7/16/2024 Weekly Update - The McElwee Report
Rate Cut Expectations, Business of Fitness Lifestyle Brands, Quantum Computing, And More
This Week’s Edition
Is the Market Too Aggressively Anticipating Rate Cuts? Analyzing the Federal Reserve’s preferred measure of inflation — the Core Personal Consumption Expenditures (PCE) Price Index.
What is Quantum Computing? Understanding the potential for this disruptive technology through the lens of a pure-play quantum computing developer, IonQ (IONQ).
Why and How Successful Are Fitness Clubs Today? The emergence of premium fitness lifestyle brands including Life Time Group Holdings, Inc.’s (LTH) evolving business model.
Other Interesting Data Findings: Foreign-born labor force exploding against domestic-born; Russell 2000 Index reaching its highest level since January 2022.
Next Week’s Edition will be sent on Tuesday, July 23rd, and will include business cycles, cyber security, nuclear energy and small modular reactors (SMRs), and more.
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Is the Market Too Aggressively Anticipating Rate Cuts?
The market now expects three consecutive rate cuts to occur by year-end beginning in September. By the end of the year, the target rate is expected to be 450-475 basis points (down from 525-550), which will lower financing rates, including mortgages and commercial loans. But these market expectations remain highly volatile and frequently change.
The Federal Open Market Committee (FOMC), a component of the Federal Reserve, helps to achieve price stability by setting the target range for the federal funds rate, which ultimately impacts all other rates of financing.
The FOMC’s preferred measure of inflation is the Personal Consumption Expenditures (PCE) Price Index, specifically the “Core” PCE.
The Bureau of Economic Analysis releases the PCE and defines it as, “A measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services.”
The PCE is a chained-link index of data from businesses. “Chained-link” means adjusting the mix of goods and services to reflect consumer spending patterns, which is more informative of current consumer conditions since it accounts for substitution effects — when consumers replace higher-priced items with lower-priced items.
The Core PCE excludes food and energy, as food and energy prices tend to be more volatile and may skew the overall trend of inflation. For example, gas prices may spike one month due to a geopolitical event but normalize in the month after.
Last week, Fed Chairman Jerome Powell stated that it will begin to cut rates before inflation reaches its 2% goal.
Prior to May 2024’s PCE release of 2.6%, the FOMC released its Summary of Economic Projections, a collection of economic projections of Federal Reserve members and presidents that occurs four times a year.
From these projections, the median consensus for Core PCE is 2.8%, well above the 2% target and a higher projection from a previous release in March 2024 (2.6%).
Included in these projections is the Federals funds rate, which they expect to be 5.1 by year, a very modest cut expectation from the current target rate of 525-550.
Fed Chair Jerome Powell describe the PCE forecasts as conservative but inflation is continuing to impact American consumers from different angles — especially as it relates to housing.
For example, this newsletter often includes the Zumper National Rent Report, which is a leading indicator as its data measures asking rents today. In May, this report’s national index had the highest monthly gain since fall 2022.
And, as highlighted in the June 13th edition, the U.S. continues to close the housing supply gap by developing premium rate “Class A and B” multifamily complexes — driving prices higher for renters.
With the lagging nature of the PCE, housing will likely continue to put pressure on inflation. And, as Yahoo Finance highlights, the Consumer Price Index (CPI), another measure of inflation, weighs housing costs at about 43% of its core measure, much higher than Core PCE’s weight of 17.5%.
Consequently, the latest annual change in the Core CPI was 3.3% — higher than the Core PCE’s latest annual change of 2.6%.
Will the Fed cut rates even when these costs are still inflated?
For now, economic data releases remain the most important factor for rate cut expectations and the next release of the PCE Price Index occurs on July 26, 2024.
To Stay Ahead
To see real-time updates on the market’s expectations for rate changes, click here.
What is Quantum Computing?
As AI continues to capture investor attention, there are other emerging technologies that may also have a profound impact on society.
The fourth industrial revolution (4IR) is currently underway, and the advent of its technologies will significantly change the ways humans economically and socially transact.
A groundbreaking technology that is emerging from this revolution is quantum computing.
An example of a pure-play quantum computing company is IonQ. IonQ, which exclusively licensed its technology from the University of Maryland and Duke University, is led by Peter Chapman, a former Amazon director responsible for the development of Amazon Prime’s 2-Day delivery.
As IonQ explains, a classical computer, which we use today, stores information in bits “that are represented logically by either a 0 (off) or a 1 (on).” However, quantum computing uses quantum bits (qubits), which are units “that can exist in both states 0 and 1 simultaneously.”
The dynamic structure of quantum computing may solve problems that classic computers cannot or would take “millions to trillions of years.”
