Yesterday I wrote http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2016/08/01/what-me-worry/ that the combination of slower GDP growth (1.2%) in the second quarter plus declining consumer sentiment worried me. Continued strong consumer spending–household consumption grew at a 4.2% rate–in the quarter added 2.8 percentage points to GDP growth in the period. In other words without the consumer stepping up big, growth in the quarter would have been negative.
Today more grist for the ol’ worry mill.
Consumer purchases rose 0.4% in June, according to a report from the Commerce Department this morning. That was ahead of the 0.3% increase forecast by economists surveyed by Bloomberg. The 0.4% gain in June followed a 0.4% increase in consumer spending in May.
That’s all good news.
It’s the implications for continued consumer spending in this morning’s income figures that concerns me. Incomes rose by a lower than expected 0.2% in June. And, no, your math isn’t crazy: Consumers spent more by putting less into savings. The savings rate dropped to 5.3% from 5.5%. That takes the savings rate to the lowest level sine March 2015.
Nothing here to indicate the immediate end of the world–for U.S. savers a 5.3% savings rate is very healthy. But consumers won’t dip into savings to fuel consumption indefinitely. It would be great news for the economy if business spending picked up and took up some of the burden now carried by consumers. Given forecasts for global growth, however, that seems unlikely in the near term.
Am I the only one who finds Friday’s GDP report of 1.2% annualized growth worrying? Especially when combined with a drop in consumer sentiment?
What’s bothering me?
The deeply disappointing second quarter GDP number was only as good as it was because consumers kept up a spending binge. Think what second quarter GDP growth would have looked like if household consumption, about 70% of U.S. economic activity, had’ t grown at a 4.2% annualized rate in the quarter. The largest increase in household consumption since the end of 2014 added 2.8 percentage points to GDP growth.
In other words without this growth in household consumption, GDP growth in the second quarter would have been negative. Not surprising since businesses continue to pull back on their spending. Spending by companies on equipment, structures and intellectual property, decreased by an annualized 2.2%. That follows on a 3.4% drop in the first quarter. Spending on equipment has now tumbled for four of the last five quarters.
You really can’t blame companies for not wanting to spend. From where they sit it’s hard to justify spending on expanding production. So far in the second quarter earnings season, 363 of the 500 companies in the Standard & Poor’s 500 have reported. On the basis of these results we’re headed for a 3.2% year over year drop in earnings for the quarter. That’s better than Wall Street analysts were expecting at the start of earnings season, but the trend, if it holds up, would still be the fourth consecutive quarter of negative earnings growth. (Revenue is down, so far, by 0.1% year over year.)
The results of the University of Michigan’s survey of consumer sentiment added some caveats to that strength in household spending. While consumers remain confident about the current economy, their attitude about the future is turning increasingly negative. The gap between positive attitudes toward the present economy and darker future expectations is the widest since 2006. The gap, which has, sometimes, signaled a coming recession, is a relatively strong indicator of the strength of future consumer spending. People tend to spend less, for obvious reasons, when they are less confident about the future than they do about the present economy.
Given that consumer spending is about all that is propping up GDP growth right now, I find this picture troubling.
I’d find it less troubling, however, if I saw signs that other investors and traders were worried about this picture.
But I don’t see a sign of worry anywhere on the horizon.
The CBOE VIX index, which reflects fear/complacency in the stock market based on how much traders and investors are willing to pay for options to hedge risk in the S&P 500, is way, way, way toward the complacent end of the scale. The VIX closed at 11.87 on Friday, down another 6.7%, and much closer to the 10.88 that marks the 52-week low on the VIX than to the 53.29 52-week high.
Technicians that I respect and follow, such as Jim Stack at InvesTech (https://www.investech.com) aren’t seeing warning signs from their indicators either. Yes, the market is over-valued on a PE basis, but momentum indicators point to a continued extension of this bull market rally.
Markets are often said to climb a wall of worry.
Right now I can’t find a molehill of worry let alone a wall.
Concern about the future has constrained the U.S.stock market’s reaction to very good news about current consumer spending.
