The November Employment Report: Not So Fast

Morris Segall      absence of high paying job creation, consumer spending, employment report, job creation, long term unemployment, low paying job creation, seasonal service sector jobs

The November employment report showed an increase of 120,000 new jobs, 140,000 in the private sector and a loss of 20,000 in the government sector. The latter continues the negative trend begun in the second half of 2008. Of import was the sharp drop in the unemployment rate from 9.0% (which has been the level over the past 12 months) to 8.6%, the lowest level since March, 2009. Additionally, prior months job gains in September and October were revised upward by a total of 72,000, moving the average monthly gain in job creation over the past three months up to 143,000 versus an average of 76,000 over the prior four months.

As impressive as the headline numbers appear, one needs to analyze the details behind the numbers. Upon further examination we find the following:

1. The large drop in the unemployment rate reflects a large drop in the labor force of over 300,000
persons in the month of November. This is indicative of a continuing flow of discouraged workers
leaving the workforce which now numbers over 2.5 million and causing the labor force participation
rate to fall to a multi-year low of 64%.

2. The number of unemployed over a 5-26 week period actually increased by over 30,000 persons in
November from September levels.

3. Virtually all of the job gains since September have come from the service sector sector, notably retail
trade, professional and business services, most of which were temp jobs, healthcare services and
leisure and hospitality jobs. Most of the retail and leisure and hospitality jobs are seasonal and are
considered temporary. All of these service sector jobs are generally lower paying jobs relative to
manufacturing, construction and goods producing jobs which are not showing increases over the
past three months.

4. Average hourly earnings are little changed over the September-November period despite the large
increase in monthly job creation. This further validates our thesis that the bulk of the jobs being
added are low paying.

5. The average duration of unemployment in weeks amounted to nearly 41% in November, near the post
recession highs of 40%-45%, despite the increase in job creation since September and the recent
decline in first time unemployment claims during this same period and a decline in the number of
unemployed of 5 weeks or less.

So, while the increase in job creation since September is welcome and helpful to income creation and consumer spending in the near term, we must look at these numbers with circumspect as they may not last and appear to do little to improve the longer term unemployment distress in higher paying jobs and among the long term unemployed.

Morris R. Segall

The Super Committee fails: Now What?

Morris Segall      Bush tax cuts, consumer spending, democrats, Economic Growth, economic outlook, employment, eroding middle class, future trends, mandatory federal spending cutbacks, military spending, public education impairment, republicans, U.S. credit rating downgrade, U.S. economic and military superiority

Yesterday’s announcement that the Bipartisan Congressional Committee, charged with formulating a long term deficit reduction plan, could not come to an agreement on such a plan was anti-climatic. It had been rumored for weeks that the members of the committee were far apart on critical issues and by this past weekend, it was apparent no agreement was going to be reached. We had long been skeptical this committee was going to succeed (See our blog video of October 7) but we felt there was a chance statesmanship would triumph over politics at the eleventh hour. We were wrong. We have commented since last summer’s near disastrous debt limit negotiations that the ideological divide between Republicans and Democrats is so wide that the parties are incapable of bridging the gap, even when the well being of the nation is at stake. It will reside in America’s voters in next year’s election to decide this country’s long term public and fiscal policy by electing a President and Congress of one political party or the other. A split vote that results in continued divided government in Washington will be a formula for economic and social disaster.

In the meantime, Congress must fund the government past next month and decide if it will extend last year’s tax breaks via a reduced payroll tax on wage earners and extended benefits to this nation’s chronic number of long term unemployed. In the present partisan atmosphere in Washington, none of these important issues can be counted as certain of passage. Failure to pass any of these items will certainly diminish the economic outlook for next year at the least, and potentially plunge this country into economic chaos at the worst, if the government is shutdown for lack of funding.

Beyond the immediate issues affecting the economy for next year are the prospects of mandatory federal budget cutbacks and the expiration of the Bush tax cuts in 2013 as a result of the failure of the “Super Committee” to fashion a long term deficit reduction package. The combination of increased taxes and federal government spending cuts will result in higher taxes, particularly on the already stressed middle class, and significant reductions in federal assistance in vital areas such as education, again disproportionately affecting middle and lower income sectors of our economy. At the same time, mandatory federal spending reductions will fall heavily on the Defense Department causing drastic cuts vital to our national defense while our strategic enemies are increasing their defense spending and closing the gap on our technological superiority. It is this technological superiority, through necessary research and development, that allows us to field a world class military with fewer numbers than our adversaries. Oh and by the way, defense spending cutbacks of approximately $500 billion over the next ten years are estimated to cost approximately 1 million defense related jobs according to estimates by the Defense Department.

