Primary Vision Insights – Enterprise Subscribers

Brent is following the trading range path we laid out once Saudi Arabia and Russia committed to keeping their voluntary cuts through year end. The trading range was shifted higher to $88-$96 with some clear areas of resistance. We outlined the first level of resistance at about $92 with the next level hitting $94. The market hit $94 early today and has quickly paired back to the next layer of support. Demand continues to be a broad issue when we look across the crude complex.

There is always a seasonal aspect to the drop in demand, but the move lower in gasoline and distillate is much greater versus normal reductions. It follows what we have been highlighting when it comes to consumer pressure on gasoline and diesel. The pressure grows as gasoline prices continue to push higher even as we “officially” end summer blend as of today. Based on the elevated price of crude holding firm, we don’t see a meaningful adjustment lower in the near term, which is another layer of pressure on the consumer as we will discuss shortly regarding near- and medium-term inflation.

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When we pivot over to diesel, the price pressure has also picked up substantially over the last month. The year/year comps are still elevated, but are getting “easier” as we progress through the next few months.

I think this chart helps put into perspective the pivot on a month/month increase, and how year/year comps won’t be able to “hide” the problems. The average cost for a gallon of gas in the United States just hit $3.90, the highest since August 2022. On a trailing 12-month basis, this is a new seasonal record as prices are up 11% over the last month. Compared to the historical average at this time of the year, gas prices are now 35% MORE expensive.

When we look at the broader U.S. market, the slowdown in refined product demand is going to pick-up, not only along seasonal lines, but also because of cyclical pressures. We never got a big increase for Labor Day, and the broad slowdown typically accelerates starting now and gains steam as we head into the 1 st week of October. This is the “seasonal” slowdown we referred too, but the fact we stay much lower than historical averages is more of the cyclical issues we highlighted on price pressures and inflation.

This is increasing the inflationary pressure in the market even as wages have started to roll-over. The pivot higher in crude pricing is accelerating pressure across different PPI (Producer Price Index) metrics, which is an important leading indicator for inflation trends. While Saudi Arabia and Russia have achieved a near term goal, it will create a problem in the longer term as demand weakens further. Driving data confirms that we have seen softness on a global basis, and the U.S. is a big part of the shift.

On the U.S. export front, distillate exports have fallen off inline with our commentary that the arbitrage opportunity closed heading into Europe. We have seen some slowdown in exports across both crude and products, but the slowdown in crude exports will just be inline with normal seasonal shifts. The distillate pivot is something that will last a longer given some of the price opportunities that remain in the U.S. vs the international market. Here is a good breakdown of what has typically happened in the first half vs second half of the month for crude flows into Europe: “Vortexa data for September (days 1-10) shows lower imports of US crude into Europe mainly driven by the Netherlands, especially after record high imports in August. Simply put, we observed a significant increase in crude exports, especially to Europe, in the second half of the month compared to the first half of the month. A potential reason is that the WTI trading window rolls into the next trading window around the 20th of each month, while the expiry of the Brent contract happens towards the end of the month.

This is just a long way of saying- U.S. crude exports into Europe is more of a timing delay vs a bigger shift in imports. Instead, any reduction in total exports are expected to be along seasonally normal step downs. On the distillate front however, there is a much bigger shift based on price competition and arb opportunities between PADD 3 (GoM) and PADD 1 (East Coast).

On the other hand, we are seeing a slowdown from Asian buying for U.S. crude. It started to ebb at the end of August, and we see it continuing over the next few months. There has already been pre-sold volumes for Oct/Nov, but during the current maintenance season- we don’t see any spot or additional purchases in the near term. Now- KSA could increase OSPs for Asia light again, which could reopen the arb, but in the current backdrop we don’t see a surge of new buying. “Preliminary data for September (days 1-10) suggests lower exports mainly due to a lack of buying from Asia where competition from other grades in China and refinery turnarounds in India are keeping US barrels at bay for the time being.”

Asia was a big buyer in the summer months as KSA surprised the market with some sizeable increases in OSPs, which kept U.S. volumes VERY competitive into the Asian markets. We are heading into turn around season, so even if KSA raises prices again- the increase in buying will still be “lower” driven by seasonal norms.

The bigger impact going forward will be the re-acceleration of inflation around the world as underlying economic activity remains sluggish. The data has stabilized in a contractionary standpoint, and we see the data holding around these levels throughout year end. As inflation pressures pick back up, it will likely cause another small leg down in activity as we get to the other side of the “seasonal” bump for holidays. “August global manufacturing PMI was up six tenths to 48.2, yet remains below the 50 threshold for 1 year, still suggesting a global slowdown . The rebound was driven by rising short-term price pressures from very low levels while activity components was marginally up.” One of the key points in that explanation is the “bump” or “increase” closer to 50 was actually driven by rising prices, which is a key leading indicator for inflation.

