Personal Income, Savings and Retail Stocks: Reality Speaks

It is fascinating to watch irrational exuberance at work. People seem to always be jumping on bandwagons, grasping at straws, and driving stock prices up or down for no rational reason. So it was on Wednesday, Thursday, and, then, again, in the morning on Friday. By the end of the day on Friday, of course, some measure of reality prevailed and many of the retail and building company stocks that had started skyrocketing, had fallen back to earth, at least somewhat.

The insanity started Wednesday morning, with the release of "better than expected" durable goods orders. Orders for non-defense capital goods rose by 4.8%. The vast majority of this increase was composed of ultra-volatile transportation sector goods, like airplanes. Boeing has now seen the cancellation of about seventy 787 "Dreamliner" orders, and the drop in such orders will surely take a toll in June (see here). Excluding transportation, durable goods orders increased only by 1.1% in May. More important, that increase reflects replenishment of drawn down inventories, rather than demand increases. But, no one was thinking too deeply, it seems, and people were in the mood to have a party.

On Thursday, Bed, Bath and Beyond (BBBY) announced relatively good earnings numbers. They didn't turn in a great performance, but it was very good, given the terrible state of the economy. Part of the credit must be given to the lucky (for them) fact that their main rival, Linens & Things, has gone bankrupt. Management has also been much more aggressive than other retailers in the area of cost cutting. All in all, management deserved a "pat on the back", and it got one, with the increase in their share price.

Nothing about the BBBY announcements, however, supported a vast increase in the stock prices of other retailers. The sparkles of good news were specific to Bed, Bath and Beyond. For example, not all retailers are cutting back. Some, amazingly enough, are opening new stores into the midst of the depression, increasing their costs dramatically by doing so. Most important, not all retailers are lucky enough to have a bankrupt main competitor, at least not yet. Indeed, some of the retailers whose stock soared may be the next to go bankrupt. Only the deep cost cutters will survive this shaking out.

The government helped, by announcing, on Friday morning that, in May, personal income rose 1.4% from the month prior. This was then heavily spun by some of the "business" media, into part of the "green shoots" or economic recovery argument. As far as I can see, however, there aren't any real green shoots. There are mostly brown weeds on the horizon, as far as the eye can see. Let me explain what I mean...

The truth is that most of the rise in income was government largess, particularly billions of dollars worth of $250 checks that were issued to Social Security recipients. These checks are a one-time deal, and the stimulatory effort, will be removed in June, when no checks will be received.

Thursday also gave us the earnings report of a “down and out” home builder, Lennar Homes (LEN). They managed to squeak out a terrible, but "less horrible than it could have been" earnings report. For people grasping at straws, that was enough cause to start bidding up building company stocks. Forgotten was the fact that the company lost a heap of money, is in terrible shape, and gave every indication that there is a very good chance that things will get worse. The fundamentals for both retail and home building could not be worse. But, when did that ever stop a Wall Street rally?

Month to month income figures showed a 1.4% rise, but year over year the increase was merely 0.3%. Most important, the critical income and spending number was lurking in the background, but mostly forgotten. The locomotive behind sustainable spending is always "wage and salary income". This critical forward-looking indicator fell 0.1%. That's a very bad sign. Year over year consumer spending decreased by 1.8%. That is a dramatic decrease which is poison for retailer earnings, going forward. Yet, in spite of this reality, retailer stocks went up wildly on Friday morning.

Perhaps, huge numbers of manic-depressive denizens of Wall Street forgot to take their lithium tablets. Had they been thinking clearly, they would have seen that the core personal consumption expenditure index (PCE) increased by 1.8%. Yes, that means it cost more to buy things -- inflation. When both the spending decreases and cost increases are considered, the actual amount of goods and services that consumers bought decreased by 3.6%.

Meanwhile, the statistics are showing that people are saving more of their income, and controlling their spending, because they are frightened. The individual savings rate went up, and that's a good thing for the American economy over the long term, but not for retailers or builders. The average person is now earning 1.5% less (inflation at 1.8% minus the year over year wage increase of 0.3%).

