The Most Important Messages From The 4Q GDP Report
Although quarterly GDP reports are usually not at the top of
our list in terms of intensive review given the fact that by the
time this news is actually reported it is stale at best, we
believe there were some VERY important messages to be garnered
from looking at the totality of 4Q 2008 GDP report, above and
beyond the more than noticeable headline number decline. The
character change witnessed when reviewing the components of the
report is some of the most striking we have seen in a very good
while. We believe realizing what is happening and “seeing”
this character change will be very important to individual US
equity sector outcomes ahead as well as macro investment decision
making. Although we sure as heck hope not to bore you with
economic stat details, which can easily happen in a heartbeat, we
saw little to no coverage anywhere in the mainstream financial
media of the issues we’re going to cover in this discussion.
We come away with what we believe are two very important bottom
line takeaways from the report. First, behavioral change in
the US consumer may be approaching the definition of secular if
indeed current trends continue throughout 2009 and beyond.
We know that sounds melodramatic, but keep an open mind while you
look at the historical and current character relationships we’ll
cover in this discussion. Secondly, the total character of
the GDP report is suggesting to us that current stimulus plans
being proffered by the incoming Administration will be inadequate
at best if indeed consumer behavior is very importantly shifting,
as the numbers in the GDP report show us is occurring. Add
in the proposal of meaningful tax increases and the storm clouds only darken.
Let’s
get to it.
Some very quick headline background.
Although it may have been a bit lost in the shuffle, a rise in
inventories contributed modestly to the headline GDP number.
Academically, rising inventories are a positive for GDP in that
they are additive to the number. Of course actual businesses may
see it a bit differently, no? Here’s what we believe to be one
important observation. In almost classical terms, US
recessions in the post war period have been led by inventory
corrections. The key character trait is “led” by
inventory corrections. Absolutely classic stuff. But in our
current circumstances we’re now supposedly 14+ months into the
current recessionary interlude and it’s only in the last quarter
that an inventory problem is now occurring.
You can see in the chart above
that the inventory-to-sales ratio was climbing a good year prior
to the official 2001-recession period. We’ve seen a fair
amount of commentary over the past year suggesting that
corporations had kept inventories in great shape in the current
cycle, and that ours has really been a financial sector led
recession as opposed to a manufacturing, or consumer based
inventory led recession up to this point. That’s no longer
true at all. Certainly what began as a macro financial sector issue
has hit the heart of the US manufacturing and service sectors dead
center. At least as per the message of history, inventory
corrections do not abate in a quarter or two. The fact that
an inventory problem is showing itself to us now suggests we have
a ways to go before inventories and sales are back in
alignment. The massive spike you see in the chart above also
tells us the drop in consumption, which caused this anomaly, has
been very abrupt and sharp. As we have been suggesting for some time, it’s
magnitude and duration of the current economic downturn that is
key to financial market outcomes this year. In our eyes, the
inventory issue speaks to elongated duration. Does that mean
we have not yet found an equity market bottom if indeed the
duration of the current recession will be longer than most perhaps
believed up to this point? Recent financial market character is
clearly suggesting as much.
Lastly, we now know manufacturing and production is now in the
midst of being cut hard into 1Q 2009 given the very evident 4Q
inventory issue. The chart above is relatively dramatic in
its message. Economic reports in the current period already
have and in the months ahead will continue to offer little in the
way of comfort or corroboration that we’ve seen the trough of
the current economic cycle. In bottom line terms, we need to
push out expectations for an economic cycle trough and ultimate
recession conclusion. As we suggested, that means the
financial markets are still in the process of trying to discount
this elusive economic bottom that has now been pushed forward
perceptually. The bottoming “process” in equities will
continue based on this data.
The next MAJOR message from the GDP report, as we see it,
concerns the US consumer. It’s probably no big surprise at
all that consumption was weak. BUT, the big surprise to us
was that consumption was as incredibly weak as witnessed within a
period in which consumer prices were actually falling, energy
prices being the keynote poster child example of this
phenomenon. In many senses this is very meaningful character
change for US consumers relative to what we have experienced in
the postwar period. This is what we referred to as possibly
being secular in our comments above.