We have already discussed over the last few weeks how the leading indicators across the U.S. and Europe have picked up, and we are now seeing the same in Asia. This increase will also be “imported” into other countries particularly the U.S.

PMI Activity components rose by two tenths to 47.7 driven by #EM, in particular EM Asia (+1.8pts over the month), which excluding China remains the region with the highest PMI activity components, and by a wide margin (>54)

I think an important chart is the shifting moves in total activity and dynamics. We are seeing some outliers- such as India- which will remain strong but some headwinds that will drop it into decelerating. The deteriorating front is going to get a bit worse as European data comes in below expectations, and I think that will help weigh on some growth projections.

China posted some stronger numbers against estimates, but we want to breakdown why some of these bounces are likely short lived.

On the pricing side, here is a bit of a backdrop of the increase in prices. These are based on weighted averages from official numbers, which we know are grossly underweight when looking at comparable data. So while things look okay, we believe many countries are not properly reflecting their price pressures. Even with this misrepresentation, we are seeing a much bigger increase in broad price pressures.

One of the bigger sticking points remains food prices. The below chart puts into perspective how prices have stabilized, but haven’t budged to the downside. We see a bit of a re-acceleration to the upside as pressure grows on volumes in the near term.

We will get some more data in the near term, but the heat and moisture reductions in the U.S will likely have another impact on yield estimates. There has already been a flatlining of yields, which has expanded around the world and impacted most (if not all) of the grains and meats of the world.

Another driver behind the increase are the rising rates that are increasing costs for farmers. There are also adjustments to the availability of fertilizer with China initiating some suspension of exports. “China has asked some fertilizer producers to suspend urea exports after domestic prices jumped, a move that’s likely to restrict supplies and boost costs for farmers in key buyers such as India. Some major Chinese fertilizer makers halted signing new export deals from early this month following a government mandate, according to people familiar with the matter, who asked not to be identified as they’re not authorized to speak to the media. The restriction only applies to urea so far, they said. Urea futures on the Zhengzhou Commodity Exchange surged almost 50% over a seven-week period from mid-June to the end of July, but have fluctuated since. Prices slid almost 6% on Thursday, snapping two days of gains.”

These are issues that have been plaguing the market for years, and we see it getting progressively worse as weather patterns shift and soils degrade further.

In the U.S., small businesses are issuing guidance that prices are going to go higher again. They see the need to push compensation higher while trying to recoup the big increase in energy/input costs that spiked again.

The below chart shows the compensation plans:

The problem is- this shift higher in pricing is coming on the back of weakening sales.

I think these charts do a good job of highlighting the increase in underlying costs for producers: Goods sector (orange) a large chunk of PPI #inflation increase in August with +2% month/month gain … compared to services (blue) with +0.2% gain

The consumer goods side has seen a meaningful bounce in cost as energy prices have exploded higher. “Consumer goods portion of PPI #inflation has started to reaccelerate … 3-month annualized gain has shot back up to +15.3% (in upper end of range relative to history).”

While this is hitting producers, it’s also having a huge impact on the consumer market. The below data helps put into perspective the huge shift higher in cost to the consumer at the gas station. This was the main driver of “retail sales growth” while core sales pulled back hard.

When we turn to core retail sales, you can see that the downtrend remains intact after the increase in July. In our research, we believed that July was more of a “one off” month, and not a change in trend.

I thought this was a fun chart looking at the m/m hit from gasoline and fuel oil. As we have been saying, the “flexible” costs were going to surge in August with more follow through in September/October given the pivots in the market. This will keep pressure on consumers, while the “sticky” data is very slow to improve and is actually pivoting higher as well. This is partly driven by companies slowly recovering some of these sizeable increases in cost, while rent and other “sticky” items stay elevated as seen in the next chart.

These pivots in prices are all happening as wages continue to roll over.

Median U.S. asking rent in August was $2,052, just $2 below record high set a year earlier and up from $2,038 a month earlier per Redfin - rate of change might have eased (bottom panel), but renters still feel pinch of higher prices in level terms

Not only are rents moving higher again- you also have home prices making another move up. The issue remains between existing and new home sales- there needs to be an increase in home completions to help close the volume gap. We have a record amount of 5+ units under construction, which will help drive down rents- but in the meantime- it will continue to weigh on inflation and consumer activity.