Investors must have taken their pills before the end of the day on Friday. Perhaps they were suddenly able to see a deeper reality, and this caused them to pull back. The numbers I've just rattled off, are valid only if the U.S. government reports are valid. Economist John Williams thinks otherwise. He runs a website known as ShadowStats.com, and presents rather compelling evidence showing that government inflation numbers are heavily gimicked to the downside. If the numbers are recalculated to remove the gimicks, using a pre-Clinton formula from the early 1980s, inflation is running at several percentage points higher than the government admits.

If that is true, and it appears that it is, the decrease in consumer spending and spending power is several percentage points more severe. So, the situation is much worse than the dismal one I've already described.

Everything is very negative for retailers and builders. As Lennar pointed out in its report, there has been a huge rise in long term interest rates. This, combined with fast rising unemployment, continued foreclosure activity, and impending resets on pick-your-payment mortgages will severely impair consumer spending and hurt both home building and retail. If we then add in the fact that the S&P 500 has just finished breaching its 200 day moving average on Wednesday, we have a recipe for deeply falling markets.

The overall market looks bloated. Retailers and builders look even more bloated. It appears likely that we will see a deep fall in stock prices which will challenge previous lows. That isn't necessarily a bad thing. It would help bolster the value of the dollar, and assist the government in selling bailout bonds.

Disclosure: Not long or short on any stock mentioned by name in the article.

Comments

[jimboy:]

Thanks Avery for another sobering dose of reality. I think we are going to see a lot more "jumping on bandwagons, grasping at straws" as you call it and the reason is monetary. The recession has been highly destructive of almost everything apart from money - the housing bubble pushed broad money (MZM) from 4.3TN $ at the start of the decade to 7.2TN $ at the end of 2006. Since then the Fed's "cure" for this private sector excess has been to push it on further to 9.6TN $. The real estate bust, unemployment and industrial slack are depressing prices in most markets but there is an ever-increasing amount of money sloshing around this broken economy and it has to bubble up somewhere - a stock market rally here or an oil price spike there. It's making for a very unpredictable market which is hard to call short term. I buy into the long term commodity/hard assets theory as a way to protect yourself when inflation really takes off.

Jun 28 07:05 AM

[Kristjan Ve...:]

Avery,
Thank you for yet again bringing out relevant information and putting it in context. Articles like this are the reason I rather spend my time browsing SeekingAlpha than watching CNBC.

Jun 28 08:23 AM

[Mr. Positiv...:]

The end of the world is tommorrow. If the market went down for no reason then that is a good enough reason for it to go up. The reality of the market is that it makes money for those who go with it and looses money for those who are contrary.

Jun 28 08:35 AM

[Roger Knights:]

"People seem to always be jumping on bandwagons, grasping at straws,"

As long as they're green, they'll grasp. (And flounder.)

Jun 28 08:38 AM

[BlueOkie:]

This is a myopic view of the markets. Instead of week, look at year. Retail is already beaten down from last year. In my view it overshot the downturn.

Jun 28 08:40 AM

[Alphameister:]

Perhaps the year-over-year decline is dramatic by historical standards, but measured against such rhetoric as "retail sales have fallen off a cliff," and against talk of the economy "sinking into a black hole," I find the above numbers reasonably comforting. That being said, US retail is not a sector I like for the long-term.

Jun 28 09:47 AM

[untrusting ...:]

Article seems realistic. Were it not for the artifical support by Goldman, JPM, the Fed, etc and their massive program trading, late day support spikes, etc. the market probably would have started the downward correction at least a month ago. Given the artifical intervention by the biggies with significant Fed money and apparent Fed approval, it is mighty hard to guess when a downward correction may be allowed to happen. It does also seem pretty apparent the other big players such as pension funds, mutual funds, hedge funds, endowments, etc. are not being fooled by the artifical market support and are not buying much at this time, as evidenced by the Tyler Durnan articles showing much of the current volume is coming from Goldman, JPM, etc. Certainly insiders are selling at record levels now and getting out as fast as they can. Will be interesting to see when/if the Fed actually permits the market to correct downward. Your guess is probably better than mine, as it is certainly unclear when or if this will be allowed to happen.