Let’s take a very fast look
at final sales to domestic US purchasers. Important
why? Because this measure excludes inventories. In the
combo chart below we're doing a little mixing of apples and
oranges. The top clip is the year over year change in real
final sales to domestic purchasers. Current weakness is
clearly on par with every major recession of the last three
decades at least. Importantly, we need to remember this weakness is occurring within the context of falling
nominal prices. Every other low in this indicator over the last
three to four decades occurred while headline inflation (CPI) was
rising, not falling. Absolutely key differentiation point.
If we strip out the whole inflation adjustment caught in the
“real” GDP and final sales numbers, we get a much better sense of consumer
weakness in nominal terms. The bottom clip of the chart
above does just that, as we are looking at the quarter over
quarter change in nominal final sales to domestic purchasers. We’ve never seen
anything like what occurred in 4Q anywhere over the last six
decades. It’s as simple as that.
Again, very simply, in a period of supposedly falling prices
(falling CPI) real consumer purchasing power is academically
increasing by default. As such one would anticipate that
inflation-adjusted consumer spending would not necessarily be all
that weak. But as we said, that was not the case at all in
4Q. The prior near six-decade history of the year over year
change in real personal consumption expenditures lies below.
As we detail in the chart, the current 4Q number showed us a year
over year decline of (1.54)%. Over the last six decades, the
worst experience seen prior to the present was a (1.46)% drop
during the very deep mid-1970’s recession. As the chart
reveals, we’ve hit a new low over the period shown.
The above is one expression of character in terms of
magnitude of consumer weakness in the current environment.
As we have done a good number of times in the past, we’ve
shown you the history of economic stats and asked you to imagine
you were looking at a stock price chart. One more
time. If what you see below were a stock chart, would it be
suggesting you buy, or sell? Secular change afoot as we
mentioned in terms of personal consumption behavior? It’s
still early in the game for the current consumption reconciliation cycle, but
it’s sure starting to look that way when reviewing so many US
consumer character points.
Maybe one of the most important charts of
this discussion that illustrates our point about incredibly
meaningful consumer weakness evident in the current GDP report
lies below. First, we are charting the very simple year over
year change in the CPI numbers going back to 1950 simply as a
proxy for price inflation. Alongside
is the very same data used to construct the chart above that
documents the year over year change in real personal consumption
expenditures. But this time we have inverted the year over
year change in the real PCE numbers. Important point being,
history tells us that in periods of falling prices (declining rate
of change in CPI), the rate of change in personal consumption
expenditures increases, and vice versa. Again, because the
consumption numbers have been inverted in the chart below, it
looks like historically consumption rises when CPI rises, but it’s exactly
the opposite.
You can see that we’ve shaded in the anomaly that is the
current cycle. Point blank, we have not seen this type of a
dichotomy anywhere in the US postwar period. For now, this
is something completely different. THIS is probably the key
message of the GDP report that we believe has been virtually
completely neglected in mainstream financial reporting. Key
point being, not even lower prices could spark consumption
strength. This is quite the oddity in the post war period
shown as households have always used price weakness to
increase real consumption. Always...until now.
Stepping back for a minute, we believe this set of
circumstances implies a few very important ideas that we believe
will be meaningful to our investment decision making ahead.
First, consumers are not responding to Keynesian type stimulus at
all, at least not yet. In fact, quite the opposite.
But for now, the prescription for economic recovery from the
Fed/Treasury/Administration continues to be even more Keynesian
stimulus. Second, it is clear that consumers are moving to
increase their savings. We have discussed this many a time
over the recent past. You already know that a consumption
dependent economy will not be vibrant during a period of increased
household saving. And it sure as heck looks like this
process has begun. Finally, in a consumption challenged
economic environment, just how the heck can we expect corporations
to increase capital spending? The powers that be may be
begging financial sector institutions to lend, but why would
corporations borrow for capital spending purposes when the facts
we have laid out are more than clear to them in terms of the
behavior of consumers? It also seems a pretty darn good bet
consumers will likewise refrain from borrowing at the trough if
indeed this level of consumption weakness continues. As we
see it, these are the very important issues and questions
generated by our little review of the 4Q GDP numbers.
