FMX | Connect – www.fmxconnect.com - (Reported 5/14/2010)
Excerpts from MARKET MUSINGS & DATA DECIPHERING
U.S. RETAIL SALES — SOFT BENEATH THE SURFACE
The big deal in the April retail sales report was the “core control” segment (excludes autos, gasoline and building materials), which feeds directly into the consumer spending component of the GDP accounts. The metric fell 0.2% MoM in the first meaningful decline since last July and the largest drop since the depths of despair in March 2009; a huge miss, vis-à-vis the consensus estimate of -0.3%. So this was the big downside surprise beneath the surface. In addition, the University of Michigan consumer sentiment index, while improving in May, to 73.3 from 72.2 in April, is actually still in recession terrain as in downturns, it averages 73.9; and during expansions it averages 90.9. So, we have the statistical illusion of a recovery, but in reality, organic growth is still hard to find.
The headline did come in above expected, at +0.4% MoM, but that was due to a spurious 0.5% increase in the automotive segment (even though the U.S. Commerce Department already told us two weeks ago that unit vehicle sales showed a near 5% slide) and a 6.9% bounce in building materials, which may be part and parcel of the flurry of housing activity ahead of the expiry of the federal tax credits. So, to show what a lopsided report this was, one-quarter of the retail sales pie dominated by two sectors accounted for all the headline growth and then some — the other three-quarters posted a 0.2% dip with broad-based declines across clothing (-1%), sporting goods (-1.9%), department stores (-1.5%), electronics (-0.4% — despite the iPad!) and furniture (-1.2% — despite ‘cash for appliances’!). E-tailing (+0.2%) and restaurants (+0.1%) barely eked out gains.
One bright spot was sales activity at drug stores — up 0.9% in the best month since last September; it would seem as though a lot of tranquilizers flew off the shelf on the day of the 1,000 points, 15-minute slide in the Dow. It certainly was not related to indigestion because food stores posted a 0.5% decline on top of a 0.3% dip the month before — the first back-to-back declines since everyone lost their appetite after the Lehman collapse in late ’08.
Upward revisions to what were already pretty good spending months took Q1 “core control” retail sales up to a 7.9% annual rate, the best tally since 2005 Q4. The drop in the savings rate, perhaps due to the lagged wealth effect of the equity market rebound, along with strategic mortgage defaults, double-digit growth in tax refunds and the array of spending subsidies at the federal and state government levels certainly helped. Renewed job creation also gave an assist even though wage growth has recently stagnated. The problem is not the first quarter as much as the outlook — April provides a weak starting point for Q2 (+2.8% “build in” for nominal “core control” — well below the Q1 pace) and at this point it could well be that we see a +1% print for real consumer spending (at an annual rate) for the current quarter. We doubt that is priced into retail stocks at current valuation levels.
GLOBAL DEFLATION THE PRIMARY TRENDLINE
Spain’s underlying inflation rate just turned negative in April for the first time since at least a quarter century and this is likely the thin edge of the wedge as we have yet to see the full brunt of fiscal austerity hit aggregate demand. Core consumer prices, which exclude energy and food, fell 0.1% from a year earlier from the miniscule +0.2% trend in March. All the deficit-challenged countries in the Eurozone, which technically means all of them since none come close to meeting the Maastricht budgetary targets, could be facing severe deflation pressure in the future based on the amount of slack in their economies.
Ireland is already experiencing deflation, with nominal GDP falling faster than real GDP (both are down for two years straight but nominal is falling faster — nominal GDP was down by 11% in 2009, real down 7.5%). Not surprisingly, there is a lot of slack in the economy and the output gap stands at -7.1%, which suggests more deflationary pressures over the medium term. This problem is now widespread: Spain has an output gap of -5.3%, Portugal -3.6%, Italy -5.7% and Greece -4.6%.
Even with the recently announced austerity measures for Spain and Portugal, these countries may have trouble improving their fiscal ratios, if deflation sets in and GDP falls (as it has in Ireland). It’s otherwise known as the ‘catch 22’ — and the future of the Eurozone project, as it currently stands, is more in doubt than many are willing to believe at the current time. Either the Euro plunges or several of the EMU members will inevitably opt for their own currency of yesteryear to ease the deflationary pressure on their economies.
For anyone wondering why there is some sober second guessing over the outlook for the Euro, have a look at these two articles on page 18 of the WSJ — Portugal Approves Tax Increases, Salary Cuts and Italy’s Lack of Growth Makes Debt Burden Heavier.