The sum of such fiscal developments, we believe, will be a low level of economic growth on an extended basis from suppressed consumer income and spending and continued high levels of unemployment. Erosion of our public education system to the detriment of a future generation of students and impairing our ability to compete in the world economy. This combination may well result in the creation of a burgeoning number of low income earners replacing what has historically been a growing and thriving American middle class. The disparity between the “haves” and “have nots” will reach historic proportions threatening the future social, economic and military superiority of the U.S. Lastly, there is no guarantee that such mandatory spending reductions will stave off a further lowering of our credit rating. Indeed, we expect the rating agencies will be taking an unfavorable opinion of our economic prospects in the near term. Lower spending matched by lower tax receipts may not result in the improved federal fiscal situation necessary to maintain our AAA credit rating. In short, absent a robust economic recovery, hallmarked by substantial job and income growth, the future social and economic outlooks for this country are not encouraging.

Morris R. Segall

Second Quarter backsliding

Morris Segall      consumer sentiment, consumer spending, Economic Growth, employment report, GDP, industrial production, inflation, retail sales, unemployment

Last week saw a number of important economic reports for the month of June, including wholesale and retail inflation, consumer sentiment from the University of Michigan/Reuters survey. There were no surprises to us in these reports. We expected inflation to recede from the elevated levels of the first five months of this year as energy prices declined in the month of June. We also expected consumer sentiment numbers to decline reflecting the weak stock market in May and most of June and the very weak employment situation in both months (See our blog article of July 8 on June unemployment).  For us however, the two economic reports of most importance were retail sales and industrial production. If there were going to be signs of improvement from the very weak data reported in May, it would be seen in these two reports.

Unfortunately, while retail sales, excluding grocery store and gasoline station sales, increased .3% in June from depressed May levels, June retail sales were essentially flat with the level of April and lower than the peak level of sales in March. So it would appear consumer discretionary spending is down at the end of the second quarter from the peak levels at the end of the first.

We were anxious to see the Fed’s June report on industrial production and capacity utilization to see again if our expectations of a June rebound in industrial activity would be fulfilled. Here too we were disappointed with the results. Similar to the retail sales report, June industrial production did improve from weak May data but only by a slim .2% and all of the increase came in mining and primarily from utilities. The latter benefitting from increased usuage of power for cooling in the extended and massive heat waves last month. Given the continuation of hot weather in July, utility consumption is expected to be high again this month. More importantly, industrial production in manufacturing showed no increase in June from May and prior months industrial production in April and May were revised downward to negative readings. Indeed the revised numbers indicate overall industrial production in the second quarter showed no improvement from the first quarter. In addition, total industry capacity utilization declined in June from March levels. Manufacturing capacity utilization is also down in June from March levels and has not increased above the 74.4% level since April. As a point of comparison, this level of capacity utilization is well below the 79% long term average utilization rate of 1972-2010 .

Concurrent with the weak employment numbers already reported and the increase in the trade deficit reported for May, the weak retail sales and manufacturing data for June point to GDP growth in the second quarter lower than the 2% growth recorded in the first quarter. We raised concerns about this in our July 8th blog article. It now appears second quarter GDP growth will be in the 1.5%-2% range. Furthermore, we are increasingly pessimistic about a catlyst in the private sector that would rejuvenate the economy in the second half. Given the pessimism amongst consumers, and the retrenchment we have seen in the business sector, we are hard pressed to see what will “jump start” this economy in the absence of another Federal stimulus program which is not expected.

Morris R. Segall

The June Employment Report: Now we are getting pessimistic

Morris Segall      business spending, Capital Markets, consumer sentiment, consumer spending, debt default, deficit reduction, democrats, Economic Growth, economic recovery, future trends, inflation, job creation, June employment, obama, recession, Republican Party

