The Best Indicator Of Economic Health?
Courtesy of Nic Lenoir, ICAP
Traditionally, many people in the industry view the ISM as the best stock market predictor. With a GDP being calculated as the total production of the country I guess it makes sense. But the ISM completely ignores the financial health of the country. That's why, as some only found out recently, having 4% growth on borrowed money for 4 or 5 years doesn't do you any good when comes the time to repay your debt. This is one example of how short-sighted economic reporting can be sometimes. Granted, if you start adjusting growth for population growth, inflation, and debt creation, you will not necessarily get much, especially these days. But even if that led to a darker picture, wouldn't it be a more coherent fundamental assessment of economic progress.
ABC consumer confidence has been lagging any sort of recovery we are currently having. All economists are unanimous though, the business cycle is in full effect and we are headed for 3% to 4% Q4 growth. Numbers don't lie, activity has picked up. However there is a slight problem, consumer credit is shrinking, wages are certainly not higher, and confidence is low. Last time we fueled growth using credit, consumer confidence picked up but modestly only, and we are now seeing lows not seen since the recession in 1991. A look at the attached chart of consumer comfort against ISM and GDP makes it very clear, and we also see that ISM is usually a leading indicator, maybe explaining why consumer comfort is currently trailing green shoots. Interestingly it seems the cycles in consumer satisfaction correspond with 8-year presidential cycles. I am only observing, as I don't have enough data to go more than two preseidents (Clinton and Bush II) on the chart, so this is in no way an expression of my political opinion. But will the pick up in ISM this time again lead to a pick up in consumer comfort and prosperity? It's difficult to assess. My inclination is that we have many secular problems to deal with and credit infused prosperity at the individual level is not really a possibility.
To go around the difficulty of the consumer's balance sheet, already rotten with debt, the government has made it its mission to restart the economy using sovereign debt. In essence whether it's the Fed or the government, this is what always happens anyways, and that is precisely why production always leads consumer confidence. But this time we have a real problem, because we are trying to restart an economy with a level of debt never encountered before. What I find trully fascinating is that we are already claiming victory. This recession is over, and even though growth will be subpar, we are led to believe all is well. The stock market certainly says so. Is the stock market a good indicator of economic prosperity? I don't know but it's not the point. The point of all this is to show that economic activity always front-runs consumer prosperity because governments somehow spur activity, whether it's through the private sector or themselves, everytime the economy is in decline. So in a sense, the government uses the ISM or the stock market (both move in sync historically anyways) to assess its performance, and that is where it is dangerous, because as we discussed earlier ISM is only one component of economic prosperity. It is certainly necessary to have a strong production to have an economy that functions well, but at what cost?
By no means is government intervention an American problem. My original inclination was to blame democracy, as elected representatives will do anything for a short-term boost in outlook to scure their re-election or legacy. But it is very interesting to see that every government around the world is doing the exact same, whether that government is elected or not. The US government bails its banks and its economy using taxpayer money, just like European governments or even the Chinese government. What's completely absurd is that by nature of ideology, capitalist countries should let failed institution sink and care for the fiscal health of the country, socialist countries should prop the economy using public money but let stocks go bust and takeover failed institutions or businesses to punish failure of capitalist enterprise, and China... well a communist country with a stock market and a currency that one can't trade is absurd in the first place. It's not banks that are too big to fail, it's our economy that can't tolerate shrinking for a few quarters. One thing is for sure propping the economy up because we can't tolerate volatility, whether it's in the GDP numbers or the stck market, is a very bad idea in the long term, and we have been doing it for a very long time. If it works this time it will be worst the next. By trying to fight volatility we are guarantying explosions of volatility far more painful than what would occure otherwise.
The best indicator of health would be a GDP declining to reflect we have moved our manufacturing overseas, we have too much debt, and unfunded pensions are a ticking time bomb that makes the housing market a pleasure to deal with.