Wages are still “elevated” but they have fallen below inflation again with more downside risk coming. Under surface of Atlanta Fed Wage Growth Tracker, much of reversal in growth has been driven by 16-24 age group (blue) … wage growth for 25 and older groups has rolled over but at a much slower pace.

One of the key leading indicators- job switchers and job openings. For job switchers, pace of wage growth has slowed dramatically per Atlanta Fed … current change of -2.8% over past year just slightly worse than year/year pace seen in late 2009 (a change of -2.7 percentage points).

The market is going to “pull down” some wages, but not at the speed that the Fed would like to see. The leading and current data show some softness, but companies are still struggling to find “quality” labor. This is keeping their compensation expectations elevated even as companies look to slowdown expansion.

As of August, quality of labor remained single largest problem for small businesses per @NFIB

… inflation climbed as an issue but remains in second place for now.

It’s also not hitting people equally with the lowest earning quartile seeing the biggest move lower. These are the people that are the most sensitive to price changes and now with falling wages and exhausted savings- they turn to credit.

The debt-to-income ratio for all homebuyers in the US just hit 40% for the first time in history. Even in the 2008 financial crisis, this ratio peaked at ~39%. This comes as total household debt just hit a record $17.1 trillion and credit card debt crossed $1 trillion for the first time ever. Consumers are borrowing at a record pace all while savings are declining and rates are rising. As wages fall, savings deplete, and prices rise, consumers turn to credit which is why we see a much bigger fall out in spending over the next several months.

Revolving credit continues to push higher, and we expect to see more delinquencies across all credit in the next few months.

The slowdown has been “delayed” given the positioning of people with loan mortgages, savings, and elevated networth. Consumers saw their networth spike, but we have started to see some of that bounce now slowdown.

Households’ net worth is contracting for the 4th time since 1990 At a time when credit card debt is above $1 trillion, the highest levels ever And credit card interest rates have soared above 20% Consumers do not look to be in good shape.

We are in for a prolonged slowdown, but not something as deep as we have seen in previous cycles. As inflation pressure moves higher, we are going to see more pressure on the Fed to raise rates again as well as keep them elevated for longer.

The below is a breakdown of where the “optimal” rate is, but I think Powell stops below it in order to “stay there longer.”

These pressures on rates and another bounce in inflation will keep the bond bear market very much intact.

There has already been another bounce in India-

Especially as export prices continue to press higher for key bellwethers in the market.

On the China front, problems remain in the longer term with some near term reprieve in the data.

China’s stats bureau published the monthly econ data for August on Friday. We have been highlighting how the private data in China continue to deteriorate and unless there is a big pivot- any bounce in the data will be short lived. While the below data “looks good,” it was mostly driven by state owned enterprises while the private sector continued to shrink. The consumer data was also very lumpy with the trend remaining sideways. We have been saying that consumer activity will bounce, but stay in a fairly tight range- which played out in this data release.

The headlines:

Retail sales rose 4.6% y/y in August, up from 2.5% growth in July.

Fixed asset investment (FAI) rose 1.8% y/y in August, improved from 1.2% growth in July.

Value-added output at industrial firms rose 4.5% y/y in August, versus a 3.7% increase in July.

The data broadly beat expectations.

Things are looking up, but don’t get too excited: There are some pretty major caveats to the improvement seen in the August data.

For example, the pick up in industrial activity has favored state, rather than private, firms:

Industrial value-added output increased 5.2% y/y at SOEs but only 3.4% y/y at private companies.

Growth in FAI has also been tilted towards state companies, which increased spending 6.1% y/y.

Private firms cut spending by 2.2% y/y.

For August’s recovery to be sustained, private participation needs to increase.

The increase in retail sales is a positive sign, but growth remains well down from the 8.1% y/y rate of expansion recorded in 2019 before the pandemic.

And while a 10bp fall in the urban unemployment rate to 5.2% last month is another good indicator, the stats bureau is still not publishing data for youth unemployment.

Get smart: To maintain last month’s recovery, improved economic activity needs to broaden beyond state-driven growth.

And that requires boosting businesses confidence – to drive price sector investment – as well as encouraging households to spend and reviving, or at least stabilizing, the real estate sector. Car sales were the main driver, which was supported by a slew of incentives from the CCP as well as cost reductions. We don’t see this as a meaningful pivot in trend, but rather a short lived bounce from government support.

Even as we had some fixed asset investments bounce- it was ONLY in the state-owned businesses. The bigger issue is another drop in the real estate investment side with more downside on the horizon as prices took another step down.