Today’s employment report for the month of June is unequivocally a blow to expectations that May’s weak report was an aberration.  Instead of rebounding from May results, the June report deteriorated in virtually all key aspects  of employment. Nonfarm payrolls increased by a neglible 18,000 jobs, the weakest level of job growth in nine months. To make matters worse, the Labor Department revised downward its previous readings on job creation in April and May by a combined 41,000 jobs, including a 29,000 job reduction in May to 25,000 from an already weak level of 54,000 jobs. The June report and the April-May revisions reveal a virtual absence of job creation since April. Of the 18,000 jobs created in June, 57,000 were created in the private sector, offset by a reduction of 39,000 jobs in federal, state and local governments. Of the 57,000 private sector jobs the vast bulk of these, (34,000),  were in the Leisure and Hospitality sector- low paying, seasonal and tenuous given its sensitivity to the economy. According to the Household survey, the unemployment rate reached a year to date high of 9.2% in June despite a contraction in the labor force of over 270,000 from May levels. In addition, the June Household survey showed an increase of 173,000 in the number of unemployed workers and an increase of nearly 450,000 persons not in the labor force. Other statistics from the June monthly report include: a recessionary employment/population ratio of 58.2%; a $.01 decrease in average hourly earnings resulting in no increase in average hourly earnings since April; a decrease in the average workweek and factory overtime; an increase of 100,000 in the number of discouraged workers from May to nearly 1 million persons; an overall increase of 474,000 in those categorized as marginally attached to the labor force from May to a level of 2.7 million people; and an increase of over 400,000 from May in the number of unemployed less than 5 weeks to over 3 million persons. In June, the percentage of workers unemployed, those marginally attached to the labor force and those working part time because they can’t find full time work amounted to over 16%, the highest level this year. Two years after the recession ended, these numbers are unprecedented in post-war economic recoveries.

In our June 7th website article on May unemployment data, we concluded that the May data had been suppressed by the severe storms in the south and mid-west in April and May and the supply dislocations in Japan. We saw reassuring data in the May report that encouraged us to believe we were not on the verge of a double dip recession. Unfortunately, the June report contained none of those positives and should be relatively unimpeded by exogenous events. We believe  the June data confirms our fears that the business sector has retrenched in its spending since March, insecure in the outlook for consumer and customer end demand given the high levels of inflation and pressure on incomes and profit margins and deteriorating economic conditions in major markets overseas. This is confirmed in the underlying weakness in the June ISM manufacturing survey ( See our website article on the June Manufacturing Survey), and the weakness in the June ISM non-manufacturing survey, both released earlier this week. This retrenchment now appears to include a reduction in hiring.

This business spending retrenchment will have enormous implications for economic growth for the remainder of this year and into next if not reversed. An economy that does not provide job growth cannot grow. We have long focused on business and consumer spending as the drivers of economic recovery in the absence of contributions from housing and the government sector. Business retrenchment in spending and hiring will remove both of those drivers from the economy. The absence of private sector job creation will soon be reflected in reduced consumer sentiment and spending. Reduced consumer spending will slow business sales and pressure corporate profits causing businesses to retrench further. The net result is an economy that does not grow and one that could easily fall back into recession. We commented in our last website article how important the June employment report would be for the future direction of our economy. With the June numbers showing such employment weakness, we are now pessimistic the second half of this year will show renewed economic growth and the outlook for 2012 has become decidedly less sanguine. We expect to revise downward our expectations for GDP growth for this year to the bottom of our 2%-3% range and we may have to reduce our projections further if current economic trends persist.

We expect the weak June employment data to complicate if not preclude an agreement on raising the nation’s debt ceiling. The weakness of the June report will, in our opinion, harden the resolve of Republicans to reject revenue raising measures advocated by the President. The same employment weakness will, in our opinion, also strengthen the resolve of Democrats to avoid stringent federal spending cuts, particularly in entitlement programs. The current weakness in the economy will widen the ideological chasm between the political parties. Thus, we are not optimistic a far reaching deficit reduction program will be reached in the next two weeks. Rather we now believe a stopgap measure to avoid government default, possibly through the end of the current fiscal year, will be the only agreement that can be fashioned.

Clearly these events and the current economic environment are not conducive to stock market appreciation. In view of the recent rally in stock prices at the end of June and the first week in July, we believe the equity markets have increased downside risk and less upside potential. We would advise a more defensive and risk averse capital market strategy in light of present circumstances.

Morris R. Segall

May Manufacturing: Pause or Peak

Morris Segall      consumer spending, Economic Growth, economic recovery, economy, manufacturing, slowdown, stock market, trends

The ISM national manufacturing survey for May fell precipitously from April levels, confirming the trend seen in regional manufacturing surveys released over the past two weeks. For a number of reasons, the economy, including manufacturing, is slowing as we proceed into the second quarter. This looks very much like the pattern in economic activity we experienced last year as economic growth peaked last March-April and receded over the summer before reviving in the fall and winter. The reasons for the slowdown this year are primarily related to the surge in inflation since last summer, led by huge jumps in food and energy prices. This has been a restraining factor on consumer discretionary spending and has put pressure on corporate profit margins. It appears the rising level of prices is causing businesses to reduce spending to a greater extent than consumers as the experience of the recent recession has taught businesses to move quickly to cut spending to protect profitability.