WHY THE DEPRESSION IS ONGOING
There are classic signs indeed that the recession in the U.S. ended last summer — output, sales, etc. But the depression is ongoing and the reason we say that is because real personal income, excluding handouts from the government, has barely budged. In fact, real organic personal income is nearly $500 billion lower now than it was at the peak 16 months ago and this has never occurred before coming out of any technical recession. It is a depression, as the chart below attests — that is the trendline for real household incomes, until the government comes in to top them off with handouts, subsidies and extended jobless benefits. The share of U.S. personal income being derived from Uncle Sam’s generosity has risen above 18% for the first time ever.
Real consumer spending is up $200 billion over the past 16 months and everyone believes we have a sustainable recovery even though organic income is down almost $500 billion. Think about that for a second because once the stimulus wears off, and with a 10% deficit-to-GDP ratio and concerns surfacing everywhere about sovereign credit risks, there is little out there to support future growth in consumption.
Some are clinging to the notion that employment growth will accelerate. From our lens, once you remove all the assumptions the Bureau of Labor Statistics uses in its monthly data, there is little growth in the nonfarm payroll data. And, the Household survey is much too volatile and too small a sample size to rely on, even if all of a sudden it has become a focal point for the bulls (who conveniently were ignoring it as the recession began).
The ADP private payroll survey is showing marginal employment growth with none in the small business sector at all. And jobless claims, as we saw yesterday, have basically stopped falling; however, at still around the 440k level, they are not consistent at all with sustainable job creation. After plunging from 600k in June 2009, to 440k, as of January 2010, claims have basically stopped declining. That is a problem.
To reiterate: outside of the lagged impact of all the government stimulus and the arithmetic impact of inventory accumulation, the economy is not growing. The National Federation of Independent Business small business survey is showing that economic growth is stagnant at best. Even if you take the government data at face value, the past four quarters have averaged a mere 1.38% in terms of real final sales, which goes down as one of the very weakest post-recession trajectories in recorded history. We know it’s a tough pill to swallow, but we are sure that mostly everyone will get over it.
If you don’t believe that consumer frugality is a secular theme, then go to the New York Post story titled Young Gals Find Thrift is a Gift: Recession Has Put an End to Their Wild-Spending Ways — a Citi survey shows that 72% of females plan to boost their savings. Only 43% intend to take a vacation in the next six months. The article quotes 32-year old Tenira Forman, a former shopaholic, as saying “Within the last two years, I’ve been living a new life. I had an epiphany not to spend and to save more … I have the urge to shop, but I’m fighting it. I’ve given up electronics, shoes, clothes and home goods.”
If there is a bright spot, it is in the industrial sector:
•The just-released U.S. industrial production data was strong, rising 0.8% MoM in April beating analysts’ expectations of a 0.6% increase. On a year-over-year basis, production is running at 5.2%, the strongest pace since mid-1997. Manufacturing is a bright spot with production jumping 1% MoM, matching the gain in March and is also up 6% YoY.
•Steel production is up 74% year-on-year.
•Lumber production has risen 29%.
•Automotive by 67%.
•Truck tonnage has risen 7.5% and container traffic out of Long Beach has surged 19%.
•Railway carloadings are up 14% over the past year. Some of this is related to global growth, some it to the lagged impact of U.S. dollar depreciation, and some of it related to the improved productivity position of U.S. manufacturers, which indeed seem to be enjoying somewhat of a renaissance (something we wrote about three years and should be on archive back at the old shop).
•The latest foreign trade data showed that U.S. exports of goods and services have exploded 20% YoY, as of March.
So you see, the news is not all bad. The 20% of the economy related to exports and capital spending — the latter will benefit from the fact that capacity actually fell a record amount over the past two years and some of that surely has to be rebuilt and most pronounced in areas like transportation equipment, chemicals, plastics, industrial machinery — are certainly bright spots.
Let’s face it, left to our own devices, the U.S. personal savings rate would be going up, not down. But the government has done everything it can to perpetuate a consumer spending cycle even though such expenditures command a record of over 70% of GDP. Mortgage applications for new home purchases and miles driven across the U.S.A. are both negative year-on-year, and although consumer confidence has certainly rebounded from the lows, they are still consistent with recessionary environments (and this follows a record amount of bailout and handout stimulus from the federal government).
Keep in mind that even with the ‘cash for appliances’ program, almost 80% of chain stores missed their sales targets last month; and the new normal in the aftermath of the ‘cash for clunkers’ program seems to be around 11 million units at an annual rate on auto sales at a time when replacement demand should be closer to 12 million. Moreover, once the foreclosure moratoria is over, and the government no longer tries to play around with market forces and allow for price discovery, home values are back on a downward track, now evident in all the data series. There is no denying, after looking at the latest Census data, that there is an excess of five million vacant housing units across the U.S. acting as a continued dead-weight drag on house prices. While this is not good for homeowners, especially the 25% of the mortgage population already ‘upside down’, think of the affordability potential this will offer the one-third of the population who rent and who were crowded out during the price frenzy of the last cycle.
