August 2010 Personal Income and Outlays, Retail Sales and Consumer Debt: The Myth of The Deleveraging Consumer

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Bureau of Economic Analysis data revealed that growth in disposable personal income (DPI) outpaced personal consumption expenditures (PCE) in August. DPI increased by $52.0 billion (0.5 percent) while PCE rose by $41.3 billion (0.4 percent) relative to July. The advance in DPI was the largest so far this year, but it was largely propelled by a resumption of extended and emergency unemployment benefits rather than improved private sector hiring.

"[Consumers] are not retrenching, but neither are they splurging," observed Sal Guatieri, a senior economist at BMO Capital Markets Inc. in Toronto. “The recovery is on track, but remains lackluster."
 

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Retail-sale activity paralleled PCE in August, rising 0.4 percent compared to July as back-to-school discounts and tax holidays lured consumers to stores. "The tax-free holidays really gave a boost," said Ken Perkins, president of Retail Metrics. "Retailers came out of the gates strong on the promotional front in the last week of July and that carried through for basically the entire month of August."

Same-store sales, considered a key indicator of retailers’ health because they exclude results from new and closed locations, rose 3.5 percent. As we have argued in the past, however, this metric can provide deceptively strong signals because closed stores concentrate customers into the fewer remaining locations, thereby boosting their sales figures.

Another noteworthy item is that the annual percentage growth in retail sales has slowed dramatically from the heady pace seen in April. This development bears watching.
 

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Total consumer debt outstanding declined in August as the retreat in credit-card purchases more than offset a small rise in non-revolving debt. Total credit decreased 1.75 percent (SAAR); revolving credit fell by 7.25 percent while non-revolving credit increased by 1.25 percent.

A recent Wall Street Journal article questioned the assumption that consumers have been deleveraging voluntarily as a way of eliminating debt. By looking at the Federal Reserve’s Flow of Funds report, WSJ found consumers have instead been aggressively leveraging more and more until the banks put them into involuntary bankruptcy, cutting off the money spigot.

Of the $600+ billion in deleveraging that has occurred since mid-2008, WSJ found that only about $20 billion was voluntary. Contrary to what has been the “received wisdom,” it appears a large proportion of consumers do not, in fact, moderate their spending while still in possession of credit; on the contrary, they accelerate spending until breaching the lender’s charge-off threshold -- at which point all credit is cut off. “This is a startling realization,” said Tyler Durden, whose blog brought this analysis to our attention. “[It confirms] that the average American is actually ‘hyperleveraging’ to the point where all available credit is forcefully eliminated by a lender institution! The conclusion is that consumers do not pass a moderate ‘Go’ on their way to insolvency, they go from hyperleverage straight into bankruptcy.”

September 2010 ISM Reports: Manufacturing Stumbles; Services Speed Up

The Institute for Supply Management’s (ISM) reports on the manufacturing and service sectors provide a more up-to-date view of conditions than either the Federal Reserve Board’s report on industrial production and capacity utilization or the U.S. Census Bureau’s report on manufacturers’ shipments, inventories and orders.

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With a 1.9 percentage point decrease in its PMI, manufacturing expanded at a noticeably slower pace in September. "While the headline number shows relative strength this month as the PMI reading of 54.4 percent is still quite positive, the overall picture is less encouraging,” said Norbert Ore, chair of ISM’s Manufacturing Business Survey Committee. “The growth of new orders continued to slow, as the index is down significantly from its cyclical high of 65.9 percent (January 2010). Production is currently growing at a faster rate than new orders, but it typically lags and would be expected to weaken further in the fourth quarter. Manufacturing has enjoyed a stronger recovery than other sectors of the economy, but it appears that weaker growth is the expectation for the fourth quarter. Both the Inventories and Backlog of Orders Indexes are sending strong negative signals of weakening performance in the sector."

ISM’s manufacturing report points to "an economy that is growing but not growing very rapidly," said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. "We may see a cooling off in manufacturing in the next few months."

After exhibiting no changes for two months, Wood Products reported some movement in September; unfortunately, most of those changes were disappointing. Paper manufacturing, on the other hand, lengthened its string of positive changes.
 

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Growth in the service sector picked up speed in September, nearly offsetting the PMI decline; the non-manufacturing index rose by 1.7 percentage points (to 53.2 percent). None of the service industries we track showed much change. One Construction respondent indicated that the "general state of the business has not changed in the last three months. The market is still soft for new sales due to financing requirements."