Another factor hurting manufacturing currently is the dislocation of orders and shipments from and to Japan as a result of the earthquake and tsunami that has devastated that nation and created havoc with its industrial production and shipments.

In addition, the contraction in economic growth in Europe and ongoing sovereign debt issues are suppressing exports to the weaker economies in the Euro zone.

The unrest in the Middle East and North Africa has dislocated business orders and shipments from that region.

Lastly, the huge decline in shipments reported in the regional and national manufacturing surveys in May, reinforce our belief that a significant factor in May’s manufacturing weakness is due to the severe storms experienced in April and May in the Eastern U.S. and particularly the Midwest. In all of the manufacturing surveys production measures experience some of the biggest declines in the month of May.

It is noteworthy that the category of “No Change” increased significantly in many of the regional and national surveys in May. The increase in this category in May raised the absolute readings in this category to levels that far overshadowed the levels of weakening responses in the surveys. We interpret this that more of the weakness in these manufacturing diffusion indices is due to a “flattening” in the key metrics rather than massive deterioration. In addition, employment in virtually all of the manufacturing surveys remained positive. We acknowledge that employment is a lagging indicator and further weakening in orders, shipments and backlogs will result in weakening trends in employment going forward. Surprisingly, in many of the manufacturing surveys, including the national, respondents were generally positive regarding the future and expected key trends in orders and shipments to improve from May levels. If we are correct in our assessment of the impact of weather on the May surveys, we would concur. Finally, it should be noted that in the national survey, 14 of 18 industries reported growth in May with only 3 industries reporting contraction and those three industries were not major capital goods sectors.

It remains to be seen if the manufacturing growth trends rebound in June and beyond. If so, the capital investment cycle that has led the economic recovery will remain intact. If not, and the May surveys are signaling a weakening trend, then we will have to face the possibility this cycle may have peaked.

We are not optimistic that if such is the case, the federal government will resuscitate it with further stimulus as it did last year. The absence of further strong growth in manufacturing will lead to reduced overall economic growth this year and into next. Because of the flagging growth in manufacturing and net exports so far this quarter, we will be re-evaluating our economic growth projections for the second quarter and the rest of this year. We will evaluate the May employment report before we make our revisions.

The weakness in the May manufacturing report along with a forecast of weak employment growth by the independent payroll processing firm, ADP, caused a major sell-off in the U.S. equity markets on Wednesday that is being replicated by Asian markets Thursday morning and likely will spread to Europe. The world capital markets are nervous about the outlook for world economic growth and financial stability and have become very volatile. Those outlooks will dim further if the U.S. economic recovery stalls out. This is why we have emphasized private equity and the investment themes of merger and acquisition, infrastructure investment and business growth financing in our capital market strategy for the intermediate and longer term (See our website article of January 6, 2011 and our website Economic and Capital Market Presentation of February 2, 2011). Recent events overseas and the fragility of our own economic recovery plus our long term financial difficulties, reinforce this strategy.

Morris R. Segall

Economic Update

Morris Segall      April job growth, consumer credit, consumer spending, corporate profits, Economic Growth, future trends, GDP, inflation, manufacturing orders and shipments, non-manufacturing orders and production, personal income, unemployment

There has been a large amount of important economic data and news over the past week that is shaping the outlook for the U.S. economy as we proceed through the second quarter.

First, preliminary GDP growth for the first quarter was reported in line with our expectations (See our blog article of April 24, “First Quarter GDP will be a Slowdown”) of just below 2% higlighted by reduced consumer spending, reduced business capital investment, negative net exports and a surprising cutback in Federal government spending in defense. Our expectations of a beginning reorder cycle in inventory accumulation is also apparent in the report. We expect the second and third revisions to the GDP report will be upward based on stronger consumer spending numbers in the Personal Income and Spending report for March and strong capital goods orders for February and March.

Consumer income and spending data released after the preliminary GDP report reveals significantly stronger growth in both in the first quarter, particularly in February and March, aggregating a total increase of 1.5% for the two months. Spending was widespread among durable and nondurable goods and services over the two month period. Savings helped fuel the spending as the savings rate dropped to 5.5% from nearly 6% in January.