One example is in chemistry. The Haber-Bosch process is used for nitrogen fixation to make fertilizer. But, this process consumes “about one percent of the world’s energy and produces about one percent of the world’s carbon dioxide.” Quantum computing could simulate this process to develop a more efficient method.
Other use cases may include faster drug discovery, quantum algorithms for Monte Carlo simulations used to price options for the financial industry, as well as significant security risks such as breaking RSA encryption, which is commonly used for internet communication security.
There are many other companies involved in quantum computing including large technology companies such as Google (GOOG), IBM (IBM), and Microsoft (MSFT), in addition to other pure plays including Rigetti Computing (RGTI). These companies use different technological approaches in achieving quantum computing.
Overall, the industry is still highly speculative, since it is in the early stages of commercialization. And, as IonQ’s financials reveal, there are significant expenditures incurred for development. Today, the company has an accumulated deficit of $392 million, in comparison to only $25 million in revenue from the past twelve months.
McKinsey estimates a market size for quantum technology to be $173 billion by 2040 with a potential economic value from quantum computing amounting to $0.9-$2 trillion by 2035.
If the technology is successfully commercialized, it would likely bring significant systemic change to society — solving problems beyond the capabilities of human intellect.
But this won’t occur without significant concerns and risks.
Resources
If you’d like to continue to follow developments on quantum computing, follow The Quantum Insider which provides real-time news updates, reports, and a newsletter. Click here.
Why and How Successful Are Fitness Clubs Today?
No doubt, we have become a more socially fragmented society. As an estimated 40% of full time employees are now working remotely or in a hybrid arrangement, The Cigna Group reported that more than half of U.S. adults (58%) are considered lonely.
And this social isolation is not without physical consequence.
To quote a 2023 letter from the U.S. Surgeon General: “The mortality impact of being socially disconnected is similar to that caused by smoking up to 15 cigarettes a day, and even greater than that associated with obesity and physical inactivity.”
Human nature’s necessity for social connection appears to be increasingly answered by the proliferation of community-focused, high engagement lifestyle fitness brands.
Today, the Health & Fitness Association, a global trade association for the fitness industry, reports that the U.S now has more than 72 million health club and studio members and the second highest percentage of active members of fitness facilities than any country other than Sweden.
Although 41% of American facility users pay $25 or less per month for membership, the average monthly membership is $59 — which indicates a significant portion of Americans paying premium membership rates.
An example of a premium fitness lifestyle brand is Life Time Group Holdings, Inc. (LTH). Life Time operates 171 “luxurious athletic country clubs” located in “affluent suburban and urban locations” with members having a median household income of $157,000.
For Life Time and other fitness club brands, the business model has transitioned from “higher membership, lower usage” to “high quality member experiences.” This increased emphasis on engagement and community has increased average visits per membership from 108 in 2019 to an estimated 138 for 2024.
Its average revenue per center membership has increased to $2,810 in 2023 — an 11% increase from 2022 and a 34% increase from 2021. Today, the average membership price is $186 a month, up 12.7% from the first quarter last year.
Life Time’s focus on higher income households lends to its “recession resistant model.” During the Great Recession, retention at highest priced centers were 30% higher than retention at lowest priced centers.
Even with inflationary pressures, Life Time’s retention rate is “roughly 10% better” than ever seen by the company as it prioritizes member engagement
Reflective of lifestyle fitness clubs’ emerging role in facilitating social connection, Life Time has increasingly placed its athletic clubs in renovated shopping malls - once epicenters of American social activity.
Other premium fitness lifestyle brands include Equinox, which recently secured $1.8 billion in loans for refinancing and expansion after a 27% annual revenue increase and “record-high member engagement”, and Barry’s Boot Camp, whose studio revenue grew [ironically] by 27% in 2023 and had class attendance of more than 7.4 million.
Ultimately, success is determined by the fitness brand’s ability to manage increased demand for physical connectedness through prudent investment..
And, as F45 Training has shown after being de-listed from the New York Stock Exchange, a successful brand with high-growth sales can still be usurped by financial mismanagement.
Tip
The push to expand the U.S. fitness industry’s market size includes the Personal Health Investment Today (PHIT) Act, which would allow Americans to use pre-tax dollars from Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) to cover fitness club dues.
For updates on this, click here.
In need of financial copywriting or research? Feel free to reply to this email.
Other Interesting Data Findings
In a LinkedIn post last week, Liz Ann Sonders of Charles Schwab stated that, “Since right before pandemic, foreign-born labor force (orange) has grown significantly while domestic-born labor force (blue) has barely grown.”
The Bureau of Labor Statistics stated in a May 2024 news release that, “Foreign-born men continued to participate in the labor force at a considerably higher rate in 2023 (77.5%) than their native-born counterparts (66.1%).”
The Russell 2000, a U.S. stock market index of small market capitalization stocks, is breaking through a resistance level in place since January 2022. This may indicate that the markets are now more comfortable with risk.