Consumers Flash Warning Signal
At the end of last year we began discussing the issues of the excessively optimistic analysis of the mainstream media and analysts which were confusing a skew in the seasonal data caused by an unseasonably warm winter and global Central Bank interventions with an organic economic recovery. (See the report "Pollyanna Meets The Economy" for a primer - free membership required) The problem with maintaining an "optimistic bias", which attracts readers and viewers for media driven outlets, is that it fogs the lenses of logical thinking. The recent releases of consumer sentiment and retail sales are clearly a story of an economy, while statistically growing, remains in recession for Main Street America.
Personal consumption expenditures drives a little more than 70% of economic growth in the U.S. as shown in the first chart. Therefore, it is no surprise that watching consumer confidence, retails sales, personal savings rate and changes in credit can tell you a lot about the real state of the consumer and the likely impact to the economy in the future.
The recent releases of consumer confidence measures have uniformly shown declines not only in current sentiment but the overall outlook for future economic conditions. Consumer confidence, despite media analysis to the contrary, DOES MATTER. Then again why shouldn't it? If a consumer is financially strained, unemployed or worried about their future they are going to be more reticent about spending and more frugal about where they do spend.
Retail sales in June were much softer than expected, including auto sales, which contradicted manufacturers numbers for the month. This is an important point. We have discussed that automobile dealers are again stuffing inventory channels with near record levels of autos even though they are not moving off of the dealer lots. Furthermore, with auto manufacturers skewing seasonal employment data recently by not shutting plants for retooling during the summer, as is historically the case, this leads to further concerns about future economic data. (Click here for lawsuit against GM for channel stuffing)
Retail sales in June fell 0.5 percent, following decreases in both May and April as well. This is the first time since 2008 that retails sales have declined 3-months in a row, and historically, this has never occurred without the economy either in or about to be in a recession. With both sales of automobiles and gasoline (lower prices leads to lower dollar sales) stripped out retail sales still declined by 0.2%. Most importantly this core sales data showed widespread weakness in June with declines in building materials & garden equipment, sporting goods & hobby, furniture & home furnishings, electronics & appliance stores, health & personal care, general merchandise, and food services & drinking places.
As shown in the chart retail sales declines tend to lead consumer confidence reports. Therefore, with retail sales on the decline we should expect to see further weakness in the coming months where consumer confidence is concerned. For the markets, however, this "bad news" has been good news as market participants continue to build the case for further stimulative programs from the Fed. This is why the markets have held up so well in face of a continued string of weak economic reports.
I have been forecasting that the Fed will most likely launch further Quantitative Easing later this summer (most likely September) in an attempt to stabilize a weakening economy. The problem for market participants, with high hopes for further Fed induced liquidity, is that with the markets near their highs for the year, and the economy growing at the Fed's assumed target, they may be shooting themselves in the foot. The Fed has already voiced concerns about "dimished returns" from their actions and with markets stable and "pricing in" future Fed actions there is little room for the Fed to act.
Consumers, however, are reacting to the real life recession that they are faced with everyday. Stagnant wage growth, high unemployment, government transfers making up more than 30% of incomes and tight credit has made maintaining the status quo a challenge. The chart shows the month-to-month change in Real Personal Consumption Expenditures and Disposable Incomes compared to changes in Consumer Credit and Personal Savings Rates.
With personal consumption expenditures driving more than 70% of the economy any substantial change to that dynamic could negatively impact the economy. Since the beginning of this year consumers have seen an increase in disposable incomes due to declines in commodity costs even though wages have remained fairly stagnant. This rise in disposable income, however, has not made its way into significantly more consumption but instead into higher personal savings rates. While higher personal savings rates are important to longer term economic prosperity - in the near term it decreases potential current consumption and aggregate end demand which keeps economic growth under pressure.
One important note is the significant rise in consumer credit in recent months without a relative adjustment to consumption. Historically there has been a fairly consistent correlation between changes in consumer credit and consumption. However, as of late we have seen continued increases in credit without coincident increases in consumption. In our article on "Consumer Credit And The American Conundrum" we go into this phenomenon in much more detail stating: "Most of the deleveraging process that has been occurring up to this point has NOT been voluntary. Banks have been cutting off excess credit lines, consumers have been defaulting on debt, mortgage foreclosures, and personal bankruptcies.
Consumers, on the other hand, are struggling just to make ends meet and are in reality doing very little in terms of voluntary debt reduction. As incomes have decreased over the past two years - the inflationary pressures in food, energy, medical and utilities have consumed more of that declining wage base. This is why today we have 1 out of 2 Americans on some form of governmental assistance, more than 47 million people on food stamps and transfer receipts making up more than 35% of personal incomes. It is hard to make the claim that the economy is on a fast track to recovery with statistics like that. That is why the recent increases in consumer debt are disturbing. The rise in NOT about increasing consumption by buying more 'stuff' it is about just about being able to purchase the same amount of 'stuff' to maintain the current standard of living.
While bad news may be good news for the market hoping that it will spur more stimulative measures from the Fed to boost asset prices - for Main Street America bad news is just bad news. More importantly, the decline in consumer confidence continues to perpetuate the virtual economic spiral. As the consumer retrenches the decline in aggregate end demand puts businesses on the defensive who in turn reduces employment. The reduction in employment, and further stagnation of wages, puts the consumer further onto the defensive leading to more declines in demand. It is a difficult cycle to break.