"This is slow and steady growth," remarked Anthony Nieves, chair of ISM's non-manufacturing survey. "There's still this cautiousness about whether or not things are turning the corner but people want to remain optimistic."

Input prices paid by manufacturing industries jumped at a significantly faster pace (9 percentage points), but the rate of increase slowed slightly (-0.2 percentage point) for the service sector. Relevant commodities whose prices increased in August included: corrugated containers, diesel fuel and paper. No relevant cmmodities were down in price. Coated groundwood and coated freesheet were commodities listed in short supply.

August 2010 Manufacturers’ Shipments, Inventories and New Orders: Digging below the Headline for a Little Encouragement

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Shipments, inventories and new orders at the total manufacturing level posted mixed results in August, according to the U.S. Census Bureau.
 

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Shipments, down three of the last four months, decreased $2.5 billion (0.6 percent) to $415.1 billion. This followed a 1.2 percent July increase. The decline was led by a $3.1 billion (5.8 percent) retreat in transportation equipment. Greater shipments of manufactured nondurable goods -- especially chemical products (up $0.4 billion or 0.7 percent) -- offset some of the fall-off in shipments.

Shipments from solid wood manufacturers declined by 4.3 percent while paper manufacturers saw a 0.1 percent increase.
 

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Interestingly, data from the Association of American Railroads indicate a general increase in the amount of rail traffic during August – especially shipments of lumber and wood products. The 1 percent decrease in the Ceridian-UCLA Pulse of Commerce Index (which measures diesel consumption of over-the-road trucking) for August was more consistent with the Census Bureau’s shipment values.
 

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Inventories inched higher ($0.7 billion, or 0.1 percent, to $526.4 billion) again in August. Transportation equipment had the largest increase, at $0.6 billion (0.8 percent), while petroleum and coal products led the decliners (down $1.2 billion or 2.9 percent).

Solid wood inventories fell by 0.8 percent while paper remained unchanged.
 

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New orders constitute the forward-looking portion of the Census Bureau’s report, and give an indication of what may be in store for the manufacturing sector. As such, the report’s headline numbers did not provide much encouragement, because new orders for manufactured goods decreased $2.2 billion (0.5 percent) to $408.9 billion. Transportation equipment -- especially aircraft -- had the largest decrease among durable goods ($5.3 billion or 10.2 percent). Excluding aircraft, however, durable goods orders increased by a much healthier-sounding 0.9 percent; this result indicates at least some companies are replacing outdated equipment. New orders for nondurable goods increased $0.7 billion or 0.3 percent to $217.1 billion.

September 2010 Currency Exchange Rates: A Paler Shade of Green

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The U.S. dollar depreciated “across the board” again in September: by 0.7 percent against Canada’s “loonie,” 1.5 percent against the euro and 1.2 percent against the yen. On a trade-weighted index basis, the dollar gave up 1.0 percent against a basket of 26 currencies.
 

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Canada: The loonie edged toward parity with its southern cousin despite revelations of a fall-off (-0.1 percent) in Canadian gross domestic product (GDP) during July -- the first monthly decline since August 2009. Manufacturing, retail and wholesale trade, construction and forestry all posted decreases. Increases were recorded in the mining sector and, to a lesser extent, in some financial industries and the public sector.

Europe: The euro strengthened against the dollar as expectations that the U.S. Federal Reserve will engage in quantitative easing overshadowed concerns about conditions in Europe. "Investors have turned bearish on the greenback as speculation mounts that the Fed will increase the monetary base to stimulate the U.S.'s lackluster economic recovery," wrote Brian Dolan, chief currency strategist at Forex.com. "We're left with an environment [in which] bad U.S. news is met by further dollar-selling as the likelihood of additional Fed easing increases, and good U.S. news is similarly met by dollar-selling as risk assets are bought."

The euro gained momentum in early September when European Central Bank chiefs began “jawboning” their way toward an exit from emergency lending measures (as opposed to taking concrete actions), and maintained that inertia despite new problems in Ireland’s banking system, warnings of “contagious effects” on Europe’s banks from sovereign debt risks, and slowing growth of Eurozone economic activity.

