Recap 10-28-11

Main Items:

  • US Core PCE was unchanged at 1.6% YoY in Sept vs 1.7% exp
  • US Personal Income growth slowed to 0.1% MoM in Sept vs 0.3% exp and -0.1% prev. Personal Spending was string, rising to 0.6% as exp vs 0.2% prev.
  • U Michigan consumer sentiment for this month was finalized to 60.9 vs 58 exp.
  • Merkel / Sarkozy was willing to risk a credit event – NYT


  • UK Gfk consumer confidence declined to -32 in Oct vs -30 prev, lowest since Feb ’09
  • Swiss KOF LEI declined to 0.8 in Oct vs 1.0 exp and 1.21 prev
  • Spanish Unemployment increased to 21.5% in 3Q vs 20.9% exp and prev.
  • Japan UE declined to 4.1% in Sept vs 4.5% exp and 4.3% prev
  • Japan CPI was flat YoY in Sept vs 0.1% exp and 0.2% prev


US consumption continued to be decent, in contrast to income. However, this divergence is likely set to turn. The personal savings rate has dropped to the lowest level seen in this recovery. (white line) The savings rate declined to lower levels in the previous decade, but that was because of the wealth effect, as proxied by the YoY change in house prices. (orange) In the absence of higher asset prices, for personal spending to remain strong, we will need to see stronger income growth or lower savings rates.

Even after the recent run up, the S&P remains reasonably cheap based on forward earnings. In fact, we are at mid-2010 levels: (~8.4% earnings yield)

The key difference here, of course, is that this time around, there is a bigger uncertainty around where earnings are going to print. After a strong 2.5 year run that has now hit all time highs, earnings now look like they are starting to roll over a bit:

As a result, we need to handicap current cheap P/E levels with the likelihood of a decline in earnings. I have stated in the past that I think a worst case EPS decline if a financial crisis doesn’t happen is a 15% YoY decline in EPS. This would take the EY down to 7.2%. In the context of low inflation and low bond yields, this still looks fairly cheap, although there will certainly be a negative mark to market impact if that happens.