Earnings & Consumer Price Index Update 2025

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Questions and Answers

What is the projected earnings growth for 2025 as mentioned?

10%

20%

15% (correct)

12%

What was the year-over-year change in Headline CPI?

2.5% (correct)

2.9%

3.2%

4.0%

Which category contributed to inflation, as indicated in the content?

Raw materials

Consumer goods

Manufactured goods

Services (correct)

Which sub-component of the CPI showed strong shelter inflation?

Rent Signup and view all the answers

What is the core CPI's change in the three-month annualized rate?

2.1% Signup and view all the answers

What limitation does the VIX have according to Societe Generale?

Does not account for financial strength Signup and view all the answers

What is the purpose of the Junk Equity Vol Index developed by SocGen?

To assess low-quality, over-levered firms Signup and view all the answers

What change occurred in core services excluding housing?

Rose 0.4% Signup and view all the answers

What is indicated by high readings in the market segment of highly-levered and highly-volatile stocks?

They foreshadow systemic distress in the broader market. Signup and view all the answers

What has been a past consequence of spikes in the index during the period of 2020-2024?

Annualized returns of -20% or more. Signup and view all the answers

Which of the following evidence indicates that the economy is fundamentally fine?

GDP growth forecast is above 2%. Signup and view all the answers

What is a potential consequence of a 50-basis point cut according to the arguments presented?

It may lead to expectations of higher future cuts. Signup and view all the answers

What recent trend in the labor market suggests it might be weakening?

Employers are more selective in hiring. Signup and view all the answers

Which argument supports the idea that cutting 50 basis points could lead to a soft landing?

It may prevent further declines in global economies. Signup and view all the answers

How did the personal savings rate in July relate to consumer strain?

It fell to a low level near 2.9%. Signup and view all the answers

What has been the effect of high core CPI and housing costs according to the arguments for a 25 basis points rate adjustment?

It indicates the economy does not need stimulus. Signup and view all the answers

What is the key idea about the risk premium in determining yield differences?

It varies based on the market's perception of risk. Signup and view all the answers

Which factor does NOT directly influence yield differences?

Market sentiment Signup and view all the answers

What characterizes ‘on-the-run’ bonds compared to ‘off-the-run’ bonds?

On-the-run bonds are the most recently issued securities. Signup and view all the answers

How do credit rating agencies assess bonds?

Through a standardized rating system. Signup and view all the answers

What trend is observed regarding the default rates of lower-rated bonds?

Lower-rated bonds show much higher volatility in default rates. Signup and view all the answers

What is the average cumulative default rate for AA-rated bonds within 12 years?

1.13% Signup and view all the answers

What typically happens to a bond's rating prior to default?

Bonds are usually downgraded quickly. Signup and view all the answers

Which yield is compared to tax-exempt yield to ascertain the effect of taxability?

After-tax yield Signup and view all the answers

What is the current average mortgage rate mentioned for new mortgages?

7.4% Signup and view all the answers

What portion of income would be used if mortgage rates drop to 5.25%?

25% Signup and view all the answers

According to the new 'Sahm' rule, what is the threshold indication that a recession may have started?

0.3% Signup and view all the answers

What does the job vacancy rate rule compare to indicate economic conditions?

Current job vacancy rate and historical job vacancies Signup and view all the answers

What is the income required to afford the median income home while putting 20% down?

$74,580 Signup and view all the answers

What defines the Sahm rule threshold that works perfectly from 1960 to 2023?

0.5% Signup and view all the answers

What triggers the two-sided recession rule to indicate a definite recession has started?

0.8% Signup and view all the answers

What is a significant effect of mortgage lock for most homeowners?

Increasing interest rates Signup and view all the answers

What percentage of Americans worked from home some of the time in August 2023?

11.7% Signup and view all the answers

What was the real median household income in 2023?

$80,610 Signup and view all the answers

How long does it take, on average, to save for a 20% down payment since 2000?

11 years Signup and view all the answers

How many part-time workers for economic reasons were reported as of mid-2023?

4.8 million Signup and view all the answers

What is the income threshold for a household to be in the top 10%?

$235,000 Signup and view all the answers

What percentage of income does housing become unaffordable if it exceeds this amount?

30% Signup and view all the answers

How many student loan borrowers were reported to be behind on payments as of January 2023?

