David Rosenberg On The Coming Gunfight At The OK Corral Between Mr Market And Mr Data
While the market continues to simply fret over when and where to start buying up risk in advance of inevitable printing by the US and European central banks, those of a slightly more contemplative constitution continue to wonder just what it is that has allowed the US to detach from the rest of the world for as long as it has - because decoupling, contrary to all hopes to the contrary, does not exist. And yet the lag has now endured for many more months than most thought possible. And making things even more complicated, the market which doesn't follow either the US nor European economy has decoupled from everything, breaking any traditional linkages when analyzing data, not to mention cause and effect. How does reconcile this ungodly mess? To help with the answer we turn to David Rosenberg who always seems to have the question on such topics. His answer - declining gas prices (kiss that goodbye with WTI at $103), and collapsing savings. What happens next: "in the absence of these dual effects — lower gas prices AND lower savings rates — we would have seen real PCE contract $125 billion or at a 3% annual rate since mid-2011 (looking at the monthly GDP estimates, there would have also been zero growth in the overall economy). Instead, real PCE managed to eke out a 2.7% annualized gain — but aided and abated by non-recurring items. Yes, employment growth has held up, but from an income standpoint, the advances in low paying retail and accommodation jobs have not compensated the losses in high paying financial sector and government employment." Indeed, one little noted tidbit in the monthly NFP data is that those who "find" jobs offset far better paying jobs in other sectors - as a simple example the carnage on Wall Street this year will be the worst since 2008. So quantity over quality, but when dealing with the government who cares. Finally, will the market continue to decouple from the HEADLINE driven economy, which in turn will decouple from everyone else? Not unless it can dodge many more bullets: "As was the case last year, the first quarter promises to be an interesting one from a macro standpoint. The U.S. economy has indeed been dodging bullets for a good year and a half now. It might not be October 26, 1881, but something tells me we have a gunfight at the O.K. Corral on our hands this quarter between Mr. Market and Mr. Data." Read on.
Less Than Meets The Eye
Some members of our investment team asked me yesterday what numbers out of the U.S. have come out soft of late. Well, here's a short list we came up with:
- Industrial production
- Core orders
- Core shipments
- Home prices (every measure)
- Real disposable income
- Real PCE for November
Keep in mind that Q3 GDP was marked down to sub-2% and I think Q4 will be around 3%. Last year's Q4 also surprised to the high side but was no predictor for the next two-three quarters. To be sure, the economy has done better than I had thought five-six months ago, but much of what "bounce" we got was a belated comeback in auto production, the sharp decline in gas prices (which I wasn't expecting) and the pullback in the savings rate which I can't see being sustained. We are creating more jobs, but in low-paying industries and losing them in high-paying government and financial sector jobs.
Hence no growth in real personal income. I see that as a problem for it means that either exports accelerate or the savings rate declines to underpin the economy going forward. U.S. home prices have sagged more than 20% annual rate in the past four months and represents a substantial wealth loss for homeowners and calls into question the degree to which home inventories have receded in terms of creating a true and durable demand-supply balance.
It is useful to compare and contrast the GDP and GDI (Gross Domestic Income) data. Earlier in 2011, the latter suggested that the surprising weakness in the former was overdone. Now the tables have turned — the "pickup" in spending is not being validated by the income data, which have all but stagnated in Q2 and Q3.
Based on the real personal income data, there is no growth in Q4 thus far and it looks as though profits, at least based on S&P 500 data fell for the first time since the recession ended 21/2 years ago. That would mean a third quarter of flattish or even negative GDI data and believe me, if this is what the more closely-watched GDP was flagging right now, the markets would be under some pressure — assuming denial was held at bay.
Okay, so to recap: We have real personal disposable income growth running at a mere +0.5% annual rate in Q4. And according to S&P 500 EPS data, corporate profits are contracting at a 3.8% annual rate for Q4. This is the first sequential decline since the fourth quarter of 2008. So at best we have a flat quarter for real GDI on our hands — for the third quarter in a row (after 0.2% at an annual rate in Q2 and Q3). Now that doesn't classify as a recession —just the next rung up that is called stagnation. This in turn explains why bonds got a heck of a lot more expensive in the past year and why it is stocks got a whole bunch cheaper. The U.S. economy, more from an income than spending perspective perhaps, is skating on some very thin ice here.
Let's do some arithmetic to help explain what has happened on the spending side.
First, since mid-2011, gasoline prices have plunged 60-cents, which is in effect an $80 billion tax cut for the household sector. The problem is that this windfall is behind us, sadly enough. Eighty billion dollars at an annual rate is akin to a 4% pay raise for the average worker in real terms. That's hardly trivial for the likes of Bob Cratchit, we can assure you.
Second, since June, the personal savings rate has plunged from 5% to 3.5%. This sort of decline over such a short time span has occurred but five times in the past 12 years. This in turn freed up $150 billion at an annual rate in real terms yet again for spending purposes.
So we have a total of $230 billion of support that temporarily bolster the consumer since the mid part of 2011.
Yet real consumer spending since June has only risen by $105 billion at an annual rate in real terms.
That means that in the absence of these dual effects — lower gas prices AND lower savings rates — we would have seen real PCE contract $125 billion or at a 3% annual rate since mid-2011 (looking at the monthly GDP estimates, there would have also been zero growth in the overall economy). Instead, real PCE managed to eke out a 2.7% annualized gain — but aided and abated by non-recurring items. Yes, employment growth has held up, but from an income standpoint, the advances in low paying retail and accommodation jobs have not compensated the losses in high paying financial sector and government employment.
Now it may be the case that prices at the pump have bottomed, but why can't the savings rate still go down? Well, if it continued to decline at the rate since June, it would be at zero by summer. That is not impossible, but it's not exactly a base case scenario either. What we do know is that in Q2 and Q3 together, the combination of weak equity markets and eroding housing values dragged down net worth by some $2.5 trillion. Now there are not a whole lot of data samples to pick from historically, but the last two times this happened, the savings rate rose in the ensuing three months.
As was the case last year, the first quarter promises to be an interesting one from a macro standpoint. The U.S. economy has indeed been dodging bullets for a good year and a half now. It might not be October 26, 1881, but something tells me we have a gunfight at the O.K. Corral on our hands this quarter between Mr. Market and Mr. Data.