As of 1:30 today, Tuesday May 31, the Standard and Poor’s 500 index was off 0.15% or 3.14 points to 2095.92. The index had opened at 2100.13, just above the 2100 level that has marked the top of the recent trading range, after closing on Friday at 2099.06.
A report from the Commerce Department this morning showed consumer spending picking up by 1% in April. Wages and salaries gained 0.5%. All that argues that the U.S. economy is set to rebound after weak growth in GDP in the fourth and first quarters. Economists had expected consumer spending to climb 0.7% in April.
But the Conference Board index for May that measures consumer expectations for the next six months fell to 79, the lowest level since November 2015 from 79.7.
There’s a good likelihood that the difference between actual consumer spending and consumer worries about the next six months will get resolved in favor of actual dollars over emotions. But nonetheless, the drop in future expectations is enough to take some of the shine off consumer spending.
Add in the recognition that higher consumer spending means stronger economic growth means greater likelihood of an interest rate increase from the Fed in June or more probably July and you can understand the market’s stutter step as it thinks about breaking above 2100.
U.S. financial markets have apparently decided that the disappointing first quarter GDP data released this morning are just another example of first quarter weakness. It’s the third straight first quarter GDP read that has shown a U.S. economy headed toward stagnation–and in each case the economy recovered to show better growth in the rest of the year. In 2015, for example, first quarter GDP grew at a 0.6% rate in the first quarter before recovering to post a 3.9% annualized rate of growth in the second quarter. In 2014 the first quarter saw a 0.9% drop in GDP ahead of a 4.6% gain in the second quarter.
With that as backdrop, the Dow Jones Industrial Average was off just 0.11% as of noon New York time; the Standard & Poor’s 500 stock index and the Nasdaq Composite index both picked up a bit of ground, climbing 0.16% and 0.50%, respectively.
Economists surveyed by Bloomberg had expected growth of 0.1% to 1.5% with a median forecast of 0.7%. In the fourth quarter of 2015 the U.S. economy grew at an annualized rate of 1.4%.
The weakness came across the board. Consumer spending, 70% of the U.S. economy, climbed by just 1.9%, down from 2.4% growth in the fourth quarter. That was the slowest growth in consumer spending since early 2015. Driven by a continued collapse in energy industry capital spending and weak demand from overseas, business investment showed the largest slump in almost seven years, dropping at a 5.9% annualized rate.
One reason that economists–and the markets–are willing to overlook this quarter is that conditions remain favorable for growth in the remainder of 2016. Gasoline prices remain low, new claims for unemployment dropped last week to near a four-decade low, disposable income adjusted for inflation rose 2.9% in the first quarter, up from 2.3% in the fourth quarter of 2015. Consumers put a big chunk of that gain in income into savings with the saving rate moving up to 5.2% from 5% in the fourth quarter.
Stripping out the effect of shifts in inventory and trade, a measure called final sales to domestic purchasers, climbed by a 1.2% rate. That was better than the GDP growth rate (because companies continue to cut inventories) but still below the growth in final sales last year. In fact this was the weakest final sales number since the third quarter of 2012.
Does it make the disappointing retail sales number this morning any better because we can explain why retail sales fell by 0.4% in March?
I don’t think so. And, in fact, the specific explanation is worrying—if only slightly at this point–for growth in the U.S. economy in the coming months.
Economists surveyed by Bloomberg had expected that March retail sales would be flat so the 0.4% decline is a surprise. Especially, coming as it does, after 1% growth in February.
The likely explanation, and it’s convincing to me, is that what we’re seeing in the March numbers is a delayed reaction to the tax increases included in January’s deal to avoid the fiscal cliff. It’s taken a while for consumers to adjust their spending downward to account for the 2-percentage point increase in the Social Security withholding tax that was part of that package. The Tax Policy Center, estimates that 77% of U.S. households are paying higher taxes in 2013 because the fiscal cliff deal let cuts to the Social Security tax rate expire. In 2012 that reduction in Social Security withholding was worth about $1,000 to a family at the $50,000 income level.
If the lower retail sales numbers are a delayed result of that tax increase, instead of a reaction to a temporary news event or sentiment shift, then we could be looking at a drag on U.S. growth that could persist for much of 2013. Read more