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American Consumer Sputtering in Q1
Gluskin Sheff
By David Rosenberg
March 29, 2011

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WHILE YOU WERE SLEEPING Overseas equity markets are weak in the aftermath of the late-day reversal in the U.S. — the four-day rally in Europe is coming to an end as bank shares retreat on concerns over capital levels (and note that the Nasdaq closed yesterday’s session fractionally below its 50-day moving average). Asian markets were lower pretty well across the board — ostensibly on the news that radiation in Japan is spreading into the soil and the ocean. Japan did produce some decent jobs numbers today, but the data are irrelevant insofar as they were prequake (have a look at Japan Faces Power Gap For Months on page B1 of the NYT for what is about to happen to the world’s third largest economy — 11% of the country’s total power generation is out of commission).

Bond markets, however, continue to trade on the defensive side ahead of fresh supply issuance ($35 billion of 5-year notes) even though there has been a respite in the commodity markets. Crude oil is trading at its lowest level in a week as the Libyan rebels make further inroads and both gold and copper are on their way for a fourth straight day of giveback (the latter on fresh signs of slowing demand in China).

News that French consumer spending almost doubled consensus estimates with a 0.9% gain in February has added some oomph to the positive euro trade too. Meanwhile, the fact that S&P issued a new warning that it is poised to cut Portugal’s credit rating yet again this week (depending on how the EU talks go) doesn’t seem to resonate (except for the country’s debt market as the 10-year bond yield heads towards 7¾% even in the face of renewed European Central Bank buying support). And aren’t the largest foreign holders of Portugal’s debt the Spanish banks, who are also saddled with toxic real estate debt? To be sure, the euro has been supported by some decent data out of Germany and France and heightened rate hike expectations, but the sovereign debt issue along the periphery remains a dark cloud and so does the recent misfortune that Angela Merkel has faced at the voting booths, which will only weaken her even more when dealing with her EU colleagues in terms of providing more bailout money (see The Lights Go Out on page 9 of the FT — a must read).

At the same time, Chicago Federal Reserve Board President Evans took a feather from James Bullard, his neighbour from St. Louis, in discussing the lack of necessity for more monetary stimulus (though hardly any want to touch the existing, though dwindling, $600 billion program). Considering there is an 88% correlation now between the direction of the stock market and the movements in the Fed’s balance sheet, the end of QE2 could prove to be another source of financial volatility and weakness during the second half of the year. So the tone, whether from a monetary or fiscal stance, from policymakers just about everywhere is one of restraint, and at a time when the major averages are near two-year highs. This is a far cry from the widespread move towards rampant stimulus back in early 2009 when the markets were trading at multi-year lows. The easy money days are either ending or about to come to an end and as such expect to see a much more discerning market in favour of large-caps, balance sheet quality, dividend growth and earnings stability. As we explain below, the outlook for the U.S. consumer is grim. Much of the payroll tax cut is now being absorbed by higher food and energy costs (gasoline prices have jumped more than 50 cents this year). In fact, over the past three months, 100% of the $55 billion increase in aggregate wages and salaries has been absorbed by the run-up in the grocery and gasoline bill. The labour market is not nearly as strong as it needs to be to provide the antidote, and at the same time fiscal policy is swinging from massive stimulus to moderate restraint (have a look at U.S. Muni Bond Demand Slides Into Deep Freeze — local levels of government are not able to raise money and as such are cancelling capital projects … sad but true… and outside of the consumer, this sector is the largest contributor to GDP). Also have a look at Michigan Cuts Jobless Benefit By Six Weeks on the front page of today’s NYT.

As the chart below shows vividly, over 22% of wages and salaries are now being devoted to the cash register at the local food store and at the pumps — we’ve only seen this level two other times in the past two decades and both ultimately landed the economy into recessions that ensnared discretionary household The euro is firming again on speculation that we will see an early rate hike by the European Central Bank (many German states are already reporting MoM consumer price increases of 0.4-0.5% for March) — the consensus is now targeting April 7th as the date of the volley. The euro has just firmed up to a fivemonth high against the Sterling as well, part of this may be home-grown for the Brits (see Pound Feels Pressure of Declining UK Outlook on page 22 of the FT). spending. The good news — a new bull market in frugality, ‘trade down’ goods and private label is likely on its way again.


And don’t look now but we are all of a sudden starting to get some mixed news out of the once-hot manufacturing diffusion indices. No sooner did the Richmond Fed index slide 5 points to 20 in March but the just-released Texas manufacturing index published by the Dallas Fed dropped 6 points to 11.5. With the stock market able, in recent weeks, to shrug off the “financial shock” from all the global turbulence we have been seeing, the next question is how investors will be coping with increasing signs of sharply slowing economic growth in coming months and quarters.

Finally, attention has to be paid on what is happening in Canada. The loonie has been a constant surprise, not only fairing very well through all the global turbulence but also the aftermath of the federal election announcement. The Canadian dollar has remained above “par” each and every day since February 1st and the long GOC bond yield at 3.7% is not only 80bps below U.S. levels but is now 7bps lower than Germany, which is another country that retains very decent macro fundamentals.

