Consumers and the Economy Are Down and Out

Periodically Citi releases a report entitled "Comments on Credit". This issue is particularly pessimistic.

The report features the Citi Financial Conditions Index (FCI), a proprietary index that is a composite of a number of financial measures. The index is a weighted average of six variables, including option-adjusted corporate credit spreads, equity values, the money stock, the trade-weighted dollar, mortgage rates and energy prices. It is stated in terms of standard deviations from a mean value. A reading of plus one sigma, for example, would suggest financial conditions are imparting a strong tailwind to aggregate demand that could promote inflationary imbalances and therefore may be a signal that monetary policy is overly accommodative. A reading of minus one sigma is suggestive of financial drag on the outlook that may point to undesirable slowing and rising unemployment.

So where does the index stand today? Here is the money quote from the report:

At more than minus five standard deviations below norms, the FCI is probing depths beyond our experience. It suggests that especially harsh economic conditions are about to unfold.

The ramifications are widespread. The following chart relates the Citi FCI and consumer spending. The chart shows the FCI is well below the levels seen during the last recession. The chart also shows that the change in consumer spending as represented by the PCE is already measurably weakened and is projected to go even lower.

The report emphasizes that the pullback among consumers is becoming a key driver in what Citi unequivocally refers to as a recession. A consequence is that businesses are being forced to scale back spending and investing as the weak consumer contributes to a weakening in new orders. This was brought home by the recent poor durable goods report. More importantly, weaker spending has reinforced the slowing in hiring. Last Friday's Non-Farm Payrolls report showed that employment declined by 159,000, much worse than expectations. Based on this data, Citi thinks that labor market weakness is now pervasive.

In Summary

Citi sees a series of cascading effects. The FCI shows extreme weakness in its financial measures. The correlation between a weak FCI and weak consumer spending appears to be strong. By extension, this will drive a slowing in production which will in turn drive a decline in employment which, in a self-reinforcing loop, will further weaken the consumer and so on.

The bottom line is that Citi sees the consumer and the economy to be down and out for some time to come.

Source:

Citi Comments on Credit, October 3, 2008

Comments

[Dividends A...:]

I think a focus on the consumer is something that will intensify in the coming months. The fact that consumers aren't able to expand their current debt means that they'll have to save money, sell assets or decrease their debt burden in order to free up money to purchase products & services.

With rising unemployment seen in the US any investor has to put into context the earnings guidance that companies were looking towards with some common sense.

2008 Oct 07 10:28 AM

[Jackson Cash:]

Thank you for that interesting metric!

I can't wait for all the perma-bulls on SA to iterate how great everything is going to be.

What can we socialize this week?

2008 Oct 07 10:39 AM

[flatman:]

Does anyone really believe that the consumer can get optimistic when their 401K and mutual funds are down 20% in addition to all the other negatives.

2008 Oct 07 10:43 AM

[Smarty_Pants:]

Feet on the ground confirmation:

I am a partner in a small restaurant. The last two weeks of September and first week of October have seen sales down nearly 20% from typical levels for this time of year. People ARE cutting back on discretionary spending.

2008 Oct 07 10:53 AM

[Alan von Al...:]

I liked the way Toro explains it: "The market is like the pretty girl at the bar who has been cooing into your ear all night. When the night is over and she has given you her phone number, you find out your wallet is gone. And the phone number she gave you isn't hers."

2008 Oct 07 11:03 AM

[byrnemm:]

I cant say I completely understand the level of shock this news brings.

You simply cannot expect people to spend and save at the same time.

Let me repeat: You cannot spend and save at the same time.

Obvious right? One takes away from the other? Well for almost a decade now middle America has been bombarded with marketing - not just from retailers but from its own government and the economic elite -telling us that spending our money is good for America. Now it turns out that saving our money would have been better for us and better for America. Compounded interest in a Roth IRA or a home that we have to stretch to afford? Save money for a downpayment or go on a family vacation? Buy a used car or lease a new one? Buy the amazing commodity with the credit card or buy the decent commodity with the debit? These are the kinds of decisions that middle America has faced in the last decade.

