GDP Reminder: Stock Market Isn't the Economy, The Consumer Is

by: Romeo Fayette

You have to play the game, but remember to keep your eye on the ball: as we've smoothly entered this earnings season, broad index plays are a bit inadvisable. There's the usual tango between earnings reports and future guidance, profits and revenues; but it's getting so hard to figure out which datum is leading the dance and which is following. How heavily are investors weighing profits, as the economy's thirsting for revenue growth to affirm a recovery?

I posted an article a couple of weeks ago that discussed the Investor's Cycle of Psychology:

The rally gained steam through short covering, earnings surprises, government interventions. Now, the "late-to-the-party" money is piling into riskier securities to catch what profits remain[?]. We're accelerating from Caution to Confidence as popular Bears turn Bull, CNBC celebrates, and analysts come out targeting Dow 10,500. We'll probably see another jump up to Enthusiasm as consumerless Inventories are rebuilt to pad GDP. We can quickly gap up to Greed/Conviction when banks report loan growth, whilst Obama & Bernanke light a cigar. The USD will have reached support in advance of that day, and Fed Funds rate futures will price a 60-something percent chance of a hike. Then we'll realize that we've just churned our economy after devaluing it...

Keeping us grounded, a friendly reminder I saw from Clusterstock Wednesday night:

What you’re watching now is a bull market on government spending. What you should be watching is the real report card:
• Inflation : There is $50T in unfunded liabilities on the country’s balance sheet. If the USA played by corporate America’s accounting rules, we’d be bankrupt. The laws of gravity still apply. We will experience significant inflation within 3 years.
• Job Growth : Since the start of the recession in December 2007, we’ve lost 7.6 million jobs. Millions more have stopped looking for work. The analysts keep saying this downward trend will stop. But it hasn’t.
• Innovation : The credit contraction makes it harder for entrepreneurs and small businesses to invest in growth. This segment of the economy is where a rebound will start. Don’t watch the Dow, watch small business credit (contracting) and patents filed (contracting).
• Education : The important word in “Gross Domestic Product” is product. We must have highly skilled knowledge workers to compete against other economic innovators. A third of high school students aren’t graduating. This is the HR pipeline??


...add to that list the CRE minefield. Also note that m/m (or even y/y) growth or deceleration in the decline of macro statistics don't represent a turnaround, but merely a bottoming. It's like exponential decay, wherein a value continuously declines at a rate proportional to its value. Yeah, it's slowing, but it's still not good.

We've got to keep our eye on the ball here: look at nominal price and revenue levels from 2006/07; look at real high water marks; look around you at the 25-50% off retail sales everywhere.

This past January, Martin Armstrong put out a great piece, "The Coming Great Depression- Why the Government Is Powerless." (If you know anything about Armstrong's background, he's a pretty contemptuous crook... er, bankster. But his economic analyses are gems nonetheless.)

The stock market by no means predicts the economy... the stock market drop may signal a recession, but the collapse in debt signals a Depression...
The bubble burst in 2000 and there was a moderate investment recession into 2002, but there was no appreciable decline... The real concentration of capital that created the [2007] bubble top, took place in the debt markets.

There are some sweeping generalizations elsewhere therein, but his data-less arguments to support his thesis are pretty interesting conversation topics.

For example, he accuses Volker's Fed of violating usury interest rate ceilings in the 1980s when it pushed rates above 10%. As a result, we've needed more subsequent debt at lower interest rates just to keep yesteryear's debt performing. Says Armstrong:

...the lifting of usury to fight inflation back in the 1980 has resulted in usury now being so high, a larger portion of income of the common worker is spent on interest, not buying goods and services that even create jobs.

I'm a huge opponent of the disinflationary policy we've seen since the 1980s. If soaring debt-to-GDP or debt-to-income don't exemplify an over-mature economy fueled by deficit, let's take a look at some other data--with Armstrong's abstract as a backdrop. From BLS's latest release:

So Consumer Spending is 70% of our GDP. That chart shows the total expenditures and the percent change y/y 2006-08. You can see what the commodity bubble in '08 did to Food expenditures. You can also see housing's proportional share of consumption. Let me stretch out some of that data over a longer timeframe:

You can see what's happened to commodity intensive products like Food & Gasoline throughout the so-called "supercycle." You can see what's happened to government subsidized [manipulated?] components like Owned dwellings.

By contrast, note that Apparel expenditures lagged severely, relatively stagnating over the past 20 years in nominal terms. The US government hasn't intervened there, probably because of Apparel's diminutive notional contribution to GDP. There's also the rise of globalization nagging domestic retailers.

The point is: the US has done little to generate real growth where there hasn't been exogenous intervention. The government persuades each facet when it hits a wall. Housing sputters, subsidize it. Transportation dies on the vine, nationalize it. Healthcare's next.

Healthcare spending on some level is an automatic stabilizer for GDP. It’s not the same as welfare and unemployment benefits, which are basically transfers from government spending from G to C in that Econ 101 formula GDP=C+I+G+NX. Right now, there's monetary velocity wrought from Healthcare expenditures, but going forward, isn’t a lot of Healthcare spending going to be a shuffling of the deck?

It's not that I entirely oppose Healthcare reform (because I don't); it's that we're seeing GDP get more and more watered down as the government pushes the limits of a fiat, reserve USD. The C is being annexed by the G in that formula because the economy can't stand on its own.

Revisiting BLS data 1988 vs 2008, let's find out which expenditures are draining consumers:

Those four items listed above are the main culprits responsible for consumption reallocations over the past two decades. Increases in consumption flows to Education and Housing have borrowed market share from Food. Intuitively, I'd like to attribute the increased Healthcare expenditures to demographics. Similarly, I want to blame the government's intervention for incubating the Housing and Education bubbles. Further, I wonder what will happen when the Healthcare bubble gets wound up [more than it already has].

Remember, when the US set out on its campaign for housing, it was trying to make Housing more affordable for everyone. Same with Education and Healthcare. Hmmm. The crazy part is, 1988's interest rates were coming off a decade-defining spike, so Housing as a percent of expenditure would've been much lower in, say, 1980. (An earlier date would've been a more dramatic illustration of my point, but BLS just doesn't post archived data from before 1984).

In summary, we're trying to wring Healthcare for all the growth it's worth. Food demand is inelastic, Housing and Education have hit the wall, Transportation is assembling to troops to unveil a 21st century campaign (don't hold your breath). So until GM finds its sweet spot, the economy has only Entertainment as a candidate to launch consumption to the moon? Well, 4Q09 bottom line and top line growth for techs is a start. It could be worse...

Disclosure: RIMM