Orders, shipments and backlogs of manufactured goods increased at accelerated rates in February and March with orders and shipments in March growing at an outsized rate of growth approximating 3%. Order and shipments strength continued the recovery pattern of growth in both durable and nondurable industries. Manufacturing backlogs, on a non seasonally adjusted basis, are up over 13% year over year in March.

Purchasing managers indices for manufacturing and non-manufacturing receded in April from record levels in February causing concern about an economic slowdown but examination of the subsets of the indices reveal continued strong levels from respondents regarding orders, shipments, backlogs and employment. However, respondents in both surveys noted a continuation of price increases from suppliers.

Employment growth continued in April by a stronger than expected 244,000 jobs with private sector hiring accelerating to 268,000 from upwardly revised levels of 261,000 and 231,000 in January and February, respectively. However, the unemployment rate increased to 9% in the Household survey due to a calculation of fewer jobs created versus the Business establishment survey. The increase in job creation was broad and included manufacturing, retail trade, professional and business services, healthcare and leisure and hospitality sectors. Within professional and business services, the recent improvement in management and technical consulting services and computer systems services continued and provided much of this important sector’s monthly growth. This confirms anecdotal evidence we have been gleaning for much of the February-March period. Unfortunately, the labor force participation rate has not improved from a mediocre 64.2% and the number of people working part time for economic reasons and marginally attached to the labor force increased further. In addition, wages have not increased during the first quarter and have increased less than 2%, year over year, in April, less than the rate of inflation.

Consumer credit expanded again in March for the third consecutive month in both revolving and nonrevolving credit. Most of the increase in consumer credit continues to be led by nonrevolving credit such as auto and student loans. The small increase in revolving credit in March does not bring it back to fourth quarter 2010 levels.

Finally, commodity prices declined substantially led by a collapse in silver prices. We had felt commodity prices were building a bubble similar to the price action in the summer of 2008 and we expected a similar result when they broke down in the fall of that year.

Our conclusions from all of this data is that the first quarter ended on a stronger note than expected given the rapid rise in inflation during the quarter. Demand from consumers and businesses were remarkably resilient. With the recent decline in commodity prices, even temporarily, some pressure on consumer incomes and business profitability will be relieved. This augurs well for consumer and business spending in the second and third quarters and fortifies our optimism for heightened GDP growth for these periods. Another very positive development in the first quarter was the stronger than expected level of corporate profits reported for the period. Our optimism must be tempered by adverse events overseas, the current debate regarding the federal budget, which will impact the level of federal spending going forward, and the expiration of the Fed’s QE2 program which has supported low interest rates and ample liquidity for the economy and the stock market. We will be publishing our power point, comprehensive economic update and outlook on our website shortly.

Morris R. Segall

Osama Bin Laden is Killed and Risk Tolerance Rises For the Moment

Morris Segall      Al Queda, Capital Markets, consumer spending, debt ceiling deliberations, economic realities, Fed's QE 2 program, geopolitical changes, inflation, kudos to U.S. intelligence and military, obama, Osama Bin Laden, President's reelection, risk aversion, stock market

Last night’s news that U.S. military forces killed Osam Bin Laden is another unexpected geopolitical development in a year that is already seeing huge changes in the world’s political landscape. The news of Bin Laden’s death is causing an immediate reaction of relief and exultation which is seeing large gains in U.S. equity futures which will translate into large gains in U.S. stocks at today’s open. The very short term reaction in U.S. stocks will see a reversal in recent surges in safe haven investments led by gold and oil which are already trading down in Asian and futures markets. This reversal of risk avoidance will last in the very short term but economic and geopolitical realities will reassert themselves in fairly short order.

First, the U.S. markets will still have to deal with U.S. budget contentions that threaten to stall a rise in the U,S. debt ceiling that must be done to avoid a potential U.S. debt default. We continue to believe an eleventh hour agreement on raising the debt ceiling will occur but the cost in the form of higher taxes and decreased federal spending will be significant.

Second, the rise in inflation through the first quarter and extending into the current quarter threatens the growth of personal consumption and business profitability. Already more companies are announcing price increases necessary to pass along higher commodity, manufacturing and distribution costs. Unless, commodity prices collapse on an extended basis through the second half of this year, inflation will continue to be an economic headwind, not just for the U.S. but more importantly, for most economies overseas.

Third, the Fed’s QE 2 program will end at the end of June. What will the effect on the U.S. Treasury market be once the Fed stops absorbing the continuing large issuance of Treasury debt to finance this year’s large deficit.