We realize that there is a healthy debate emerging over the outlook for residential real estate in the U.S. as some former noted bears have suddenly become bullish. We shall let the data do the talking — more home sellers cut their listing prices in April despite what should have been a flurry of sales activity ahead of the federal tax credit expiration. Prices on 22% of the homes on the market, as of May 1, have been cut at least once (this compares to 20% a month ago). See page A6 of the IBD for more.
GOLD STILL GLITTERS
Here’s the deal on gold. When we had the post-Lehman collapse, gold fell from $900 to $720 an ounce but it still managed to outperform other commodities and rise in many other currencies, outside the U.S. dollar. That post-Lehman collapse phase was a giant margin call where investors sold their winners, like precious metals, and on top that, there was insatiable appetite for dollars from the global banking system caught short of greenbacks.
What is happening today is truly fascinating. Gold has broken out to the upside even as the U.S. dollar has done likewise on the back of a renewed flight-to-safety bid. What this means, of course, is that gold has managed to hit new highs even as, (i) the U.S. dollar has risen, which means gold is breaking out against all major currencies; and, (ii) other industrial commodities, such as oil and copper, have slumped from their recent highs. So what this all means is that gold is no longer being considered as part of a resource complex that is outperforming the segment but is increasingly being viewed as a currency of its own.
Moreover, with the growth rate of fiat currencies globally being met with a skeptical eye by investors, especially now that we know that if the ECB, of all central banks, can engage in debt monetization (those clinging to the belief that this was modeled after the Bundesbank have been clearly duped), the one thing we do know about gold is that most of it is already above ground and that production peaked a decade ago. In other words, investors have more faith in what the shape and direction of the supply curve for bullion looks like relative to individual country money supply growth. This is why deflation is good for gold — the reflationary efforts provide a big boost. Even without the interventionist efforts to monetize the debts, as long as policy rates are near-zero, gold leasing rates will do likewise.
While FDR fixed the dollar price of gold in the 1930s, we know that bullion doubled in Sterling terms during that deflationary cycle. Gold is a hedge against instability of all kinds — don’t think for a second that deflation does not engender instability whether it be financial, economic or political. To be sure, gold is also a hedge against inflation — but that is going to come much, much later and will be the icing on the cake.
While I am concerned near-term that gold is overbought and could be ripe for a setback; however, unlike the equity market, bullion is in a secular bull market, which means dips, when they occur, are to be bought. Gold can trade down to $1,130 an ounce and none of the trendlines would be broken.
More to the point, secular bull markets usually end in parabolic blowoffs and we are nowhere near that point — see the chart below for what long-term trough/peak moves across different asset classes looked like in the past and tell us that gold is now in a bubble. Not a chance. And, as we have said in the past, if central banks were to ever be compelled to hold the same share of gold in reserves to back up their respective monetary aggregates, the gold price would rise to $3,000 an ounce.
Believe it or not, $3000 an ounce on gold may yet prove to be a conservative forecast. If the gold price to world GDP ratio were to ever scale up to the peak three decades ago, it would imply an ultimate peak of $5,300 an ounce. Even better if the relationship between gold and the M3 money measure where to revert to the 1990 high, gold would move to $5,700 an ounce. A more cautious projection would merely put gold on the same footing as the CPI, and heading back to the previous peaks in this ratio would suggest $2,300 as the peak in gold — only a double from here. Or perhaps the gold price-M1 ratio is one that should be considered and even here gold would go to $3,100 per ounce under the proviso that prior highs get reestablished. For more on this fun-with-figures analysis of how far gold can go, see Why We May See Gold Hit $5,000 on page B2 of the NYT.
LEARN TO LOVE THE BOND
It is rather unbelievable but the asset class that has delivered the best risk-adjusted returns for a decade now is still so completely maligned. We are talking about Treasury notes and bonds here. Sentiment surveys are wildly negative. The net speculative short position on the CBOT (Commitment of Traders report) is near a record 209,000 contacts ($100k face value, futures and options). So it would seem that further short-covering could drive yield activity even lower — and why not embrace it? The bond rally has allowed mortgage rates to decline to their lows for the year (4.93% on the 30-year fixed).
As for inflation … well, if Wal-Mart is cutting 10,000 items and Taco Bell now offering a $2 combo meal, it’s not on our list of concerns (see page 3B of the USA Today). Consumer demand is still so soft that the U.S. is becoming a nation of coupon clippers —- see Sign in with Pals, Get Better Coupons on page 1B of the USA Today as well.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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