Back to Goldilocks economy

In this post, we talk about the champagne indicator, receding inflation and finally we look at the first results of the earnings season. Banks are doing well, but leveraged buyout deals like Elon Musk's Twitter purchase is now coming at a cost as interest rates rise.

I've been hyping the eurozone economy an unacceptable amount lately, so I'll just quickly mention this time that the German economy grew by 1.9% last year, even though it was supposed to freeze in the energy crisis. Even the toughest bears have already started to take back their statements about the de-industrialization of Europe. If there is even a recession this year, we will enter it from strong positions.



Okay let’s dive into today’s topics.

The champagne indicator

I just have to bring up how champagne sales in Finland seem to go hand in hand with the performance of the Helsinki Stock Exchange. Pasi Sorjonen, Akava's chief economist, tweeted a statistic about Alko's champagne sales, and I couldn't help but compare that development with the Helsinki Stock Exchange. Cleverly branded and premium-priced in the Champagne region, this royal sparkling wine is a more celebratory drink, and its correlation with the general trend in wealth wasn’t surprising per se. The Tweet is in Finnish, but it shows the monthly champagne sales in Alko stores. It looks just like the stock market!

Mr Sorjonen later pointed out how well champagne consumption moves with economic growth, calling it the champagne indicator. We have apparently fresh data on champagne, and it suggests that Finland's economic growth will drop a couple of points in the near future. Forecasters such as the Ministry of Finance and the Bank of Finland expect the Finnish economy to enter a mild recession this year. GDP growth would be -0.2 - 0.5% according to them. Based on the Champagne indicator, the decline in GDP would be steeper.

This graph shows champagne sales (moved forward one quarter) in dark blue with the scale on the left-hand side and GDP in teal and its scale on the right-hand side.

Inflation is coming down

Inflation data from the US came in as expected last Thursday. The stock market is looking ahead, and receding inflation seems promising. On an annual basis inflation slowed to 6.5%. On a monthly basis, the change was -0.1%. Inflation was particularly slowed by energy. Thus, core inflation that excludes energy remained at a monthly rate of 0.3%. Shelter, which is around a third of the weight of the price index, are still inflating rapidly. However, as I have probably pointed out a hundred times, the shelter data is outdated, and we can expect real costs to calm down as the housing market cools. On the other hand, price pressures continue in many other sectors.

The Cleveland Fed's trimmed inflation rate is a measure from which the most volatile parts of inflation have been stripped out. Thus, the rate gives a smoother picture of where prices are heading under all the fuss. This trimmed gauge is down at 6.5%, after peaking at 7.3% in September.



In turn, the Atlanta Fed has inflation gauges that weigh the change in slow-moving items. This graph shows the 3-month annualized change in this so-called sticky inflation. It's dropping like a stone now.



A tight labor market and rising wages is a force that can feed inflation in a sustainable way. Otherwise, people would soon not be able to afford to eat. This graph shows the Atlanta Fed's wage inflation gauges. Wage inflation is stabilizing slowly, but wage growth, especially for job changers, seems to be easing, which is a promising sign.



However, the labor market remains tight. There are few new claims for unemployment benefits, and there are still 10 million job vacancies in the US, although the trend is downwards. If you want to time your share purchases for catastrophic times, the moment of a tight labor market isn’t necessarily the best bet.



Inflation hasn’t yet been defeated, and it wouldn’t be unprecedented for it to become another wave of longer duration. But historically, inflation spikes have passed within a few years. Inflation drives interest rates and, in turn, stocks. Market expectations for the Fed policy rate have moderated slightly again. In a year's time, the policy rate is expected to be around 4%, as this curve shows. In any case, being publicly part of Team Transitory is no longer as embarrassing as it was a year ago.

 
In her macro reports, our economist Marianne Palmu has a few times raised the possibility of a return to an optimal Goldilocks economy for equities. If the economy remains strong and inflation calms down, stocks will have a good time. Among the many threats, it’s worth seeing these opportunities, although the recent rise in the stock market may not be rewarded in the same way as last fall's buying opportunities.   

A few words about the earnings season

A few comments on the start of the earnings season in Finland and the US. I try to have time to look at the earnings releases of companies on the Helsinki Stock Exchange and major international companies and compile them into quick thoughts in these posts. After all, the results tell us directly about the well-being of listed companies on the one hand and the state of the economy on the other. At this stage of the season, this is still somewhat easy, with a manageable number of results coming in each week. Let's see how I get on with these for the rest of the month.

Admicom, the Saas company digitalizing the construction sector in Finland that started the earnings period on Friday, grew its revenue by 27% in the fourth quarter as expected, but the increased growth initiatives with a new CEO pushed profitability below our analyst Atte Riikola's expectations. However, Atte didn’t find the drop in profitability concerning yet, if the growth pays off. Admicom's EBITDA margin was 37%, which is also among the highest on the Helsinki Stock Exchange. The company comments that so far the economic downturn hasn’t affected its customers in the construction sector. Admicom will provide more detailed guidance on its Capital Markets Day on January 30 and for now is content to say that growth will continue in 2023 and profitability will remain strong.

In the US, major banks JP Morgan, Bank of America, Citi and Wells Fargo also reported their results. Banks are directly linked to the general development of the economy, which is why their reports are always interesting to look at.

The rise in interest rates has been a treat for banks, as they can finally claw back a decent return on their loans. JP Morgan, for example, saw its net interest income swell by almost 50% and other banks by tens of percent year-on-year. However, in the future, interest income will develop more moderately as interest rates slow down and customers look for higher interest rates on their deposits. This graph shows the evolution of the net interest income of the major banks.



The business side for banks suffers because in a weaker market, companies don't do as many deals with juicy rewards for banks.

Even though things are going well now, all banks are preparing for a weaker economy. Jamie Dimon of JP Morgan, America's largest bank, described the US economy as strong, with consumer spending and healthy business. Still, the bank is preparing for worse scenarios, but at least Jamie is no longer talking about an economic storm as he was a moment ago. This graph shows the historical evolution of banks' loan loss provisions in relation to the size of the bank's balance sheet. Loan loss provisions are set up by banks to prepare for future credit losses. These provisions increase when the outlook weakens and are reduced when times improve. The figures aren't ridiculous yet, as in previous recession, but this looks more like a return to normality.

I often prattle on about how banks' balance sheets have strengthened significantly since the financial crisis, which is well reflected in this graph. It shows the ratio of banks' risk-weighted buffers to risky assets such as loans. In fine terms, Tier 1 capital. Banks are under a magnifying glass. Therefore, the triggering of a new financial crisis, which many still fears, is unlikely to come from the banks.

 
However, this doesn’t mean that during the zero interest rate period banks didn’t make foolish loans for acquisitions with a large debt leverage. The worst blunder in the spring was the debt financing of Elon Musk's Twitter deal, for which the banks borrowed more than $12 billion. Now the market considers the recovery of the loan difficult and is only being offered at 60 cents on the dollar.  There was a good article on Bloomberg on the rotting debt in the hands of the banks, estimated at around $40 billion. The amount is small compared to the problems of the financial crisis, which cost a few hundred billion. However, even a small nuisance is a small nuisance. This limits banks' willingness to finance new risky debt-driven deals.



This is a good example of how rising interest rates and tightening monetary conditions are beginning to crowd out the most speculative forms of economic activity. Time will tell how much the slowdown will eventually be reflected in the real economy.

Thank you for reading the post! Read analysis and make good stock picks!