Economic Indicators Not Reflecting Exuberant Expectations
There has been a plethora of articles of late discussing that the slowdown in Q4 GDP was just an anomaly caused by Hurricane Sandy and that economic growth is showing definite signs of turning up. This conclusion is supported by the surging stock market that has finally returned investors to where they were just a mere 5 years ago. This would all be very good news if it were true, however, there are very few indications that the economy is gaining any real momentum much less "escape velocity".
One of the key drivers of an economy reaching "escape velocity" is employment. With an economy that is currently more than 70% based on consumption the ability individuals to secure full-time employment is critical for continued economic expansion. As I discussed in my most recent report on employment:
The average number of jobs created each month during 2012 was 187,800...this was below the 313,000 average increase in the working age population 16-years and older.
The last bit of information explains why the employment-to-population ratio, and labor force participation rates, has not improved since the recessionary lows. This is more clearly evident when looking at the number of full-time employees (which are required to have a healthy consumption based economy) relative to the population.
More importantly, when looking at the employment data using a simple 12-month average we can see that employment may well be peaking for this current economic cycle.
This data is more indicative of an economy continuing to run below expectations or worse.
Manufacturing also plays a very important role in the economy. The production of stuff, and the capital expenditures that are made that go along with those activities, are also important drivers of economic activity and job creation. While a couple of the recent manufacturing reports have shown mild upticks these improvements come within the confines of downtrends in the data.
As I discussed recently the composite economic index, which is a very broad economic composite, suggests that economic activity peaked in April of 2010. Since that point we have witnessed a "start/stop" economic growth pattern that is directly attributable to ongoing interventions by the Federal Reserve. However, each program has had a diminishing return and has failed to create sustainable organic economic growth.
It is VERY possible that economic activity will pick up in the months ahead as the Federal Reserve pumps liquidity into the asset markets. However, as we have seen in the past, any increase in economic activity will likely be relatively weak and unsustainable.
Income & Consumption
In order for a sustainable recovery to take root in an economy, that is primarily driven by personal consumption as stated above, personal incomes should be on the rise. Higher personal incomes drive higher levels of consumption which lead to stronger economic growth. The problem is that outside of a spike in incomes at the end of 2012, which were primarily focused at the top end of the wealth spectrum due to accelerated dividend payouts in advance of the "fiscal cliff", incomes have been on the decline. Likewise weakness in consumption, which tends to track incomes fairly closely, should not be surprising.
As I discussed recently in "Is The Consumer Really Deleveraging":
What is clear is that the only real deleveraging that has occurred has been in mortgage related debt. However, this has not been the function of consumers becoming more responsible and paying off their mortgage debt but rather through:
- mortgage forgiveness
- write downs
- charge offs
- short sells
These are hardly healthy processes of deleveraging that lead to stronger future consumption. More importantly, the majority of these activities have been through the support of some form of governmental intervention (HAMP, HARP, Settlements) that also are not part of the natural deleveraging process. Case in point, many of the home owners that went through a mortgage rework process wind up re-defaulting within six months.
While we are seeing signs of economic growth, albeit weak, it has been primarily driven by artificial influences from suppressed interest rates to direct interventions through fiscal and monetary policies. Without these interventions it is likely that we would have very little, if any, real organic growth.
Consumers are trapped by a rising cost of living which exceeds their income growth. In order to maintain their standard of living they are forced to reduce their savings rate, access credit or become more dependent on government welfare programs as witnessed by the massive surge in food stamp usage and disability claims.
The weakening trend of incomes, which have failed to keep pace with inflation, is ultimately impacting consumption. With personal savings rates near their lows there is little support for sustained economic improvement in the near term. The household balance sheet deleveraging process has much further to go before there is sufficient free cash flow to fuel the next economic boom.
Temporary Data Skews Lead To Faulty Analysis
Outside of the visible data that we can examine there is also the impact of non-visible issues that are providing a near term boost to economic data. These artificial boosts are being misconstrued as longer term constructive supports. The psychological boost provided by the resolution of the "fiscal cliff" and "debt ceiling" debates boosted confidence in the short term. Unfortunately, that confidence boost will prove to be temporary as the problems were not solved - just delayed.
More importantly was the outsized boost to personal incomes posted in the last two months of 2012. This jump in incomes had nothing to do with a pickup in economic activity but rather individuals at the upper end of the income spectrum, primarily corporate executives and business owners, issuing special dividends and bonuses to themselves prior to the increase of income taxes at the end of the year.
The problem is that the boost to incomes was artificial and is not sustainable in the future. By default the economic boost received will not be sustainable either.
Lastly, the current winter season is one of the warmest in the last 55 years. This is allowing construction and manufacturing to continue when inclement weather would have normally caused it to shut down. Individuals that normally miss work because of the weather are showing up which is suppressing jobless claims. The impact of the warmer weather, when combined with seasonal adjustments, is an outsized positive skew to the economic data. Therefore, the current level of activity seems to be more positive than it actually is. However, as winter succumbs to spring, and the temperatures rise, the skew to the data will begin to run in reverse and the economic weakness that was disguised by the unseasonably warm winter weather will be unmasked.
The Real Economy
Each of these areas point to an economy that is still running at sub-par growth rates at best and, without massive Central Bank interventions, would likely be negative. The chart below is an equally weighted composite of the primary drivers of the economy - employment, industrial production, personal incomes, private investment, consumption and government expenditures. The data has been smoothed using a 4-quarter average.
There is an extremely high correlation between the real economic index and GDP - which is exactly what we would expect. Secondly, it currently shows us that there is really no improvement in current economic activity and that the peak of the current economic cycle occurred in Q2 of 2010.
This data hardly suggests that the economy is ready to turn on its heels and begin a race higher toward the expectations of 3.5% economic growth by the end of 2013. The boosts to the economic data that we have seen as of late have been driven by one time anomalies which are hardly supportive of longer term economic advances.
While the effects of the massive liquidity injections by the Fed over the months ahead will likely stabilize economic growth in the short term - QE programs have shown little ability to actually affect employment or economic growth. For now the economy remains weak. While GDP from the last quarter of 2012 will very likely be revised higher in the months ahead due the various economic anomalies - the impact of higher taxes and a weaker consumer will likely make that bump fairly short lived.