“Global growth appears to be slowing and domestic demand is likely to be limited in a number of euro-zone countries by tighter fiscal policy,” said Howard Archer, an economist at IHS Global Insight in London. Contractions in Spain and Ireland “highlight the divergent performance of the euro zone.”

Japan: Unilateral intervention in the currency markets by Japanese officials tempered, but did not reverse, the yen’s rise against the greenback. On a monthly average basis, the yen has been stronger only once before in the past 40 years -- in April 1995. Even Japan’s shrinking trade surplus and industrial production, and expectations of additional quantitative easing by the Bank of Japan were insufficient to significantly pare the yen’s lofty valuation.

September 2010 Monthly Average Crude Oil Price: High Inventories, Tame Price

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The monthly average U.S.-dollar price of West Texas Intermediate crude oil retreated by $1.51 (2.0 percent) in September, to $75.31 per barrel. That price decrease occurred despite a weaker dollar, consumption of nearly 19.3 million barrels per day (BPD) in July -- the highest levels since October 2008, but in conjunction with persistently high crude stocks.

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Recent oil-related developments include the following:

· The U.S. Export-Import Bank, an independent federal agency, loaned more than $1 billion to the Mexican state oil company PEMEX in 2009 to support the company's oil drilling in the southern Gulf of Mexico. The bank has another $1 billion in loans in the pipeline for 2010 that, like the 2009 loans, would result in PEMEX employing U.S. oil contractors and engineers for both on-shore and off-shore oil production.

Mexico is the United State's second largest source of foreign oil, according to the Energy Information Agency, accounting for 1.2 million barrels per day in imports -- 200,000 more barrels per day than from Saudi Arabia. Because the United States accounts for a large share of Mexico's oil exports, it is inevitable that the country will import oil produced as a result of federal loans, meaning that the U.S. federal government loaned money to the Mexican government to produce oil so that we could import it.

The Bank's activities are not affected by the Obama administration's ban on offshore drilling because that ban applies only to deepwater (500 meters of water or deeper) drilling and the PEMEX projects financed by the Ex-Im Bank are shallow-water projects.

· The Obama administration will require oil and gas companies operating in the Gulf of Mexico to plug nearly 3,500 non-producing wells and dismantle about 650 production platforms that are no longer used.

More than 27,000 abandoned oil and gas wells lie beneath the Gulf of Mexico, and more than 1,200 oil rigs and platforms sit idle. An Associated Press investigation showed that many of the wells have been ignored for decades, with no one checking for leaks.

The order requires operators to plug wells that been inactive for the past five years. Production platforms and pipelines must be decommissioned if they are not being used for exploration or production, even under an active lease. Current federal regulations require idle structures to be decommissioned - a process that involves plugging wells and dismantling and removing platform structures and pipelines - within one year of the lease's expiration date.

August 2010 U.S. Construction: Private Construction Spending Disappoints

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Overall construction spending posted an unexpected gain of 0.4 percent in August after tumbling during July to the lowest level in a decade. The entire August advance occurred in the public sector, thanks to government stimulus outlays for public works. By contrast, spending among all private categories -- especially non-residential -- retreated in August.

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Repeating a pattern seen in July, the number of total housing starts rose by 10.5 percent in August despite a decline in the value of private construction put in place. Even so, starts remained near the lowest levels since the Census Bureau began collecting data in 1959; also, the increase was concentrated in the multi-family sector.
"While the volatile multi-family sector was responsible for the overall level of starts in August being higher than expected, the more important single-family component remains severely depressed," noted Joshua Shapiro, chief economist of MFR Inc.

Nor is the market providing signals of a dramatic improvement. Although total permits rose 2.1 percent, permits for single-family structures -- which accounts for 75 percent of the housing market -- fell by 0.7 percent. "This marks the fifth consecutive monthly drop [for single-family permits] and is indicative of deterioration in demand for new homes," economist Michelle Meyer of Bank of America/Merrill Lynch said. "Even though single-family starts moved in the right direction, there is still weakness evident in the single-family data," added Daniel Silver, an economist at JPMorgan Chase. "The level of starts relative to permits indicates growth in housing starts may not be sustained."

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Even if starts do retreat further, we think that fall-off will be fairly modest and short-lived. It appears that 500,000 starts marks the “baseline” level of nationwide building activity. "The housing market has found a bottom, and we're bouncing along here," concurred Thomas Simons, an economist at Jefferies Group Inc. Simons warned, however, that "the market is challenged by supply, and until that is cleared out, it will be tough for the homebuilders."