Fourth, while the killing of Osama Bin Laden is a huge psychological victory over Al Queda, the reality is Al Queda has been operating independently of Osam Bin Laden for some time as witnessed by the vibrancy of the Al Queda operations in Yemen and Africa. The killing of Osama Bin Laden will not change that fact or the threats from local Al Queda chapters. In fact, these factions may intensify their threats in order to offset the psychological loss of Bin Laden.

So after a near term robust rally in U.S. and overseas equity markets, we expect euphoria to be tempered with economic realities. The impact of Bin Laden’s loss may have more mileage in the Arab world where people may feel a sense of relief and increased security that will empower them to further their fight for economic and political change in North Africa and the Middle East. In the dizzying pace of international events, it is difficult to forecast with clarity how political and economic developments will be shaped but major changes in both are underway and the status quo around the world is being altered.

Finally, we have been critical of President Obama in his handling of foreign policy including our recent website article on the Middle East. Despite critical diplomatic setbacks, we must congratulate the President and the counterintelligence agencies and the military for what appears to be first rate work in intelligence and military operations and decisive action on the part of the President to secure the prize. This will undoubtedly be a huge boost to the President’s reelection chances and deservedly so.

First Quarter GDP will be a slowdown

Morris Segall      consumer spending, corporate profit margins, Economic Growth, economic recovery, first quarter GDP growth, flattening corporate profit growth, housing weakness, inflation, inventory reorder cycle, Japanese catasrophes, overseas political unrest, rising commodity prices, sovereign debt woes, weak housing prices

We have been expecting first quarter GDP, which will be preliminarily reported this Thursday, April 28, to be slower than the growth reported for the fourth quarter of 2010 (+3.1%) because we did not expect consumer spending to be sustained at the elevated level (approximately 7% annualized rate of growth in domestic sales) achieved in last year’s fourth quarter. Therefore, we had expected first quarter GDP growth to be in the vicinity of 2.5% with reduced consumer spending being offset by strong manufacturing shipments, including exports, and a beginning of an inventory reorder cycle to replenish the strong movement of goods in the fourth quarter of last year.

However, we have been telling our clients and audiences since early April, that first quarter GDP growth could be weaker than our initial 2.5% estimate due to the rising cost of food and fuel that was stifling consumer spending more that we expected and also causing a pause in the level of discretionary business spending as businesses evaluated the impact of higher fuel and commodity prices on near term profitability. In our February 2nd economic and capital market presentation to our clients, we highlighted the flattening slope of corporate profit growth being seen in the second half of 2010 and expected to continue in 2011. We pointed out to our audience that the easy and geometric gains in corporate profits coming out of the recession were going to have be replaced by greater unit volume growth and profit margin maintenance as the economic recovery progressed. The escalation in energy, commodity and service costs is definitely pressuring corporate profits in the first quarter of this year.

In addition, to weaker than expected consumer and business spending, housing weakened dramatically in the first quarter from bad winter weather and most importantly, excess housing inventory from high levels of foreclosures, which in turn caused a further weakening in housing prices. We have been forecasting the latter since last summer but the level of housing sales in the first quarter was extraordinarily weak. This will be a further depressant to the first quarter GDP.

Given the additional negative impacts on world economic growth from continued sovereign debt woes in Europe, the earthquake and nuclear catasrophes in Japan and spreading political unrest in North Africa and the Middle East, a slowdown in first quarter GDP in likely to be incrementally weaker. At this juncture, we have been using a revised estimate of approximately 2%, plus or minus for the quarter. The weakness in the first quarter could be made up over the remainder of the year if inflation pressures recede, geopolitical events stabilize and further gains in manufacturing and employment continue. At this point we are not reducing our full year estimate of 2011 GDP growth from approximately 3% but current trends are troubling. We will have further to say after this week’s preliminary GDP announcement and the upcoming publication of our updated economic outlook presentation on our website.  

Morris R. Segall

S & P Joins the U.S. Budget Debate

Morris Segall      austerity programs, bailout, business confidence, business landscape, Capital Markets, consumer sentiment, consumer spending, Economic Growth, economic recovery, federal deficits, future trends, GDP, national debt, politics, recession, tight credit

This morning, Standard and Poor’s downgraded the U.S. credit rating outlook from stable to negative. The rating agency cited the high level of public debt as a percentage of GDP and the uncertainty that adequate actions to significantly reduce the U.S. debt level and maintain it at manageable levels would be undertaken in the forseeable future. The negative outlook and the reasoning behind it portend a “one in three likelihood of a lower long-term credit rating on the U.S. within two years” according to the text of the S & P release. Standard and Poor’s states the leverage on the U.S. balance sheet and accumulating annual deficits are higher than other countries with sovereign debt ratings of AAA.

