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There Is No Evidence Yet The Economy Is Gaining Strength

I feel I am watching snails race - and to have pundits predicting an improving economy seems baseless. This week, personal expenditures had to dismay the economic bears. Consumer spending growth was less than last month - and in a consumer economy, the opposite needs to happen for the economy to pick up steam.

  • The market looks at current values (not real inflation adjusted) and was expecting:.
  Consensus Range Consensus Actual
Personal Income - M/M change 0.1 % to 0.5 % 0.3 % 0.2%
Consumer Spending - M/M change 0.0 % to 0.3 % 0.2 % -0.1%
PCE Price Index -- M/M change 0.0 % to 0.2 % 0.1 % 0.1%
Core PCE price index - M/M change 0.1 % to 0.2 % 0.1 % 0.1%
  • In other words, both income and spending were below expectations.
  • The monthly fluctuations are confusing. Looking at the inflation adjusted 3 month trend rate of growth, income continues to trend down and expenditures continues to trend down.
  • Real Disposable Personal Income is up 2.6% year-over-year, and real personal expenditures is up 2.0% year-over-year (table 10).
  • this data is very noisy and as usual includes moderate backward revision making real time analysis problematic.
  • The second estimate of 2Q2014 GDP indicated the economy was growing at 4.2%. Expenditures are counted in GDP, and income is ignored as GDP measures the spending side of the economy. However, over periods of time - income and expenditure must grow at the same rate. Usually this differential signals a future slowdown of consumer spending growth.
  • The savings rate continues to be low historically, but improved this month.

The inflation adjusted income and consumption are "chained", and headline GDP is inflation adjusted. This means the impact to GDP is best understood by looking at the chained numbers. Econintersect believes year-over-year trends are very revealing in understanding economic dynamics.

Per capita inflation adjusted expenditure has exceeded the pre-recession peak.

Seasonally and Inflation Adjusted Expenditure Per Capita

Per capita inflation adjusted income is above pre-recession levels.

Seasonally and Inflation Adjusted Income Per Capita

The graph below illustrates the relationship between income (DPI) and expenditures (PCE) - showing clearly income and expenditures grow at nearly the same rate over time. In dollar terms, incomes are growing faster than consumer expenditures - and this is positive for long term economic growth.

Indexed to Jan 2000, Growth of Real Disposable Income (blue line) to Real Expenditures (red line)

The long term trend remains that the consumer is spending more of its income - although the growth rate has been in a tight range for over one year.

Seasonally Adjusted Spending's Ratio to Income (a declining ratio means consumer is spending less of its Income)

PCE is the spending of consumers. In the USA, the consumer is the economy. Likewise, personal income is the money consumers earn to spend. Even though most analysts concentrate on personal expenditures because GDP is based on spending, increases in personal income allow consumers the option to spend more.

There is a general correlation of PCE to GDP (PCE is a component of GDP). PCE is not very noisy compared to GDP, but subject at times to significant backward revision (see caveats below).

Seasonally and Inflation Adjusted Year-over-Year Change of Personal Consumption Expenditures (blue line) to GDP (red line)

Econintersect and GDP uses the inflation adjusted (chained) numbers. Disposable Personal Income (DPI) is the income after the taxes.

Seasonally & Inflation Adjusted Percent Change From the Previous Month - Personal Disposable Income (red line) and Personal Consumption Expenditures (blue line)

Yet year-over-year growth is not exceptional with both consumption and income below GDP growth.

Seasonally & Inflation Adjusted Year-over-Year Change - Personal Disposable Income (red line) and Personal Consumption Expenditures (blue line)

FRED Graph

The savings rate has been bouncing around - but the general trend is down. In an economy driven by consumers, a higher savings rate does not bode well for increased GDP. This is one reason GDP may not be a good single metric of economic activity. The question remains what is the optimal savings rate for the current demographics. It might be expected that as people near retirement, the savings rate rises and after people retire, savings rate falls. Econintersect is not aware of any study which documents this effect. The graph below is from BEA table 2.6. - and shows a significant fall in savings rate for January 2013 - and now remains range bound. The savings rate is now 5.7% - last month was 5.3%.

Personal Savings as a Percentage of Disposable Personal Income

It is obvious personal expenditures correlates to GDP - and without person expenditures increasing, GDP will not increase.

To view all the analysis this week - [click here].

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.