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Because of flat new-home sales (matching the second-lowest level on record), the ratio of starts to sales remained elevated in August. Granted, this ratio is something of an apples-to-oranges comparison, since starts include all activity while sales include only houses built on a speculative basis (i.e., excluding homes built on contract). Nevertheless, it gives an indication of the balance (or lack of same) between supply and demand.

"There is no upside momentum in housing, period," said Eric Green, chief market economist at TD Securities Inc. "Unemployment is so high, consumer confidence is so low, household wealth is eroded and the psychology remains negative."

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A comparison between completions and sales tells much the same story. Interestingly, however, the number of single-family dwellings for sale and months of inventory dropped slightly despite a rise in completions -- mainly in the multi-family sector.

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August’s 7.6 percent increase in sales of existing homes recouped a bit of July’s 27.2 percent plunge, and helped to whittle away at both months of inventory and the absolute number of existing homes. Nonetheless, the residual effects of the federal home buyers’ tax refund remain very evident in the resale market. “We should have relatively low expectations of what the housing sector should be able to achieve over the next few years,” opined Zach Pandl, an economist at Nomura Securities International. “You have too many homes and too many mortgages and it’s going to take a long time to work through that overhang.”

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The median new home price dropped by 0.6 percent in August, to the lowest levels (on a nominal basis) since January 2004. Price erosion was even greater for resales (-1.9 percent), which resulted in greater affordability for a second consecutive month.

Strangely, although the seasonally adjusted S&P/Case-Shiller home price indices rose in only three metropolitan statistical areas (MSA) between June and July, the 10-city composite index somehow managed to eke out an increase.

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“Home prices crept forward in July. Ten of the 20 cities saw year-over-year gains and only one -- Las Vegas -- made a new bottom, as the impact of the home buyer program continued to fade away,” said David Blitzer, Chairman of the Index Committee at Standard & Poor’s. “The year-over-year growth rates for 16 of the cities and both Composites weakened in July compared to June…. The next few months may give us an idea of the true strength of the housing market, as the temporary economic stimuli will have ended. Housing starts, sales and inventory data reported for August do not show signs of a robust market, and foreclosures continue.”

Blitzer’s contention of annual price increases is disputed by the Federal Housing Finance Agency (FHFA). FHFA reports that home prices dropped 3.3 percent in July from a year earlier. Our research into similar past disparities between these two sources revealed that different sampling techniques explain the opposing results.

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2Q2010 GDP: Final Estimate Gets a Small Boost

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The Bureau of Economic Analysis on September 30 “bumped up” its third estimate of the 2Q2010 growth rate in real gross domestic product (GDP) to 1.7 percent after having slashed the estimate by one-third (from 2.4 to 1.6 percent) at the end of August.

 

"We have a slow-growing economy," said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. "What we're getting will do nothing to bring down the unemployment rate. The improvement in the labor market is very slow."

 

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The deceleration of real gross domestic product between the 1Q and 2Q2010 was due to a "sharp acceleration" in imports and a "sharp deceleration" in private inventory investment. Consumer spending and nonresidential fixed investment made major positive contributions to growth in the second quarter. The small upward revision to the final growth estimate resulted from higher inventory investment and consumer spending that were almost completely offset by higher imports.

 

If the period between December 2007 and June 2009 constitutes the “Great Recession,” the period since then can be labeled the “Great Disappointment,” said star economist David Rosenberg.

In a recent report obtained by Business Insider, Rosenberg, chief economist at Gluskin Sheff, rattled off several statistics to highlight the recovery’s weakness.

• While GDP has recouped 69 percent of its loss since hitting a low in June 2009, employment has recouped only 9 percent of its losses since hitting a low in December 2009.
• Household net worth has recovered only 28 percent since its low in the first quarter of 2009.
• Wages and salaries have rebounded only 36 percent from their March 2009 lows.
• Housing starts have recouped only 7 percent of their losses since their April 2009 low.
• Home prices have recovered only 13 percent from their low in April 2009.
• Consumer sentiment has regained only 27 percent of its losses since hitting a low in November 2008.

“New and existing home sales are at all-time lows,” added Rosenberg. “They have never recovered.” All that adds up to the “Great Disappointment.”