Without the need for rampant fiscal stimulus or monetary accommodation, the Canadian economy has accelerated back towards a 4% annual rate. By some measures, core inflation is as low as 0.4% and this is with unemployment at 7% when placed on an apples-to-apples comparison to the United States. It’s not as if there are absolutely no blemishes at all — Ontario’s financial situation and Canadian household debt loads are a concern but the worries raised in the article on page C1 of WSJ (Housing Booms North of the Border) would seem to be misplaced. We also at one point were concerned over a possible large home price correction in Canada but the reality is that the builders here have been much more aggressive about curtailing production than was the case south of the border back in 2005 and 2006. Single family housing starts are nearly down 20% from year-ago levels and as such there is no evidence of any meaningful supply-demand imbalance that should undercut real estate valuation. We see no reason why the Bank of Canada should be aggressive in raising rates, and at the same time, the demographics in favour of real estate are actually quite constructive, notably the influence from Canada’s business immigration platform. Note that in 2009, net international immigration to Canada surged 13%. So not only is the country acting as a magnet for international capital inflow, but Canada is also being increasingly viewed as a stable place to do business and a desirable area to live.


The U.S. consumer spending and income report for February was a bit of a mixed bag. First, personal income in the U.S. did eke out a 0.3% MoM gain in February, but it was below expected and failed to keep up with the rise in inflation, which are largely, but not exclusively, being driven by food and fuel prices (accounting for half the increase). The personal consumption expenditure (PCE) price deflator rose 0.4% MoM and as such real income ― straight up, net of taxes and excluding personal transfers ― fell 0.1% in the first contraction since last September.

Recall too that nonfarm payrolls did rebound by 192k on the month and you can see that even with that, real income is slipping, not rising. Beyond this quarter, the incremental effects of the payroll tax cut starts to fade ― adjusted for inflation, wages fell 0.1% and are down now in three of the past four months. Consumer spending did manage to exceed expectations with a 0.7% MoM gain in nominal terms, but again, inflation ate into more than half that; therefore, in real or volume terms, the increase was +0.25% after a flat January. And this includes the sudden revival in auto sales ― we shall see if this lasts. But what is apparent is that consumer spending is coming in around a 1% annual rate in real terms so far in Q1 and we see from last week’s numbers on durables that capital spending is suddenly running pretty close to zero growth.

We also know that housing activity has remained moribund. So here we have over 80% of the economy just trudging along and it remains to be seen:

(i) What the March data flow will look like, and

(ii) The extent to which other components such as inventories and exports can provide an offset.

One thing is for sure: between the horse trading being done at the federal level to avoid a shutdown in Washington and the accelerated cutbacks at the state and local government levels, we are not holding our breath on any fiscal help from the government sector. Many forecasters have gone from a 4% growth forecast for Q1 down to just over 2% and now even that latest estimate may be overly optimistic.

One other thing to consider regarding the consumer. The savings rate fell to 5.8% from 6.1% in January and absent that drawdown we would have seen real consumer spending actually dip 0.1% during the month. Income fundamentals must improve going forward to help sustain the consumer ― either that or relief on the food and energy front. But with the University of Michigan consumer sentiment index faltering so badly, especially the key ‘expectations’ component, then it does appear that there will be no spending spring this spring.

You don’t have to wade far into the Commerce Department’s database to see how much more cautious the consumer has become. It is in part due to lower home prices, and in part due to higher food and fuel prices. Job markets have improved but not enough to generate significant wage growth. Of course, the headline news from Japan to Europe to the Middle East would cause anyone to pull back, at least a touch. And we saw this caution in Marriott’s numbers from yesterday ― the company said that REVPAR (revenue per room available) would come in around 7% growth on a YoY basis in Q1, at the low end of its target band of 7-9%. For North America, the pace is seen at 5-6%; down from a February call of 6-8%. This is key because accommodation is very cyclical and sensitive to how people are reacting to higher energy costs in general. And it is consistent with the latest data from the Conference Board’s consumer intentions index which showed that travel plans from December to February collapsed six percentage points from 51.1% to 45.1%.


U.S. pending home sales rebounded 2.1% in February after two awful months but are still down 9.3% from year-ago levels. This has become a notorious volatile indicator, and the trend is still extremely soft, though it does portend a bit of rebound in coming months ― but not enough to break the primary path which is visibly down. There are up to four million homes in foreclosure or in the pipeline so to be talking about any housing recovery at this juncture is premature, to say the least.


Portfolio managers as a group are running their funds overweight equities by an average of 67% relative to their typical benchmarks. And polls show that onethird of them believe QE3 is coming this summer. We already know that this Bernanke-led Fed is willing to be extremely aggressive, but as we saw in 2010, the hurdle is high for quantitative easing. We need (i) signs of a double-dip, (ii) a stock market correction of at least 15%, and (iii) deflation, not inflation. How on earth will the Fed be able to do anything at all by then if headline inflation is running north of 4% and the other central banks of the world are either snuggling policy or moving in that direction ― unless the central bank really wants to trash the dollar. We are certainly not inflationists and still see deflation in credit, real wages and housing prices.

As the charts below illustrate, the Dallas Fed trimmed mean PCE deflator accelerated at a 2.2% annual rate in February, a spike we last saw two years ago. And while it is way too early to tell if the YoY trend in the second chart is the start of a new trend or just a blip, but suffice it to say that the Fed is probably not going to have the smoking gun it had last fall.



(c) Gluskin Sheff


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