Submitted by Lance Roberts via STA Wealth Management [11],
A Word About Retail Sales
Last week we got the retail sales figures for May which showed a sharp rebound in consumer spending jumping 1.2% in total and 0.7% when excluding automobiles and gasoline. David Rosenberg was quick to jump on the "bullish bandwagon" stating:
"So here is my new forecast: we are no longer going to have to hear anymore crying about 'where is the consumer spending windfall?'
As we have said in the past, the pattern of consumer behavior in light of what has happened to energy prices since last summer is tracking what happened back in the 1985/86 deep dive when household paused at first, assessed whether the oil price plunge was temporary or permanent...to only respond positively with a lag.
But respond the consumer did, well into the late 1980's, and the just-released May retail sales results may well end up proving to be a similary inflection point in the same direction."
While this is quite the bullish prognosis, there are some key points that should be noted before jumping onto this particular bandwagon:
1) As shown in the chart below, the 1980's surge in consumer spending picked up sharply due to the pent up demand immediately following back-back recessions.
2) That surge was driven by an increase in consumer credit as a percent of disposable incomes that exceeded the previous historical range, and arguable more sustainable, 16-18% as it topped out at 20%. It then fell beck to the historical range low of 16% following the next recession as consumers were unable to sustain their "spending spree." Today, consumer credit has surged, without a relevant pickup in spending, to more than 25% of DPI. It is unlikely that we will see the repeat of the 80's unless somehow consumers can figure out how to sustain, and acquire, substantially higher levels of leverage.
3) While the pickup in retail sales was certainly welcome, singular data points, particularly following several months particularly weak data, rarely point to a return of a more sustainable trend. This is particularly the case given that retail sales are currently near levels that have normally denoted very weak, or recessionary, economic environments.
The Fed Sucks At Economic Forecasting
A few months ago I wrote an article entitled "Meet The Worst Economic Forecasters...Ever" [14] which discussed in some detail the Federal Reserve's very poor track record at predicting future economic growth. To wit:
"When it comes to the economy, the Fed has consistently overstated economic strength. This is clearly shown in the chart and table below." (Chart updated for most recent projections)
"This is the lowest rate of economic growth predicted by the since 2012. With the first quarter of 2015 shaping up to be nearly flat (0% growth), it would now require average growth over the next 3 quarters of 3.3% real growth to meet that goal. However, given the current weakening of economic data domestically, the surging dollar impacting exports, and global deflationary/recessionary pressures abroad, it is quite likely that, just as in every year past, the Federal Reserve will be reducing their goals further into the year."
Of course, the first quarter did not shape up to be flat as I originally predicted but came in a negative -0.75%. (Importantly, consensus estimates at that time were north of 2% for Q1) Therefore, it should really come as no surprise that the Fed is now lowering they continually overly optimistic economic forecast.
Importantly, while Janet Yellen suggested the Fed's economic forecast was "not a weak one," the reality is that it actually was. I have repeatedly stated over the last two years that we are in for a low growth economy due to debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity. The simple fact is that when the economy requires roughly $5 of debt to provide $1 of economic growth - the engine of growth is broken.
Economic data continues to show signs of sluggishness, despite intermittent pops of activity, and with higher taxes, increased healthcare costs, and regulation, the fiscal drag on the economy continues to be larger than expected.
What is very important is the long run outlook of 2.15% economic growth. As shown in the chart below, real economic growth used to run close to 4%. Today, the Fed's prediction is down markedly from the 2.7% rate they were predicting in 2011.
It is worth noting that it is incredibly difficult to create real economic prosperity when locked into subpar growth rates.That rate of growth is not strong enough to achieve the "escape velocity" required to improve the level of incomes and employment to levels that were enjoyed in previous decades. Has there been a recovery in the economy? Of course, but much of it has only been statistical. [16]
The problem for the Fed is that economic cycles do NOT last forever, and with the Fed's primary policy tool stuck at ZERO, the "clock is ticking" so "what do you do?"
Obsessing Over Profit Margins
David Wilson recently penned [18] an interesting piece for Bloomberg stating:
"Falling profit margins provide little reason for concern that a six-year bull market in U.S. stocks is about to end, according to Pierre Lapointe, Pavilion Global Markets Ltd.'s head of global strategy and research."
The problem with the analysis is that it is incredibly short sighted which is not surprising given it is coming from a media outlet. The disconnect, as usual, is the "duration mismatch" [19] between current events and longer-term outcomes. The chart below shows profit margins as compared to the S&P 500 index.
While it is true that falling profit margins do not necessarily have an immediate impact on stock price performance, they have been a good indicator of future negative return implications for investors.
I have highlighted in the chart above the peaks in corporate profitability and subsequent recessions and major market implications. The recent peak in profits, combined with substantially elevated P/E ratios, is likely suggesting that forward return expectations should be revised sharply lower.
Importantly, that does not mean the market will be negative this year, or even next. But it does suggest that over the next 3-5 years investors will likely have given up any relative gains and then some.
Just something to think about.
