The Schizophrenic Economy

The current state of the U.S. economy can be defined by one word; paradox.   The definition of a paradox is a seemingly true statement that leads to a contradiction or a situation which seems to defy logic or intuition.

This seems to be the appropriate label for the economy after we analyze the economic data released last week, coupled with the consumer sentiment data.

The Commerce Department released retail sales figures last Friday for the month of September.  The 1.1 percent increase was much better than the 0.6 percent expected.  Excluding autos, sales were up 0.6 percent compared to an expected increase of 0.3 percent.  Both figures were ahead of growth rates from a month ago.

In addition to this data, last week the Labor Department reported a 0.2 percent increase in workers’ hourly earnings in September, compared to a 0.2 percent decrease the month prior.  Nonfarm payrolls showed a 103,000 increase (though the number did receive a boost from the 45,000 striking Verizon workers going back to work) so there were some positives there as well.

What totally throws me is if people or spending more money and making a little more money in addition to jobs being added; then why is consumer sentiment getting worse, especially in regard to employment outlook?

The Thomson/University of Michigan preliminary index of consumer sentiment for October showed a drop to 57.5 from 59.4 in September.  The result was a disappointment as economists expected an increase to 60.2 (which seems justifiable considering the data mentioned earlier).

According to the survey, the gauge for current economic conditions fell to 73.8 from 74.9.  Additionally, consumer expectations fell to its lowest level since May 1980, at 47 from 49.4.  What’s more is the expectations gauge has faded more than 20 points since the beginning of 2011. 

So my question becomes this; if consumer sentiment is falling in regard to the current state of the economy and their outlook is worsening as well, who exactly is spending more money?

In addition to that contradiction is the fact that 39 percent of consumers said that income declines were the reason for their finances worsened.  Recall, this report come out after a month showing an increase in average worker earnings. 

If you are confused about the outlook for the U.S. economy, don’t sweat it, because I am too!

The below chart muddles it up even more:

Do you see the trend starting around 2008, retail sales soaring and consumer confidence languishing?  Apparently the economic paradox has been going on for some time now.

I don’t want to discount the strengthening retail sales numbers of late, but a quick top level analysis may give us some clarity on why sentiment is not matching results.   A majority chunk of the sales growth came from autos and gas.  When looking further into those sales, data (produced by Goldman Sachs) shows roughly 70 percent of growth in vehicle sales have come from businesses, not consumers since the auto sector bottomed a couple years back.

Along with that bit of information, I plan to keep an eye on the September consumer credit number to see if it increased after Americans cut down on debt in August.  If spending received a bump from U.S. households taking on more debt, that would not be a positive.  Hopefully this will not be the case, the change in revolving credit (credit cards) in particular is what to watch.

Your anxiously waiting end of the month data analyst,

Mitch Jaworski

Twisting Your Retirement Away

This letter we are going to touch on a bit more than usual as there are three topics that need to be visited:  Operation Twist and its negative impact on Pension Funds; Sector Returns for Q3; and Final Q2 GDP.

Twisting Your Retirement Away

The Federal Reserve did what most expected and announced Operation Twist on September 22.  However, what many do not realize is the Fed also released a stealth anchor on the nation’s largest pension funds.

Underfunding is already a big issue for pensions around the country as they seek a low risk investment that supplies an ample return to service future outlays. 

 

The 100 largest pension funds of U.S. companies had assets covering 79 percent of their liabilities at the end of August, down from 86 percent at the end of 2010. The all time low for the funds was 70 percent in August 2010.

A large chunk of pensions invest in U.S. Treasuries as not all capital can be risked in equities given the guaranteed payouts that must be made by pension funds.  Remember, most of these pensions are defined benefit plans that work on a future payout target.  Generally, it is believed that each 1 percent drop in yields increases a pension’s liabilities by 10 to 15 percent.

Plain and simple, the Fed is now pushing down yields on longer-term bonds as it goes further out on the curve with its purchases.  Fund managers get a whopping 1.92 percent on 10 year treasuries right now.  So, the question becomes:  Do funds raise their risk appetite to try and make up some ground or do they watch as the underfunding gap expands further.

Please don’t think this is just an issue for corporate pensions either.  See the below chart referencing state government underfunding on pension and healthcare liabilities.

Relative Returns in Q3; A Quick Sector Analysis

In a prior letter we discussed if U.S. equities were now a “value” based on P/E ratio as many talking heads would have you believe.  In that letter we talked about the strongest sectors in market downturns and economic recessions (Utilities & Consumer Staples) and especially how those stocks were offering solid dividend yields (better than U.S. treasuries!) as their stock prices became depressed.

The below chart of Q3 results tells us what we need to know; it was an ugly quarter but the utility and staple names held up best, while again, paying a decent dividend (more than 3 percent).

Q2 GDP and The Y-O-Y Recession Indicator

Below is a chart that has become a staple in a our recent letters.

Remember, as the chart shows, every time the year-over-year GDP growth rate has fallen under 2 percent a recession has followed (shaded area).

After the final Q2 GDP estimate, year-over year GDP growth sits at 1.6 percent.  As I’ve stated before, the writing is on the wall.

Your preparing his portfolio for the slowdown analyst,

Mitch Jaworski