Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
Gary Shilling has been more dour than most on the underlying economy the past 3-4 years, and that could be argued was a relatively good call. Despite never before seen levels of federal government and central bank intervention, the economy continues to limp along at what I call a “meh” pace. Normal recoveries sans massive intervention should have had some sustained periods of 4-5%+ type GDP growth; we’re happy with 2-3% nowadays. Gary’s long U.S. Treasuries call has been against the grain, and mostly right the past few years, and he’s had quite a few other prescient calls as well. Shilling posted 2 articles on Bloomberg, stating the case for a recession in 2012 – which is now again an outlier view. We’ll look at part 1 today, and look at part 2 which focuses on the labor market tomorrow.
Here are some of his views as he looks at the main pillars of the economy:
- For several months, I’ve been forecasting a recession in the U.S. this year, arguing that weakened consumer spending – the key to the economic outlook — would tip the economy back into a downturn. But what about recent positive data and markets? Do they affect my forecast?
- Consumers Are the Linchpin: The U.S. economy is being fueled these days by strong consumer spending, which increased in February by 0.8 percent, its best showing in seven months, after rising 0.4 percent in January. Retail sales rose 1.1 percent in February — the fastest pace in five months — while same-store sales advanced 4.7 percent. These numbers correlate with recent gains in consumer confidence and sentiment.
- I don’t see this pace continuing. Personal-income growth continues to be weak — up just 0.2 percent in February — meaning this recent exuberant consumer spending is being fueled largely by increased debt and tapping of savings.
- At the same time, pay per employee is rising slowly and continues to fall in real terms. So increased job growth remains the key to any increases in real household after-tax income, which declined in February for a second straight month and gained a mere 0.3 percent, compared with February 2011.
- Spending, Saving and Debt: The support that consumer spending has received from less saving and more debt appears temporary. Household debt – including mortgages,student loans, and auto and credit-card loans — has fallen relative to disposable personal income, though. In my analysis, this is largely because of write-offs of troubled mortgages. Nevertheless, revolving consumer credit, mostly on credit cards, is no longer being liquidated.
- Non-revolving consumer credit continues to rise in response to growing sales of vehicles — most of which are financed — and in student loans, as the poor job market keeps students in school or sends them back. Tuition increases encourage more borrowing, while interest costs on past-due loans mount. [Mar 8, 2012: What Drove Yesterday’s Surge in Consumer Credit? Massive Upswing in Federal Student Loans]
- It would seem, then, that contrary to my steadfast belief that consumers are being forced to save more and reduce debt to rebuild net worth, they have been doing the opposite lately.
- Consumer Retrenchment: The data so far aren’t conclusive, but evidence of U.S. consumer retrenchment is emerging. Consumer confidence has moved up recently but remains far below the levels of early 2007 before the collapse in subprime mortgages set off the Great Recession. Real personal consumption expenditures growth has been volatile in recent months and falling on a year-on-year basis. Voluntary departures from jobs, another measure of confidence, may be decreasing. And consumer spending will no doubt have a big slide if my forecast of another 20 percent drop in house prices pans out. (Mark’s note: that seems aggressive!)
- Housing activity remains depressed, with the only signs of life coming from the multifamily component, which is being driven by the appetite for rental apartments as homeownership declines.
- What Oil Threat?: Recently, there has been great concern about $4 per gallon gasoline and whether, as in 2008, those high prices will act as a tax on consumer incomes and force drastic cutbacks in other purchases. These concerns are overblown. American consumers have reacted to rising gasoline prices as you would expect in tough times: by consuming less. Demand (DOEDMGAS) in the mid-February to mid- March four-week period was down 7.8 percent from a year earlier, mainly due to more efficient vehicles.
- As a result, the recent surge in gasoline prices has had a relatively small impact on consumer purchasing power. The $14.8 billion increase from October 2011 to March 2012, compared with the year-earlier period, amounts to about 0.3 percent of consumer spending.
Conclusion:
- Consumer spending is the only major source of strength in the U.S. economy this year. State and local-government spending remains depressed because of deficit woes and underfunded pension plans. Housing suffers from excess inventories and may face a further 20 percent drop in prices. Excess capacity restrains capital spending. Recent inventory building appears involuntary. So consumer retrenchment will tip the balance toward a moderate and overdue recession.
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Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
