PCE Points To Weaker GDP Ahead
This morning the Bureau of Economic Analysis released the latest figures on personal consumption and expenditures. The headline analysis read: "Consumer spending was flat in December as households took advantage of the largest rise in income in nine months to boost their savings, setting the tone for a slowdown in demand early in 2012."
For the first time in a very long time the headline has it right. We have discussed several times in our posts as of late about the issue with the decline in savings which was used to boost consumption. Eventually, that comes to an end which has a negative impact to economic growth. The chart shows this relationship. Personal savings, as a percent of wages and salaries, is a bit volatile from month to month but it is the trend that is important here. When the trend of savings is increasing the trend of consumption is declining. That analysis is simply logic. What is important to note here is that rising trends in savings rates tend to coincide with recessions.
The reason I bring this up is that, as we have stated, it is highly likely that the uptick of economic growth in Q3 and Q4 was highly ephemeral due to one time restocking activities. (read this post for more explanation) The second chart shows this relationship a little more clearly. Currently, the Federal Reserve expects the economy to grow this year by 2.5% in 2012. This is up from the 1.6% rate in 2011 - do you see the potential problem here? Let me explain.
Most of the 1.6% growth in 2011 was fueled by a decline in oil prices and gasoline prices mid-year, which acted as a tax cut on consumers, and a draw down of large proportions to the personal savings rate. If savings continue a pattern of rising in the coming months ahead, as consumers continue their struggle to make ends meet, this would act as a sharp headwind to economic growth. If you combine this with a rise in gasoline prices, another threat of a financial crisis, etc., the consumer could quickly retrench sending savings rate sharply higher and consumption lower.
While personal incomes did tick up mildly in the last month that uptick did little to offset the year-over-year declines in either personal or disposable incomes. The impact of weak income growth, particularly when offset by rising inflationary pressures from food and energy, impacts future consumption. In turn, the weakness in consumption will continue to impact economic growth particularly at a time when Government spending is on the decline and there is more pressure than ever to implement austerity measures to reduce the national debt and deficit.
The outlook remains for very sub-par economic growth going forward which will impact corporate profit margins. If fact, we may have already seen the peak of that profit margin cycle and with companies already cut to the bone in terms of employment there may be little wiggle room left to further bolster margins though cost-cutting measures alone. Add to this that gasoline prices have already risen, as we predicted, from just a little over $3 a gallon the 4th quarter to $3.40 a gallon today and that increase in personal incomes is diverted to the gas tank. With oil prices remaining stubbornly close to the century mark you have all the stress you need on an already cash strapped consumer.
The coming months will tell us a lot about what 2012 is actually going to look like. Unfortunately, even the most optimistic scenario by mainstream economists don't support stock prices and profit margins at current levels. While exuberance and irrationality are certainly hallmarks of short term bull market cycles; as we stated in this past weekend's newsletter ultimately prices will play catch up with fundamentals.