We are not surprised by the S & P action. Indeed, in our website article of September 8, 2008, “Stocks, Recession and the Bail Out” we cautioned that the massive federal bailout of the housing and banking industries would add billions to annual deficits and the national debt. We further stated “The cumulative effect of ballooning annual federal deficits, the secular pressure on the federal budget from increasing entitlement spending and the continuing balance of trade deficit may lead to a downgrade in the U.S. government credit rating and a further aversion to U.S. dollar denominated assets longer term”. The extended decline in the U.S. dollar versus other currencies has reached historical proportions in the first four months of this year, even against the financially questionable euro. 

While we are not surprised by the S & P action, we are surprised at the timing of the ratings outlook. Why now in the heat of the budget debate between Congress and the President? Why didn’t Standard and Poor’s wait until mid May after some decision on the federal budget and increase in the debt limit would have been forthcoming? It is our opinion that by releasing this downgraded credit outlook now, it would have a significant impact on the budget deliberations and possibly tilt the argument in favor of more draconian spending cuts as advocated by the Republicans in Congress. It is not unreasonable to believe that outside credit analysts, rating agencies and economists have come to the conclusion that the U.S. must adopt an austerity spending program similar to those adopted by the European Union as a solution to its excessive debt burden. By using a time frame of three years (similar to that employed in the European austerity programs) to measure progress, S & P makes the same mistake such a short time period has created on the countries in Europe. It is simply too short a period of time to deleverage sovereign balance sheets without stifling critically needed economic growth to provide the means to paydown debt (See out website articles of December 17, 2010 and March 15, 2011).

Today’s ratings outlook release by Standard & Poor’s misses important differences between the U.S. economic situation and those of Ireland, Greece, Portugal and Spain. The U.S. economy is in recovery led by manufacturing, exports and more recently consumer spending. Employment gains have accelerated since last November. While the recent surge in inflation has slowed U.S. economic growth coming out of the first quarter of this year, the recovery trend is not aborted. It will be if the Federal government is forced to make drastic spending cuts which will reverse its role as an economic stimulant to an economic depressant at this sensitive point in the U.S. economic recovery. We argued in our economic articles on Europe and once again, that longer periods of time are required to deleverage these balance sheets. A longer period of time will allow the national economy to grow at a rate to raise tax receipts and pay down debt. We have long been advocates for greater fiscal discipline by the U.S. government that includes large spending cuts and higher taxes. However, a nation in recession cannot reduce its debt to GDP ratio.

By releasing its downgraded U.S. ratings outlook today, Standard and Poor’s has entered the political debate and abandoned its role as a neutral and impartial arbiter of credit conditions. Furthermore, the surprising timing of this release has caused capital markets here and around the world to decline significantly, further eroding asset values and wealth and business and consumer confidence already battered by overseas events in Japan, the Middle East and Europe. Declining capital markets and consumer and business confidence will lead to tighter credit conditions at a time when credit was just beginning to “loosen up”. This in turn will lead to investment and spending retrenchment, threatening the nascent economic recovery here in the U.S. The worries of a deteriorating U.S. financial condition in 2012 and beyond could be self fulfilling as a result of what we believe is an ill timed alarm. We will have to see in the coming days if the S & P action is transitory or longer lasting in its impact. 

Morris R. Segall

Charge!

Morris Segall      consumer credit, consumer sentiment, consumer spending, consumer spending sea change, credit card debt, Economic Growth, future trends, GDP

This past Monday afternoon, February 7th, the Federal Reserve released its report on consumer credit for the month of December, 2010.  Since peaking in the third quarter of 2008 consumer debt has steadily declined over the past two years by over $150 billion. Most of that reduction has been in revolving debt, largely credit card debt. This has reflected a combination of consumer debt repayment and the write-off of consumer loans in default by lending institutions and credit card issuers. After a further decline in November of last year, consumer revolving debt increased by nearly $2 billion on a seasonally adjusted basis or a 3.5% annual rate in December. This was the first increase since August of 2008 and most of that increase came in consumer credit card debt. Non seasonally adjusted data is more impressive, showing a better than $9 billion increase in revolving credit led by credit card gains at commercial banks. This change in credit card debt balances could be a signal the consumer de-leveraging is about over and consumer evaluations about their finances are sufficiently improved to allow them to begin increasing credit card purchases. If the December increase is not an aberration and continues in 2011, it will signify a dramatic change in the consumer spending dynamic.

