PCE - A Tale Of The Consumer
As expected, today's release from the Bureau of Economic Analysis (BEA) on personal income and outlays (PCE) came in line with personal incomes rising 0.3% but expenditures rising 0.4%. The bad news was in the downward revision to last month's personal income from a 0.5% gain to just a 0.3% gain. The wages and salaries component was also cut in half from last month's rise of 0.4% to just 0.2% in July.
Consumption, which as stated in yesterday's report on 2nd Quarter GDP makes up more than 70% of economy, rose by 0.4% on a seasonally adjusted basis after being flat in June. The rise in July can be attributed to the back to school shopping season, which started with early sales promotions and heavy discounting by retailers, but was primarily driven by the sharp rise in energy and gasoline prices which drained consumer's wallets and savings. It is not small coincidence that spending outstripped incomes in July.
While the headline shows that personal incomes rose by $42.3 billion in the latest report it is important to know where that income came from. Of the total increase of $42.3 billion - only $16.3 billion came from wages and salaries. A full 1/4th of the increase in incomes, $10.1 billion, came from government welfare programs. The remainder came from employer contributions, dividend income which rose by $8.1 billion, and interest payments which fell by $4.6 billion. The last item is of interest, no pun intended, as it is indicative of the continued low interest rate enviroment which has led to the continued run of refinancings of debt by corporations, municipalities and individuals.
While PCE did rise in the current month - it does not tell us much about the strength or direction of the consumer. As always, it is important to pay attention to the trends of the data as economic change happens at the margins. The current trend of consumption is clearly negative and weakening. While the recent uptick in spending in July was due to primarily rising gasoline and food prices, which were offset by a decline in personal savings, this bounce is likely to dissipate in the coming months post the back to school shopping season. As stated previously, consumption makes up almost 3/4ths of the GDP calculation. Therefore, the current declining trend in consumption does not bode well for stronger economic growth in the future. The decline in PCE when examined is not currently indicating an impending recession. However, when the current trend is put into context with the many other economic indicators showing signs of contraction - it is worth paying closer attention to.
Need A Handout
Dependencies on government welfare programs continues to show the true state of the underlying economy. Since 2009 there has been more than 14 million new participants added to the government food stamp program, more than 2 million additional individuals claiming disability and a surge in student loans being used for consumption purposes rather than education. Currently the various form of government financial assistance are the highest on record along with the amount of social benefits as a percentage of real DPI.
Increase in dependency on the government for incomes leads to lower economic productivity over the long term. Income from government transfers has a very low multiplier effect in the economy as they are recycled tax dollars. In order to increase prosperity in a country you need innovation, and production, which leads to higher levels of employment. Higher levels of employment lead to increased wages, higher tax revenue for the government and increased aggregate end demand which supports the organic economic growth cycle. Conversely, when more people are dependent on the government for "handouts" - the system begins to run in reverse.
Real Incomes - Wrong Type Of Employment
This morning I received an email discussing that corporations are holding over $2 trillion in cash on their balance sheets and that it was criminal that they were not hiring more workers and putting those dollars to work. While the argument is clearly an emotional one - we must take a logical look at the cause. The reason corporations are "holding cash" is due to the "uncertainty" about the future. What will tax rates be after the end of the year, what will be the impact of ObamaCare on healthcare costs, what is the regulatory environment going to look like and what will be the driver to stimulate stronger "sales" in the future.
The uncertainty about "sales" is the number one concern of most businesses when considering expanding production or hiring more employees. When there is a lack of demand there is no incentive to expend cash to hire employees. In a low demand environment additional employees add substantial costs to the employer and impact profit margins. The chart below really tells the whole employment story.
It is this continued "uncertain" environment that has depressed real incomes even as employment has improved - at least according to the official BLS employment reports. Since 2009 full-time employment remains lower by more than 1.4 million jobs while temporary hires have surged higher by 1.5 million. The economic problem is that temporary jobs are low paying, have no benefits and have very little longevity. This translates into either weaker consumption, as reflected by weakness in recent retail sales, declines in savings or increases in debt.
The recent upticks in personal and disposable incomes are likely transitory and will decline in the next couple of months when temporary summer hires dissipate. Furthermore, the recent upticks in unemployment claims, and individuals moving off extended claims, also supports this conclusion.
As I stated, the weakness in employment has important ramifications. Consumer debt has now surged back to 2008 levels in order to maintain the current standard of living. Increases in energy, food and gasoline translate very quickly to the consumer and, as shown in the first chart above, the money either has to come from increasing compensation, a withdrawal from savings or increases in debt.
What the PCE report clearly shows is an economy that is weak beneath the surface with a majority of consumers struggling to make ends meet. As stated, the overall trends counter the recent upticks in the data. Either a strong economic recovery is in the making or the recent improvements will give way to further weakness in the months ahead.
For investors, this all comes down to corporate profit margins. Currently, corporate profits per employee have surged from .90 at the turn of the century to more than 1.50 today. The use of cost cutting, wage reductions, reduced employment, outsourcing, technology and accounting gimmicks have kept corporate profits robust since the last recession at the expense of the worker. The consequence, however, has been a middle class that has shrunk leading to a growing percentage of the population that now lives at, or below, the poverty line. This is not the backdrop needed to create an economic recovery and future economic reports are likely to confirm my suspicions.