in apparel because of fashion, and four seasons a year at that. Remember Ed Hardy? In 2008-2009, their ugly T-shirts were very popular, and if you could even find one at retail, it was going to run you over $100, even in kids’ sizes. So the manufacturer stepped up production, and wholesalers and retailers stocked up on $100 T-shirt inventory.

But they weren’t $100 T-shirts. Tastes changed, everyone decided Ed Hardy was Not Cool, and no one would buy them anymore at the asking price. At some point in 2010 or 2011, my wife bought the nieces a pair of kids’ Ed Hardy T-shirts for $14.99. Those particular $100 T-shirts were actually $7.50 T-shirts at market. Who knows how long they sat in a warehouse before someone was willing to part with them at $7.50 per.

Sectoral Analysis: Residential Construction

Housing construction has been terrible since early 2018, but it has not been because demand is short. On the contrary, when we look at prices in metropolitan areas, housing inflation is outpacing just about everything else. Typically this is a big signal for builders to go to town, but they have not. Why?

This relates to what we found out in the housing crisis: you can build as many houses as you want, but if they’re in places no one wants to live, then they are not worth much, if anything.

People want to live in cities, especially on the coasts. This is where jobs are concentrated, especially in high productivity sectors. But it has become harder and harder to increase housing density in many cities, because of outdated zoning laws, and preservationist/NIMBY opposition. They may be well-intentioned, but they are dooming their growing cities to ever-increasing housing costs.

So what we saw in the GDP report is that while single family housing construction is collapsing, multifamily housing is doing quite well, but can’t make up for the single family deficit. This is because many cities severely limit density, and have zoning laws that make it impossible to build what people want: living close to where they work.

This has been your YIMBY lecture for the day. You’re welcome.

Sectoral Analysis: Communications

This was one of the bright spots both in consumption and also investment. Investment in communications continues to rise, and this is largely the product of the 5G and associated fiber buildout. These are giant Capex spends that will last at least through 2020, and probably much longer the way things are going.

My pickaxe-and-shovel play here is MasTec (MTZ), a telecom construction company.

Sectoral Analysis: Everything Else

I’m going to cut it off here, but I gave this report more than a thorough frisk. So if you have questions about other sectors, @ me in the comments.

What Did The Fed See?

This one is a little tricky, because of all the wild swings I documented. Despite the shortfall in demand from December through February, which drove the YoY core inflation rate down to 1.55% in March, a full 45 bps below the Fed target, the Fed seemed to be paying attention more to the retail frenzy of March. The MoM annualized inflation numbers are more dramatic and show how quickly this moved in Q1.

BEA Table 2.4.6U

So this, in conjunction with the weak growth in consumption and fixed investment, is a signal to ease in a Taylor Rule-like system like the Fed uses.

But, with the exception of small business owners, disposable income and employment remain strong. With so much consumer savings going into the stock market in December through February, this depressed demand, but not because people couldn’t afford things. On the contrary, most goods remain incredibly cheap. People had been choosing savings over consumption.

So the March reversal is what the Fed seems to be eyeing by standing pat. They want to see where this goes first. Me too.

But really, they aren’t standing pat, exactly. When the Fed “raises rates,” they are actually raising the 25 bps range, currently 2.25%-2.50%. For a long time, the effective Fed Funds rate was at 2.20% when the range was 2.00%-2.25%. After the December hike, the effective rate went to 2.40% and stayed there until March 19. Since then:


So the Fed began stealthily raising the rate from March 20 through April 29, the day the monthly tables on the GDP report came out. Since then the effective rate has plunged 7 bps to its lowest level since before the rate hike. You can draw your own conclusions, but it may also have something to do with this:

Chart Data by


Implications for the Stock Market: The Stench of FOMO

Overall, I’m pretty bearish on 2019, but the ingredients are definitely in place for a FOMO melt up, maybe even on the level of 1999. This is not to say it will happen, and the May declines in the market make it much less likely. But the context remains.

As we have discussed, the 2019 market rally was largely built on retail investors and their outsized Christmas bonuses, while hedge funders stayed on the sidelines. Despite the retail inflows, total YTD outflows for equites was $34 billion at the end of April. As we’ve seen, this was a very low volume rally.

Chart Data by YCharts

But volume has picked up considerably since late April. Smells like FOMO, just before the market turned on bad trade news.

What drives that? It’s fairly simple. Hedge funders are underperforming their benchmarks badly, by 50% on the S&P 500, plus they charge two-and-twenty. I imagine they have been getting one or two client calls.

So, at least some of them stink of FOMO, and have been piling back in as seen in the increased volume since April. Additionally, systematic funds are being pushed in whether they like it or not.

So, if the market turns here and goes back up, there is a definite potential for all this money that had been sitting on the sidelines to flow back in on the long side. This will drive stock prices up quickly, and then they will crash, just as quickly.

The end of the cycle is not fun, in my opinion.

Conclusions: The Giant Hole

We are in a very strange place in the US economy. So many of the top-level measures look good, but digging down shows lots of troubles. I keep hearing commentators say how strong the economy is, quoting the 3.2% top line from Q1. But when 92% is new inventories, that is not strong.

The simple numbers again:

  • In real dollars, the US economy grew by $100 billion from July to March. $83 billion was new inventories, a third of which is just light trucks.
  • The entire rest of the economy grew by $17 billion, or 0.48% — about $10 billion less than just the added light trucks inventory.
  • To clear out those added inventories this quarter, the rest of the economy would have to grow at 7.26%, just to get to zero on the top line.

That is not strong.

Moreover, the wild swings in the period, with 3 major inflections, and incredible volatility in the monthly numbers, have made it increasingly difficult for companies to properly manage their inventories. Though still below 2 weeks, even Apple, the king of inventory management, saw their DIOs rise significantly in Q1.

In March, the retail frenzy did not actually reduce inventories — they still went up. However, the inventory-sales ratios did not look quite as awful as before in the Census Bureau’s March survey. We will have to wait to see how this works out, since this was largely driven by steep price reductions and thinned margins.

As of March 31, there was an $83 billion hole in the US economy, and it will have to get filled eventually, by huge losses, reduced margins and slowing growth, or some combination of them. It seems like some companies keep violating the First Law of Holes, for some reason. If it doesn’t get filled soon, the problem just gets worse and increases the likelihood of a systemic liquidity collapse.

In the meanwhile, I’ll just be here with my Lego dungeon and pogs.

Disclosure: I am/we are long MTZ, AAPL, F, GM, TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dyslexia typo: $87 -> $83

Sorry :(