On Jun 28 07:05 AM jimboy wrote:

> Thanks Avery for another sobering dose of reality. I think we are
> going to see a lot more "jumping on bandwagons, grasping at straws"
> as you call it and the reason is monetary. The recession has been
> highly destructive of almost everything apart from money - the housing
> bubble pushed broad money (seekingalpha.com/symbo...) from
> 4.3TN $ at the start of the decade to 7.2TN $ at the end of 2006.
> Since then the Fed's "cure" for this private sector excess has been
> to push it on further to 9.6TN $. The real estate bust, unemployment
> and industrial slack are depressing prices in most markets but there
> is an ever-increasing amount of money sloshing around this broken
> economy and it has to bubble up somewhere - a stock market rally
> here or an oil price spike there. It's making for a very unpredictable
> market which is hard to call short term. I buy into the long term
> commodity/hard assets theory as a way to protect yourself when inflation
> really takes off.

Jun 28 01:53 PM

[buygolly:]

Thank you for ...IMHO...a good look at the reality of the current economic conditions and your synopsis of the Market's sometimes silly reactions to them. Alas, however, the market seems to always react irrationally...in the short term. It always has; in good times and bad. It's the age-old game of the 'smart money' guys trying to coerce money out of the pockets of the less sophisticated 'dumb money' guys. The Government, also, has always offered a helping hand in this game as alluded to in your mention of 'Shadow Stats'. This, saddly, is also nothing new. The 'Published' unemployment numbers, for example, have always been 2 to 4 percent lower than the 'Reality' numbers. A study of the late 90's Tech Bubble reveals an amazing plethera of 'bent and distorted' numbers offered up by corporations, administration officials, Greenspan and The Fed, CEOs, CFOs, market analysts, stock analysts...and of course, CNBC...just to name a few. The 'smart money' guys and gals all knew the game was fixed...but nobody cared...because the market just kept going up. (until in did'nt anymore...and then they were the first ones out.)
I think today's market has become one strictly for the traders and short term swing and momentum folks. The old days of Buy and Hold are, for the forseeable future, gone. The global and U.S. picture is just too cloudy going forward to confidently put long-term money to work right now, IMO.
For the nimble, risk averse traders out there, however, these are truely the Golden Days in Paradise.
Thanks again for an excellent article

Jun 28 04:19 PM

[petronius:]

Splendid analysis Avery! From an integrated historical perspective - to paraphrase the Durants: "Civilizations are born stoic, they die in epicurean un-reality divorced from the real world and having a "good time."
- Petronius

Jun 28 05:48 PM

[Old Trader:]

Several weeks ago, I made a couple of comments to various articles saying that at some point, production would take a nudge upwards, because inventory liquidation can only go on for so long (unless the retailer is going out of business, of course). I had also noted it would be a sort of one time "blip" as inventory levels readjust to the "new normal", and production will slump back down. Although I was primarily speaking of retail, I suspect business spending will follow a similar path. Its not rocket science...merely a bit of common sense.

Jun 28 07:17 PM

[ExaminerB:]

Economist John Williams is correct that government statistics are intentionally distorted to underreport the inflation rate, the unemployment rate, the average inflation adjusted wage-etc. As a bank examiner of many years experience I have personally witnessed the change in measurement methods and can assure the reader that the intent is to deceive. The average inflation adjusted wage has been falling for two decades and we can thank free trade and fiat money for all of this. Excellent article and cogent analysis!

Jun 29 01:14 AM

[expat in China:]

Obama goes to the Goldman sacks!

When the president answered the banks questions it was very clear that they will be saved by trillions and in return they merely had to reduce volatility and promote the green shoot confidence builder.

The markets are manipulated by the president to go up and down as he requires to stabilize (NOT GROW) growth is impossible and everyone knows it.

I THINK this earning season will show a 50-50 meet or miss result and the market will go down in steps just as it went up in steps. Alcoa is a disaster but the investment bank holdings will be pumped up early to set the trends in place. Review the program trading patterns you can see the logarithms at work with directional adjustments as required. As new earning are released they will be pumped and early reporting companies will rotate lower.

Insiders know exactly when and how far markets will move.

Jul 11 10:10 PM