A few last items of interest. The following is an update of a
chart we have shown you in the past. Real (inflation
adjusted) personal spending as a percentage of disposable personal
income. Believe it or not, this relationship is really a
directional mirror image of the US savings rate.
In very simple terms it’s telling us that for now, households
are increasing their savings at the expense of consumption. If
this isn’t a crisis in general consumer confidence and household
balance sheet and P&L confidence specifically, then we don’t
know what is. Again, set against the Keynesian (fiscal and
monetary stimulus) tsunami of the moment, are the powers that be
pushing on a string relative to their desired borrow and spend
influence on US households? Again, if that’s not what’s
happening, then we’re blind.
Last comment about the wonderful US consumer and maybe some
perspective about the facts we’ve now seen in the 4Q GDP
report. Although we may be dead wrong for all we know, US
consumer behavior in 4Q may indeed be very correctly anticipating
a further deterioration in household financial circumstances still
to come. We have another payroll employment report coming to
us next week. Personally, our KEY WATCH POINT right now
isn't necessarily the body count in terms of lost jobs, but rather
the rate of change in wages. Although we hope we are
completely wrong, we believe yet to come for consumers is very
meaningful wage pressure we have not experienced so far in the
current cycle. And unless history is to be completely off
base in terms of helping us “see” what is to come ahead, we
expect significant wage pressure to play out in the months and
quarters directly in front of us.
The average workweek has dropped meaningfully as of late.
As we
see it, employers first cut hours in an attempt to rationalize
costs, they then temper wage growth significantly. This is exactly
how cycles past have played out and provide a roadmap for what we
expect to come in the months ahead. Simplistically, history tells
us there has been downward pressure on US wages when the
unemployment rate increases meaningfully. Pretty much common
sense stuff, isn’t it? Right now, history is suggesting
very meaningful downward pressure on domestic wage growth still to
come directly as a result of growing slack in labor markets that
is caught up in the rhythm of the unemployment numbers. Is
this what consumers are anticipating with their behavior in the
last quarter of 2008? We’ll see, but wages are an absolute
key watch point for us ahead. If the rate of change in wage
growth begins to deteriorate markedly from here, which we believe
is what is exactly about to happen, then it’s a very good bet
the whole pushing on a string concept will become much more
mainstream thinking than not. Be prepared. Not a good thing
for residential real estate prices, the ability of consumers to
leverage up again, forward consumption in general, equity
valuations, and the
Administration’s vain attempt to restart an anomalistic credit
cycle, etc.
In very quick summation, we believe the 4Q GDP report was one
of the most important pieces of information we have seen in quite
some time. Consumer spending deteriorated badly and stands
at significant odds with historical patterns of the post war
period. It seems unmistakable that consumers have now
embarked on building up their savings. It’s becoming a
good bet that even more radical stimulus from the
Fed/Treasury/Administration is still yet to come as Keynesian
policy measures so far have failed to produce desired
results. The current stimulus package is going to be nowhere
near enough to get the job done. Consider the proposed tax increases
and the offset to the stimulus package is huge.
Unfortunately, there’s probably a lot more stimulus to come and
that has direct investment implications for the precious metals,
the potential for out year inflation, etc. As unfortunate as
it sounds, protecting purchasing power is set to be a key
investment objective ahead. Finally, if wage
growth deteriorates as we fully expect, consumption trends are not
about to turn around anytime soon. Is this what the markets
have been discounting year-to-date with the further very
meaningful swoon in equity prices? We need to watch out for
shifting investor perceptions ahead. Perceptions of a big
delay in economic recovery and the whole thought that the powers
that be are now pushing on a string. We believe the markets
already see and are discounting this right now.
Contrary Investor
www.contraryinvestor.com
March 1, 2009
Email this Article to a Friend 
Printer Friendly Version
