Via Lance Roberts of Street Talk Live [13],
The personal income and spending report Friday morning left a lot to be desired for those expecting a stronger economic environment soon. However, the report fell well in line with what I have been expecting over the past several months (see here [14], here [15] and here [16]) as the drag on real wages and incomes have weighed on the consumer. As we discussed in yesterday's report on GDP [17] - personal consumption makes up more the 70% of the economy therefore changes to employment, incomes or credit has an immediate and significant impact to growth.
First, let me argue the claim that the impact to personal incomes was due to Hurricane Sandy. While the storm is going to be the excuse for everything from economic reports to global warming the impact from Sandy on personal incomes was most likely very limited. The storm did not occur until the last two days of the month. Even if we assume that everyone in the Northeast was hourly pay, all quit their job five days before the hurricane, and then left town, the overall impact to the entire month of personal incomes for the entire country would still be fairly limited.
Secondly, the Hurricane excuse doesn't account for the negative revisions to the personal income data going back to April of this year. The chart below shows the level of personal incomes both pre- and post revisions in October. These revisions also resolve some the imbalances that we have noted between reported personal income data and other economic reports pre-election. We have suggested that many of these anomalies would be revised away in the months ahead which we are now seeing come to fruition.
[18]
However, for the sake of argument let's assume that the BEA is correct in their statement that 24 states were affected by Sandy for a total of about $18 billion at an annual rate. This still doesn't explain the complete lack of income growth nationwide. The chart below shows the contributions to personal incomes over the last months. More curious was the very large jump in interest income for the month of October after two previous months of decline. Absent that bump in interest income overall personal incomes would have been negative for the month.
[19]
However, in the next month or two we should see the estimates used to account for the impact of the storm revised with actual data. This could show a minor increase to the October data.
Moving on to personal spending it is not surprising that the previous estimates to spending were likewise revised down in October to reflect weaker income growth. The chart below shows the revision to the major categories of spending for the months of July, August and September.
[20]
These negative revisions show that spending in the previous months was far less robust than previously estimated which is likely to lead to a downward revision of Q3 GDP next month.
The continuing problem that faces the economy remains the impact of rising cost of living which is offsetting increases in compensation. We stated in our last report [14] that:
"...it is important to note that wage and salary disbursements have risen since the beginning of the year which has contributed to the increase in personal incomes. However, the recent rise in wages has been very nascent and has come very late in the current economic expansion. Secondly, the rise in wages has been more than offset by a large surge in food and energy costs in recent months as shown in the chart below.
[21]
While the annualized rate of change in wage and salary disbursements rose again September continuing a steady trend since the beginning of this year, food and energy as a percentage of wages and salaries surged substantially more. The problem with this is that it grossly impacts the consumer. In the most recent report - personal incomes rose by 0.4% while consumer spending surged by 0.8%. Unfortunately, when spending outstrips income the difference has to come either from savings or credit. The chart below shows food and energy as a percentage of disposable personal incomes (DPI) versus the personal savings rate as a percentage of DPI. See the problem here? While core CPI remains very mild - rising food and energy costs at the headline have an immediate impact on the consumer's ability to make ends meet."
[22]
This is still the case this month. In October that annualized rate of change in wages showed an increase of 3.04% which was enough of an increase to keep food and energy at 22% of wages.
Are We There Yet?
When it comes to the economy, and particularly the ongoing recession watch that has nearly become a sporting event, it is real (inflation adjusted) incomes that matter. In the most recent report we see that real personal incomes declined for the month from $11,546 to $11,532 billion for the month reflecting a -.12 change. Doug Short [23]always does an excellent job of tracking the four primary indicators used in distinguishing periods of economic expansion from contraction:
[24]
"At this point, with all indicators for October on the books, the average of the Big Four (the gray line in the chart above) shows us that economic expansion since the last recession has been hovering around a flat line for the past seven months. Are we tipping into a recession? ECRI has reinforced its claim that we are in a recession and puts the cycle peak in July (more here [25]). On the other hand, a post-Sandy rebound, good holiday sales and favorably received outcome to Fiscal Cliff negotiations could easily put the economy into indisputable expansion mode.
As for the recent data, of course they are subject to revision, so we must view these numbers accordingly."
He is correct in his assessment that we are not currently in a recession. However, I am not optimistic the post-Sandy rebound will be enough to stem the tide of contracting wage growth. I am also less than convinced that Washington will come to a resolution for the fiscal cliff and the debt ceiling before it impacts the economy further.
The next couple of months will be very telling about the strength of the underlying economy. The manufacturing data continues to point to further economic weakness, hiring plans have deteriorated and the main drivers of economic growth have all stagnated. With the recession in Europe continuing to erode exports, and impact corporate profitability, this leaves investors exposed to a sharp valuation adjustment in the months ahead. While we can hope to get lucky that things will work out for the best - "hope" rarely works out as an investment strategy.