The property market remained depressed in August with the supply of residential space unchanged at its lowest level since Aug 2006 while residential demand fell further to more than 10-year lows.

As a result, China’s inventory of unsold new homes continued to rise in August, reaching its highest level since January 2015, with excess supply representing almost 23 months at current sales levels and almost 22 months estimated for 2023

This excess that remains in the market drove down prices again, and given the current dynamics in the market- we don’t see a pivot higher anytime soon.

So while we had some increase in consumer spending, it still remains flat with more pressure on consumer networth. Even if we had an “Exponential” increase in spending, China’s final consumption still ranks low against world averages and won’t provide the GDP support the CCP needs.

The Chinese consumer is very weighted to housing, and the impacts it has on borrowing capacity and spending abilities is broad. “This excess supply of new homes is likely to continue to weigh on house prices over the coming months, with prices having contracted for the 3rd month in a row.”

This drop is not driven by rates as the PBoC and CCP try to support mortgage creation, but there remains no desire for additional leverage. We don’t see these cuts providing support for a “second half” rally as some are predicting. Instead, it will be more of a sideways move.

Some bonds of homebuilders have been restructured to add duration, but does little to adjust the principal and interest owed. While it gives them more time, it won’t be enough to drive growth or even keep the companies afloat in the long term.

Here is an example- the “Stabilizing moves” have been many and pronounced- but NOTHING has been able to turn the tide. This is a broad overhang that is more structural and less cyclical.

This is why some of the social construction that has taken place will only be supportive for a short period of time.

For those that know me, you know how I have said China will grow rapidly for years- but eventually hit a wall when it comes to leverage catching up. We have highlighted since 2018 that the LGFVs were going to be the downfall of the Chinese market as well as broad spending on things that wouldn’t drive long term growth. In the end- QE comes for us all (yes- EVEN the U.S.!) Here are some good quotes on the topic:

“It is time for the markets to recognize that China is not reverting to its old economic and financial playbook, and its return as a powerful driver of global economic growth is unlikely in the near future. Economic performance is likely to remain lackluster for the remainder of 2023 and the first half of 2024. Looking beyond this period, the outlook is also far from reassuring. The challenging process of reorienting the Chinese economy in the face of ongoing geopolitical tensions and the complexity of building an alternative international order poses significant hurdles. The authorities will also need to overcome their now overwhelming inclination towards centralization and, instead, enable but not micromanage the emergence of powerful private sector engines of growth. Despite what many may continue to tell you, it is no longer a given that China will become the world’s largest economy.”

From Michael Pettis- https://twitter.com/michaelxpettis/status/1700378843083616421

“While I agree with much of what El-Erian says in this piece, especially his point that the stimulus many are hoping for, expecting it to "reinvigorate domestic growth and restore China as a key engine of global expansion" would do no such thing, and would only at best postpone the urgency with which Beijing needs to transform the growth model, I disagree with this claim: "Despite what many may continue to tell you, it is no longer a given that China will become the world’s largest economy.“

In fact it was never a given. Those of us who understood China's structural imbalances and the nature of its GDP growth had been arguing for over a decade that the Chinese economy had already slowed substantially on comparable terms and was never likely to accelerate. The reason is because since the late 2000s Beijing could only maintain high rates of GDP growth (above, say, 3%) by increasingly shifting the locus of economic activity from the productive "hard-budget constrained" parts of the economy to the less productive "soft-budget constrained" parts. Because the latter isn't sustainable, and much of it must eventually be reversed anyway, the only way to preserve the GDP growth rates that fueled the "sorpasso" expectations was also what had ultimately to undermine those very expectations.

This was always an exercise in how fundamentally we misunderstand what GDP means. Even most economists – who really should know better – seem to think that GDP is a measure, comparable across countries, of the total value of goods and services produced by the economy.

It isn't. It's just a proxy for this total value, based largely on the structure of the US and British economies in the 1930s and 1940s, that tries to measure the extent to which the real economy (i.e. the real value of goods and services produced) has grown or contracted.

GDP can be useful, but only under certain very strict conditions. The most obvious, in the case of China, is that the GDP measure assumes necessarily that all activity occurs under hard budget constraints, and that losses are always expensed, and never capitalized.

The fact that GDP growth was an economic input in China, and not an output, should have made it obvious just how non-comparable it was. The only way to make GDP growth an input is to assume that all investment is productive. This effectively means capitalizing losses.”

This has been hard to explain to economists, although engineers, mathematicians, other others who think in terms of systems find it almost trivially obvious. Without hard budget constraints, there is no way to differentiate between value creation and value destruction.