Chart Of The Day: Incomes & The Cliff Effect
This morning the Bureau of Economic Analysis released December's data on personal income and expenditures. This is an important data set since personal consumption expenditures (PCE) makes up more than 70% GDP. For the month of December the total consumption of goods and services increased by $22.6 billion which just slightly more than half of November's increase of 41.6 Billion. While a bulk of the increase in November was related to the effects of Hurricane Sandy the decline in December should not be readily dismissed. The reason for the focus on December's PCE is the Personal Income (PI) report which showed a massive surge of $352.4 Billion in December and is our chart of the day.
The surge in incomes in November and December was due to businesses paying out special dividends, bonuses, etc. prior to the end of year expiration of the "Bush Tax Cuts" as the "Fiscal Cliff" loomed large. However, the greatly anticipated "Battle of Thermopylae" where 300 Republicans would defend the country from higher taxes and achieve great spending cuts against the legions of Democrats, turned into a bloodless battle as Republican's folded like wheat before the wind.
The problem with this surge in incomes is twofold: 1) It is a one time effect that has already evaporated in the system and January will record a very sharp decline in incomes and subtraction from savings; and 2) the surge in incomes did not translate into higher levels of consumption that would boost economic activity. This is shown clearly in the chart below which shows the monthly net changes to PCE and PI.
This is because special dividends primarily flowed through to business owners, shareholders and executives at the upper end of the income brackets. This one time boost to incomes from special dividends did very little to enhance the financial position of the majority of the country that is living paycheck-to-paycheck. This situation is likely to be further exacerbated in the January reports on PCE and PI as the 2% increase in payroll taxes hits an already strapped consumer.
The various anomalies to the economic data caused by Hurricane Sandy, the "Fiscal Cliff" effect, QE3/4 and what is currently the warmest winter on record in 55 years, will make it very difficult on recession forecasting for the next several months. It will likely not be until Q2 of this year before the data returns to more normalized trends. However, with the "Debt Ceiling" debate approaching in May it might even be longer than that. In the meantime all we can do is continue to analyze the trends of the data and make adjustments accordingly.
One thing is for sure - the table is set for a rather large correction in the markets as overbought, overbullish and overvalued conditions are pushing extremes. The reversion of the data in the upcoming reports for January could well be the short catalyst necessary to spark that correction. Caution is advised.