~10 million Signup and view all the answers

What is the estimated amount China needs to spend in stimulus to reflate its economy?

$1.4 trillion Signup and view all the answers

Study Notes

Earnings Estimates

Earnings estimates are optimistic, with a projected 15% growth for 2025.
This optimism comes at a time when the market is considering a potential 50-basis point rate cut from the Federal Reserve.

Consumer Price Index (CPI)

Headline CPI rose 2.5% year-over-year, down from 2.9%, with a 0.2% month-over-month increase.
Core CPI remained stable at 3.2% year-over-year, with a 0.3% month-over-month increase, representing the highest level in four months.
Inflation is primarily driven by services rather than goods.
Core goods prices decreased by 0.2%, marking a decline in 14 of the last 15 months.
Core services excluding housing ("supercore") increased by 0.4%, up from 0.3%, with increases in airfares, daycare and preschool, and car insurance.
Shelter inflation continues to be strong, with a 5.2% year-over-year and 0.5% month-over-month increase, up from 0.4%.
Owner's Equivalent Rent (OER) increased by 0.5%, and rent rose by 0.4%.
Shelter constitutes roughly 40% of core CPI and accounts for approximately 70% of the year-over-year increase.
Disinflation is slowing down.
The spike in goods, food, and energy prices has subsided.
Food and energy prices are showing deflationary trends.
Services inflation remains elevated.
Shelter inflation is proving resilient and seems to be correlated with the Zillow index on a 17-month lag.

JunkVIX

The VIX (volatility index) is at relatively moderate levels (16.56), but Societe Generale suggests it is not a reliable predictive model.
Societe Generale proposes focusing on the performance and volatility of the weakest segment of the equity market for early signs of stress.
The Junk Equity Vol Index ("JunkVIX") was developed by Societe Generale in 2018.
JunkVIX tracks the relative volatility of low-quality, sub-segments of the market characterized by poor performance, high leverage, and weak balance sheets.
Higher readings (top 1/3) of the JunkVIX have historically resulted in annualized returns of -20% or more, foreshadowing significant market events.
Currently, the JunkVIX is extremely high.

Arguments for a 25-Basis Point Rate Cut

The economy is fundamentally sound.
GDP is above trend, with the Atlanta Fed's GDPNow forecasting 2.5% growth for the third quarter.
The University of Michigan's consumer sentiment for September reached a four-month high.
Core CPI remains elevated, and housing costs increased by 0.5% month-over-month.
The labor market is not weak, with payroll growth improving in August, low unemployment, low layoffs, and jobless claims at the same low level as one year ago.
Wage growth increased to 0.4% month-over-month.
A 50-basis point rate cut could signal alarm about the economy or lead to expectations of further cuts in the future.
A 50-basis point cut could be perceived as politically motivated.
A 50-basis point rate cut could potentially push stocks higher and fuel inflation.
The Federal Open Market Committee (FOMC) prefers to act by consensus, and a 25-basis point cut might be the easiest path.

Arguments for a 50-Basis Point Rate Cut

Cutting rates by 50 basis points is the FOMC's best chance at a soft landing.
Higher interest rates are cooling spending, investment, and hiring.
Businesses and financial firms serving low- and middle-income consumers are reporting signs of increased strain, and the personal savings rate fell to 2.9% in July, near its lowest level since 2007.
Global economies are cooling, particularly China.
Commodity prices are declining.
Inflation is cooling, resulting in a very restrictive real Fed funds rate.
Inflation expectations are low.
The labor market is weakening, indicating that the FOMC needs to act proactively.
Hiring over the past three months has been at its lowest level since mid-2020.
Job openings have declined, and layoffs have increased.
Anecdotally, employers are becoming more selective in their hiring practices.
The average time for a new housing project to go from the permit stage to the start of construction, as well as the time from the start of construction to completion, are both at record highs.
Despite potential future rate cuts, homeowners will likely experience mortgage lock.
The average mortgage rate was 3.8% in March, compared to 7.4% for new mortgages in that month (the current 30-year mortgage rate is 6.20%).
Even if existing homeowners sell, most will likely purchase a new home.
For a median income household earning 74,580toaffordthemedianincomehomevaluedat74,580 to afford the median income home valued at 74,580toaffordthemedianincomehomevaluedat422,600 with a 30-year mortgage and a 20% down payment, a mortgage rate cut to 5.25% would consume 30% of their income.
To keep housing affordability near 30% after accounting for insurance, taxes, homeowners association fees, and maintenance, a mortgage rate of 3.6% is necessary.

