As American Express Goes, So Goes the Economy

I’ve never been fond of the distinction that folks make between Main Street and Wall Street, as if there were some actual divide between the “real” economy and the “financial” economy. My hunch is that the correlation between the performance of our financial institutions and the performance of our economy is fairly strong (and positive). And if anything, that correlation is becoming stronger as we move toward an increasingly service-based economy (with more than 80% of our economy now devoted to services).

Nevertheless, if there was ever a company that speaks to the general health of our economy, it is American Express (AXP). Amex is a consumer and business finance company, and scrutinizing the behavior of its customers can provide insight into the direction of the broader economy. So where the adage once was, “As General Motors (GM) goes, so goes our economy”, my guess is that could be changed to, “As American Express goes, so goes our economy.” After all, consumer spending accounts for something like 70% of GDP.

It is for this reason that I was troubled by the earnings presented by American Express (see American Express Falls), and also by subsequent comments made in the conference call.

Don’t get me wrong. I am not troubled by what Kenneth Chenault said. Just the opposite. I applaud him for being honest about current conditions. Rather, I was troubled by the content, and what it likely means for the U.S. economy.

As reported by Bloomberg:

American Express Co., the biggest U.S. credit card company by purchases, fell the most in New York trading since the Sept. 11, 2001, terrorist attacks after earnings missed analysts’ estimates and the lender withdrew its 2008 forecast.

Chief Executive Officer Kenneth Chenault said yesterday in a conference call that the business climate was “much weaker” than earlier this year and American Express was hurt in the second quarter by rising U.S. unemployment and falling house prices.

Moreover, as reported by Calculated Risk from Amex’s conference call (see here and here):

“Fallout from a weaker U.S. economy accelerated during June with consumer confidence dropping, unemployment rates moving sharply higher and home prices declining at the fastest rate in decades,” said Kenneth I. Chenault, chairman and chief executive officer. “Consumer spending slowed during the latter part of the quarter and credit indicators deteriorated beyond our expectations.“

“In light of the weakening economy, we are no longer tracking to our prior forecast of 4-6 percent earnings per share growth. That outlook was based on business and economic conditions in line with, or moderately worse than, January 2008. The environment has weakened significantly since then, particularly during the month of June.”

“Over the past month or so, we have seen clear signs that the US economy is weakening. Unemployment rates, as we know, took the largest jump in over 20 years. Home prices declined at the fastest rate in decades, and consumer confidence is at one of its all-time low points. Card member spending particularly among consumers slowed sharply during the latter part of the quarter. Credit indicators as we signaled a few weeks ago deteriorated beyond our expectations, and by almost any measure the US economy and business environment are much weaker than the assumptions we first spoke to you about back in January and the conditions that existed in early June. Now this fallout was evident across all consumer segments, even our longer-term super prime card members.”

“Affluent customers in some situations are cutting back on discretionary spending…we’re seeing a slowdown in spending across the board…The severe decline in home prices and the marked rise in oil prices have had a fundamental impact on consumer budgets and behavior. Not just as it relates to mortgages and home-related spending, but also across the full spectrum of the consumer economy…we now believe the economic weakness in the US will likely worsen throughout the remainder of the year…” (emphases added by Calculated Risk)

Given this information, my expectations are that the chances for a second-half rebound are extremely remote, irrespective of what happens to oil prices (see Mish’s excellent posts on Deflation here and here). Moreover, I now expect conditions similar to those experienced by Amex to spillover to a broader swath of corporations, not limited to housing, finance, and consumer discretionary.

For me then, this news speaks to the breadth of impact that we should expect from this recession - on both Main Street and Wall Street. My call therefore is still for long-and-deep versus short-and-shallow.

Comments

[investor88]

Insightful analysis. I agree with the Robert's conclusion for a long and deep recession, not a short and shallow. Traders and investors will do well to bear this view in mind although there are other views on the subject.

2008 Jul 23 08:16 AM

[Pch101]

I concur with the analysis. The credit crunch is deep and has a long way to go as it ripples through the broader markets and commercial real estate.

But I do question the value of using AmEx as a proxy. For one, AmEx maintains a niche within the financial sector, targeting business users and higher spenders with its cards and travel services, so it does not represent the economy or the financial sector as broadly as do the banks, Visa or Mastercard. For another, AmEx is facing ever increasing competition from Visa, Mastercard and online travel businesses for its various foreign exchange and travel services, so it is slowly getting squeezed in a space where it once had a strong brand and considerable market share.

In that sense, I think that using AmEx as a barometer for the broader economy would be akin to evaluating the performance of the automotive sector by focusing on BMW, instead of Toyota. AmEx is too specialized a company and there's too much other potential noise in the numbers to use it definitively. Perhaps companies such as Bank of America and Visa would provide better shorthand on the financial side.

2008 Jul 23 08:55 AM

[Emerald]

Comments on Amex as too small a barometer miss the point completely. We are in a credit contracting phase of the economy. When banks won't (or can't) lend, business contracts. Sales go down, employment decreases, etc. Earnings decrease and stock fundamentals decrease. We will borrow the Fannie bailout from China and head south. Capital preservation is paramount.

2008 Jul 23 11:17 AM

[Ermilo]

I personally I'm short Amex. That may not make me the most popular guy in the room, but common sense is screaming in my face: SHORT. I know that sooner or later, Amex will probably rebound. However, with all this credit mess, and the affluent consumer now hurting.....I truly believe we are in the recession. I wish all the best in their investing endeavors.

2008 Jul 23 11:37 AM

[Jason Rines (iThinkBig)]

PCH 101 has a valid point. It's a little like granny smith apples vs. mcintosh. My thought is this, AMEX still appears to have a larger portion of it's business on the pay as you go model, with the entire balance being paid in full in 30-60 days. I believe that is why they saw a 2% increase in defaults from 3%-5% in such a short period. It is a credit crunch and cash is drying up. The other part of there model of credit lines would probably be holding up better and my assumption (without looking at MC or Visa) is that this is the last bastion of credit the consumer can still tap into. Can anyone quantify these assumptions?

I am really curious as back in April I argued why AMEX would be a bad short term or mid-term investment. I assume they will be a great cheap buy in the next quarter. I was called a moron in April on my position but I am not interested in vindication. I intend to forever attempt to maintain a position of humility. Pride cometh before the fall and boy is this market reinforcing that truth!

I am interested if knowing if the extended credit line portion (blue is the trade name for extended credit card or something like that) is still showing growth or if it receeding. Sorry if the terminology about AMEX model (pay as you go customers vs. extended credit business cards) is off.

2008 Jul 23 04:38 PM