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“Every generation has underestimated the potential for finding new recipes and ideas.  We consistently fail to grasp how many ideas remain to be discovered.”

-Paul Romer

I love big ideas.

Elegant, intuitively appealing big picture epiphanies resulting from restless minds finding “harmonious resolution in dissonant details”.     

Paul Romer had just such an idea when he conceptualized the “Romer Model” in the early 90’s. Up to then, conventional growth theories followed some Solow variant whereby capital & labor combined to produce output while some exogenous (i.e. external and unexplained) productivity factor acted as an offset to diminishing returns in support of sustainable long run growth. 

Romer added a crucial third factor to the productivity formula – #Ideas. At a most basic level, the interplay between ideas and objects (capital, labor & everything else) can be summarized like this:

Objects can be viewed as all the atoms, elements and raw materials of the universe. Ideas represent the recipes and instructions for using those raw materials. 

That’s it. Simple, obvious even.  

But in formalizing the idea (about ideas), macroeconomics found a tractable explanation for sustainable growth. Ideas, unlike capital, are non-rivalrous (i.e. anyone can use them and one person’s use doesn’t restrict its use by anyone else) and when combined with capital and labor provide for increasing (not diminishing) returns.

The number of different ways of combining and employing the atoms of the universe is virtually unlimited. And adopting this very fundamental perspective – Objects & Ideas, Raw Materials & Recipes - makes the scope for ongoing innovation feel almost infinite. 

Moreover, as China & India (i.e. a third of the world’s population) continue to come up the sophistication curve and bring their collective acuity to bear on the edge of frontier research, the rate-of-change of growth in ideas stands to benefit. 

Increasing returns, Sustainable growth, Unlimited innovative capacity …. Not your grandfather’s dismal science. 

DIY Macro - light

Back to the Global Macro Grind …. 

Ideas don’t have to be revolutionary to strike a chord. Simple, “new to me” ideas can be similarly satisfying.

Case in Point: In discussing domestic Income & Credit trends on yesterday’s Macro Show, I walked through the math on front-running the official income and spending figures from the BEA using the relevant data from the employment report. 

Multiplying three terms is elementary school math but, based on my inbox flow, the Macro DIY base we’re hoping to empower seemingly finds satisfying utility in “the little things”.

Here’s the deal: 

Income growth anchors the capacity for consumption growth and total spending is what matters in a modern, Keynesian consumption economy. Divining the slope of income growth, therefore, is of obvious import - and in the very near term, it’s also relatively straightforward. 

The aggregate income data is reported alongside the Household Spending data about a month after the Employment report. But income – and the likely path of consumption, by extension - can be well inferred from the BLS Employment data.

At the aggregate level, total labor income is just the product of aggregate hours and earnings. 

In other words: how many people are working * how many hours each person works per week * how much they get paid per hour (all of which is in the NFP release)

As can be seen in the 1st Chart of the Day below, if we do that exercise with the October employment report, income growth was largely flat sequentially despite the big sequential increase in net payroll gains and the acceleration in hourly earnings. 

Flattish income growth is what we should expect to see when the official data is reported on 11/25.

The absolutist read-through on consumption is that it will remain “good” in October. From a pro-cyclical investors perspective, the slope of the line for both income and consumption will hold negative off the 1Q15 peak and will remain so through the balance of the year as we lap peak payroll gains recorded in 2H14. 

How can consumption growth be supported in the face of decelerating wage income growth?

#Credit homie!

Credit 101: Generally, credit is pro-cyclical with banks loosening standards and extending credit in response to rising demand and improved credit risk.   

The reason for the pro-cyclicality is rather straightforward: Household capacity for credit increases as incomes rise alongside positive employment growth and as net wealth rises alongside the rise in real and financial assets that typically accompanies an expansionary economic phase. 

Thus, cash flows to service debt and the collateral values backing the debt both support incremental capacity for credit and serve to drive an upswing in the credit cycle, which can serve to jumpstart and/or amplify the economic cycle.   

The 2nd Chart of the Day below shows revolving credit growth (i.e. credit cards). Household appetite for credit card debt went negative following the financial crisis and remained in hibernation for ~3-years before inflecting positively in April 2014. The latest September data showed a 3rd month of acceleration with revolving credit growth making a new cycle high at +4.73% YoY.

Accelerations in revolving credit growth typically show up in rising higher ticket, discretionary durable goods consumption. If the current pace of revolving credit growth persists in the coming months then durables consumption in 4Q would remain pretty healthy and would help support aggregate consumption growth.

In other words, the Keynesian spending coin has two sides and, if the collective domestic consumer is so inclined, credit growth has some modest runway to offset decelerating income trends over the nearer-term. 

Over the medium and longer-term, however, given already zero bound rates, the initial debt position (HH debt/GDP still = ~77%), and negative consumption demographics, we certainly aren’t in position to jumpstart a repeat of the prior credit based consumption cycle. 

So, that’s the current set-up and immediate-term outlook for Income, Credit and Consumption. We’ll get the latest update on the state of domestic consumerism with November Consumer Confidence and October Retail Sales (remember Retail Sales only = Spending on Goods) this morning. 

None of the analysis and context above requires black-box sophistication. It’s mostly just doing the work and passing the output through a commonsense filter.   

We consistently fail to grasp how many ideas remain to be discovered …. and our own capacity for insight and productive application. 

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.09-2.38% 

SPX 2036-2089 

VIX 15.55-19.02 
Oil (WTI) 41.08-44.64 

Gold 1065-1105 

Be the change you want to see. Have a great weekend.

Christian B. Drake

U.S. Macro Analyst

DIY Macro - EL CoD1 Income Growth

DIY Macro - EL COD2 Credit Growth