 Up until last year’s fourth quarter, consumer spending had been anemic due to high unemployment and lagging consumer income growth, in addition to the de-leveraging of consumer balance sheets. That changed in the fourth quarter as consumer spending surged to pre-recession levels. The Federal Reserve data would indicate expansion of consumer spending in December was supported by the use of credit cards. This would explain the large increase in consumer spending (.7%) in the month of December, well above the .4% increase in consumer income growth in that month. If the December data portends a return to credit card financing by consumers, the prospect of continued high levels of consumer spending in 2011 is heightened. The willingness of consumers to increase credit card debt will counteract the suppressing forces of moderate consumer income growth and a continued high level of unemployment. This will promote a greater consumer spending contribution to the economy than one would have expected and augments the outlook for improved GDP growth this year, importantly led by the consumer.

 It remains to be seen if the December data is the beginning of a trend and we will be looking at future data to confirm or deny this important development. However, a note of caution. If consumers abandon the financial discipline of the past two years and return to spending in excess of income growth, a consumer spending renaissance will be short lived and a financially weak consumer sector will re-emerge, constricting long term economic growth.

Morris R. Segall, CFA, CIC

May Retail Sales: Unexpected weakness

Morris Segall      consumer spending, disinflation, wealth destruction

May retail sales reported this past Friday showed a surprising decline of 1.2% from upwardly revised April levels. We usually would would look at the May decline as a normal respite to strong gains in the previous month. So while retail sales, excluding food and gasoline sales, did increase significantly (.7%) in April, the comparable decline in May sales amounted to 1.2% and the declines encompassed many areas of discretionary consumer spending including building materials, clothing and autos. In addition, the level of retail sales in May, again excluding grocery and gasoline station sales, was also approximately .5% lower than comparable retail sales reported in March. After surging through the first four months of this year, consumer spending may be stalling, at least temporarily, as a result of the dramatic and severe decline in the stock market last month. We commented in our last blog posting, June 6, 2010, that “ the pace of the U.S. economic recovery could be retarded by the current stock market decline”.  Combined with the expiration of the home buyer tax credit and impending expiration of extended federal unemployment benefits, consumer spending could be at least taking a hiatus if not a more serious retrenchment. We expect consumer spending will rebound from May levels over the summer as Americans take vacations this year and increase domestic travel  due to lower gasoline prices and overseas travel due to the strong value of the U.S. dollar.

 The question is will it and if so by how much. Consumer incomes will have to grow consistent with the .3%-.4% rates of the March-April periods to provide the resources necessary for consumers to step up their spending. The psychology of consumers facing new wealth destruction from the stock market, suppressed equity in their homes and new fears regarding economic and job growth could cause consumers to become cautious again. A cautious consumer will not fill the void being created by abating Federal stimulus and aid programs.

At this time we are sufficiently concerned about the recent confluence of negative events in Europe, the worldwide capital markets and the suppressing effects on U.S. economic growth to revise downward our projections of  U.S. and overseas economic growth for this year and next. In our April 4th blog posting, “Happy Days Are Here Again…”, we projected U.S. economic growth in the second quarter would be in the range of 4%-6% largely based on the surge in consumer spending we were detecting coming out of the severe winter. Indeed, consumer spending in the first quarter accounted for 2.4% of the 3% growth in the first quarter, the highest level since the onslaught of the recession. We now believe second quarter GDP growth in the U.S. will range between 3%-4% due to lower expectations of consumer spending from our previous forecast. We continue to project total U.S. GDP growth for 2010 of 3% but within a range of 2.5%-3% rather than the 3%-3.5% previously projected. For 2011, we are using a projected range of 1%-3% for U.S. GDP growth next year, down from our previous expectations of 2%-3% growth and we are telling clients and audiences that this revised outlook is subject to further change as developments here and in Europe become clearer. Commensurate with our lower expectations of  U.S. and worldwide economic growth this year and next, we now project disinflation in the U.S. over the remainder of this year and into next as the upward pressure from rising commodity prices seen in the first half of this year reverses from the recent fall in energy and industrial commodity prices.  

We will publish a more detailed discussion of our current economic and capital markets analyses and forecasts on our website, www.spgtrend.com.

Morris R. Segall, CFA, CIC