Courtesy of Doug Short.
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Consumers Gone Wild! I have this image in my head of shoppers running about frantically over the last quarter shelling out dollars at everything that isn’t nailed down to the floor. That was the general consensus Friday after the GDP report came out showing a lift from 1.3% to 2.5% primarily on the back of the consumer, as shown in the chart. However, the real question is where did the money come from?
If we dig down into both the GDP release on Thursday and the Personal Income and Consumption report on Friday, we find several very disturbing trends that are becoming much more dominant. However, before we get into that, let me provide you with a quick reminder that the first estimate of GDP released by the Bureau of Economic Analysis is tied closely to the consensus estimate of economists, as there is incomplete information about the various subcomponents to make a more accurate estimate. Therefore, it should really come as no big surprise — given the shocks that hit the economy from the debt downgrade, political infighting over the debt ceiling and the Eurozone crisis — that the release was EXACTLY in line with the consensus estimate of 2.5% growth yesterday. The reason I point this out is that it is VERY rare that the consensus is EVER spot on to the first decimal point with the release. I find this very suspect.
Of course, the release was immediately met with the resounding stampede of analysts and media mavens throwing in the towel on any recessionary calls they might have had and assuming that all is well in world. Unfortunately, these are also the same ones who have generally been wrong when there are upticks in GDP during the initial phases of a move into a recession.
We pointed this out earlier this week in our post on the GDP release with this table. The same analysts and economists who are currently throwing in the towel on the recession are the same ones who threw in the towel on the uptick in economic growth in the 2nd Quarter of 2007 when growth was an annualized 2.9% just before the slide into the biggest recession since the “Great Depression”.
However, the issue that we want to focus on today is not that businesses are selling down inventories, which is the opposite of what we have seen since the bottom of the last recession, but what happened with consumption and where the spending spree came from. If we subtract out PCE from the last report, GDP growth came in at a very tepid 1.3%, which is unchanged from the previous quarter.
If we dig behind the details of the PCE (Personal Consumption Expenditures) we find that health care and utilities drove consumer spending last quarter, reiterating our recent post on consumer “frugality”, as they are spending on necessities rather than luxuries. Outside these two key areas consumer spending was fairly stagnant, and GDP growth was only 1.5%.
Now things are starting to make a little more sense. This is also jives with the recent reports on consumer confidence, which has shrunk to historically low levels. When food and energy are already consuming more than 22% of wages and salaries, things are tough. Now, utilities and medical bills are eating away at the balance. No wonder consumers still say that the economy never left recession territory, because for them it hasn’t.
This becomes even more apparent when you realize that real incomes are declining as well. With personal incomes, and particularly disposable personal incomes, deflating on a year-over-year basis, combined with rising food and energy prices, the reality of “stagflation” becomes all too clear for many Americans. In the recent reports every discernible measure of real disposable incomes was negative. Considering that nearly 1 in 5 Americans are unemployed, underemployed or simply not counted, these huddled masses are dependent on some form of government assistance, which includes those approximately 45 million poor souls utilizing food stamps. How surprising is it really that nearly 25% of personal incomes are comprised of some form of Government assistance.
If we exclude Government transfers in the recent report, we will find that real incomes declined 0.6% on an annualized basis, which is the first decline since the bottom of the recession in 2009. This is important because personal incomes are one of the four indicators used by the NBER (National Bureau of Economic Research) in calculating beginning and ending dates of economic cycles. It is a fair bet that the decline in personal incomes will soon be followed by the rest of the indicators as well.
Save Less Spend More
However, even with all of these data points, we still haven’t said where the spending came from. We know incomes declined, which means that less money was coming into the household to meet spending requirements. We now know that the majority of the funds were spent on food, utilities and healthcare and not much anywhere else. So, if you have less money coming in and more money going out, there are only two places from which to obtain more funds: credit and savings. With consumer credit lines being slashed by banks and consumers in the process of deleveraging their balance sheet at home, it is not surprising that we have seen a massive draw down in personal savings.
The latest report shows that the personal saving rate in the U.S. has declined from 5.3% in June to a mere 3.6% in September — a massive 32% reduction in the personal savings rate. This is particularly discouraging for those economists betting on a “no recession” call. Why? Because with incomes falling, the drawdown on savings can only go on for so long before the economy locks up. Without the subsequent support of housing “ATMs”, credit lines and other forms of credit to fill the gap between incomes and the requirements of living, the economy is going to be hard pressed to stay out of a recessionary spat.
That Was So Last Quarter
Of course, everything that we have talked about so far is what has happened over the last quarter. As we look at the question of whether or not there is a recession in our future, little has changed. While economists are quick to jump on the GDP report, which by the way has lots of issues with the way that the data is assembled, let us not forget that there are a variety of other indicators that are telling us more about the economy during that same period. Consumption makes up 70% of the economy and therefore this spending spree should be showing up in other areas of the economy — from manufacturing and production to service. The problem is that it isn’t.
Our STA Economic Composite indicator combines the largest Fed manufacturing regions, the Chicago Fed National Activity Index (which is a composite of 85 indicators in and of itself) along with NFIB Small Business Survey, Leading Economic Indicators and others to get a broad overview of the strength of the underlying economy. When the index falls below 30 (dotted red line), currently at 27.5, the economy is usually entering into or already well into a recessionary phase. Therefore, unless something dramatically changes in the coming couple of months, the composite index is already telling us that the bump we saw in PCE in the last quarter didn’t make it to areas of the economy that will keep it out of a recession. As such, we will likely see a retrenchment of consumer spending in the coming months and continued weakness in the economy.
This gap between incomes and spending is what has us feeling so uneasy about the current situation, because it has rarely been this wide outside of a recession. Setting aside the massive market rally based on potential hope that Europe will somehow be saved from the horrors of a Greek default, the reality is that soon investors will have to pay homage to the weak economic environment at hand. If consumer incomes don’t start to recover soon, and there is little evidence that they will, there is little that can be done to push economic growth higher without further intervention by the Federal Reserve. Maybe this is why they have already started throwing about the words “additional asset purchases”, more commonly known as “QE”.
For us, our best guess remains that the economy will be in a recession in early 2012 without further intervention from the Fed which, at this point, would not surprise us at all. However, even that may not be enough to stave off the decline.
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