The worst part of it all is that middle America is NOT taught personal finance in highschool, we do NOT hold MBAs, and we do NOT maintain an overview of the macroeconomic health of our nation - yet were told by those that DO have MBAs and PhDs and hold the highest positions in the economic world, those who have the responsibility to oversee our economic health - that our spending would bolster the economy and strengthen the nation. GOOD CALL. The American consumer has lost a great deal of purchasing power and has found themselves in a position where he or she is beyond their means and must now retreat to the piggy bank.

Sorry for any anger. I am not trying to put off the blame from the American consumer, BUT those in positions of trust regarding the economic health of the country emphasized the need of the American consumer to spend his money, so how can we be surprised to find out that they did?

2008 Oct 07 11:05 AM

[moonbat1775:]

The way I understand it, people were forced into the Stock Market because the Fed held interest rates below the "natural" rate. Also, why should people put money in the bank for interest rates below the true inflation rate? No wonder they looked to their houses and the Stock Market for their retirement.

Thus, people learn about the government backed fractional reserve banking cartel the hard way.

2008 Oct 07 11:32 AM

[whidbey:]

The indicator is a leading indicator of where employment goes. We will have further increases in unemployment, and there is not question we will be disinflation, recession and maybe depression. I know the latter is considered far removed from possibility, I think it is about two Quarters away when we discover that the TARP has little effect for the reasons this post makes clear. I think government bonds are indicated.

2008 Oct 07 11:36 AM

[Perception:]

Pretty much EVERY pundit, oracle, and even level-headed financial "joe regular" has said we are in uncharted territory as far as modelling the markets goes. I have little confidence in Citi financial's market models, evaluations, or for that matter, their observations on whether or not the sun is shining. Their brilliant predictive powers and business acumen are the source, at least in part, of the nightmare we now see unfolding in the economy. This model is meaningless. Putting it forward as a resonable indicator of the direction of the economy is roughly akin to trying to model subatiomic particle behavior with newtonian mechanics. It doesn't work.

2008 Oct 07 11:37 AM

[sf94127:]

Is Bernanke still concerned about inflation!!!

2008 Oct 07 11:46 AM

[akapital:]

interesting...I have a different prediction. I think the current crisis can be surmised as follows, "the more you have the more you stand to lose" because this is a crisis that affects wealth and excess capital and not so much basic subsistence. I know that many would argue that it is all interelated which is true but there is still a distinction here in quality of life changes.

I think we are going to see huge de-valuation in luxury real estate and luxury items across the board. Because those are the areas that a vast majority of buyers were overextended into - essentially buying beyound their means. But I think subsistence on buying within our means will essentially be unaffected.

The family that lives pay check to pay check in the fringe town, eats meagerly, and gets by on hope and happiness will be fine. Those who live pay check to pay check in the mega-mansion, eating out every night, traveling, and generally living beyond their means will have to make serious life style changes. That will be hard part for some. But in the realm of things how bad is that?

2008 Oct 07 11:54 AM

[Socialism c...:]

Just keep voting for Obama...he's gonna fix it all!! Not. Be prepared for even HUGER government, MORE socialism, HIGHER taxes...everything we don't need. What's needed right now is cutting the government to the CORE and MASSIVE tax cuts -- should have been done a LONG time ago -- but right now, we may finally find the support and impetus to do it, if we can let go of our bloody entitlement comfort blanket!!

The ONLY way to return to a sustainable, growing economy is to take out the excessive taxation at the knees, and restore to the people their FREEDOM and MONEY by these means.

Remember this at the polls...call and email your Congress-critters frequently. We MUST DEMAND THIS be done NOW!!

2008 Oct 07 11:58 AM

[dw57:]

I can't imagine how we though that keeping workers wages low, was going to translate into a vibrant economy. When workers wages weren't enough they had go into debt to buy goods and services. now that isn't available, they are cutting back in their spending. and those in charge and had led the charge against wages are now shocked by this?

2008 Oct 07 11:58 AM

[anarchist:]

Anyone know of and ETF that shorts consumer discretionary goods?

2008 Oct 07 12:27 PM