Has the Recession Started?

Authors Pascal Michaillat and Emmanuel Saez (August 2024) have devised a "new Sahm" rule for identifying a recession.
The rule uses the minimum of two indicators:
- The Sahm rule, calculated as the difference between the 3-month moving average of the unemployment rate and its minimum over the past 12 months.
- The Job vacancy rate rule, calculated as the difference between the maximum 3-month moving average of the vacancy rate over the past 12 months and the current 3-month moving average.
The rule designates a potential recession start when either indicator reaches 0.3% (no false positives).
A definitive recession has begun when the indicator reaches 0.8% (no false negatives).
The intuition behind the rule is based on the observation that job vacancies decline rapidly during a recession, while unemployment rises.
Incorporating both rising unemployment and declining job vacancies provides a more accurate and swift signal of a recession.
The Sahm rule threshold of 0.5 has proven effective from 1960 to 2023.
Since mid-2023, the number of workers classified as "part-time for economic reasons" has increased by 600,000 to 4.8 million.
The percentage of Americans holding multiple jobs is 5.3%, another increasing trend.
Real median household income was $80,610 in 2023 (+4% YoY), statistically not different from the record high income in 2019.
The real median household income was ~113KforAsianhouseholds,113K for Asian households, 113KforAsianhouseholds,89K for white households, 65.5KforHispanichouseholds,and65.5K for Hispanic households, and 65.5KforHispanichouseholds,and56.5K for Black households.
A household income of ~$235K was required to be in the top 10%.
Housing affordability is considered a challenge when housing costs exceed 30% of household income.
Since 2000, average household income has doubled, but the average price for Zillow listings has tripled to $360K.
The time required to save for a 20% down payment has risen by nearly half to 11 years.
The share of household income dedicated to mortgage and insurance payments has risen to approximately 35%.
The Government Accountability Office estimates that around 10 million student loan borrowers (more than 25% of the total) were behind on payments as of January.
Approximately two-thirds of these borrowers were more than three months late, indicating "serious delinquency."
Trump proposed 100% tariffs on imports from countries shifting away from using the dollar.
The dollar's global role stems from the voluntary choice of countries to use it.
Donald Trump suggested creating a sovereign wealth fund.
A sovereign wealth fund is typically established with budget surplus funds or proceeds from state-owned resources, such as oil companies.
China is facing a growing risk of deflation.
Entry-level salaries are 10% lower than their 2022 peak.
Economists suggest that China needs a $1.4 trillion stimulus package to reflate its economy.

Building Up an Interest Rate: Benchmark Rate + Risk Premium

The benchmark rate serves as a foundation for setting interest rates.
"On-the-run" refers to recently issued Treasury securities, while "off-the-run" refers to older Treasury securities.
Factors influencing yield differences include:
- Risk premium: Reflects an additional return demanded for holding securities with higher risk.
- Taxability: After-tax yields are lower than tax-exempt yields.
- Liquidity: More readily tradable securities tend to have lower yields.
- Options: Securities with embedded options can have different yields.

Credit Rating Agencies (CRA)

CRA assigns ratings to bonds based on their creditworthiness.
One-year migration data shows the percentage of bonds with a specific rating that end up with a different rating within a year.
Lower-rated bonds are more volatile in their ratings.
Average cumulative bond default rates over a 12-year period reveal that lower-rated bonds have a higher probability of default.
Bonds rated "B" or lower have a significantly higher chance of default.
Data on cumulative defaulters from original ratings shows that CCC-rated bonds underperform quickly, while B-rated bonds eventually face challenges.
Time to default is shorter for lower-rated bonds.
Bonds tend to maintain their ratings before experiencing a rapid downgrade just prior to default.

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Description

This quiz covers recent earnings estimates projecting a 15% growth for 2025 alongside the Federal Reserve's potential rate cut. Additionally, it examines changes in the Consumer Price Index, highlighting key trends in inflation driven by services, as well as shelter and core goods prices over the past months.