the economy poised for a recovery, as the stock market seems to expect?
Or are we in for another few more quarters of recession and/or slow
growth? In this week's letter we take a look at consumer spending,
inflation, and other data to see if we can find a clue or two to give
us an idea of the direction of the economy. There is a lot of data, so
let's jump right in. (Media note: Right now I am slated to be on Kudlow
and Company next Wednesday.)
Retail Sales Take a Dive
commentators, looking for a bullish lifeline, have pointed to the fact
that retail sales grew in April by 1.8% over this time last year. But
that is truly grasping at straws. Just last November they were growing
at 6% year over year and have been dropping relentlessly for the last
six months. And as good friend and data maven Greg Weldon points out,
retail sales last November were 1.3% over inflation and now are a
negative 2.1% below inflation. Retail sales are clearly headed down. (www.weldononline.com, a must-read for those who need in-depth analysis of all things and data economic)
there was growth. Gasoline sales were up 16.3%. And food sales were up
6.1%. 77% of the increase in retail sales this year has been from
increases in food and gas sales. If you take out food and gas, retail
sales are down by about 2% in the last three months.
is getting squeezed. Reuters did a rather anecdotal, but revealing
survey of Wal-Mart buyers at the beginning of the month. They found a
significant increase in store traffic from the end of the month to the
first of the month. Surveys showed that shoppers were stretched on
their budgets due to rising gas and food costs and simply had to wait
until their monthly checks came to go to the store for food. Many
indicated they had changed their buying habits, now shopping at
lower-cost stores like Wal-Mart.
At the Mauldin household I must
admit to a kind of food shock upon my return. I eat a lot of smoked
turkey from a local grocery deli. Arriving back from South Africa last
night, I sent my oldest son to the store to put in a supply for the
next few days. My "regular" turkey that was about $5.99 a pound a few
months ago is now selling for $8.99. That is considerably higher than
the 5.9% food-at-home inflation rate that the folks who give us the CPI
tell us is the case. Next time I will find a less expensive brand, as
the Reuters survey suggest shoppers all across the country are doing.
do recognize the inconsistency of saving a few dollars at home while I
eat out at nice restaurants where the price increases are even greater.
It is all about what is in your head. There are books and massive
studies devoted to such behavior.)
"Leslie Dach, executive vice
president of corporate affairs and government relations at Wal-Mart,
said the cycle of shoppers running out of money in between paychecks
and then flocking to its stores on payday is 'more pronounced, more
While many U.S. retailers are facing waning sales as
shoppers cut back on purchases of clothes, jewelry or home furnishings,
Wal-Mart's vast grocery business and its emphasis on low prices is
spurring a resurgence at its U.S. stores and in its stock price."
But prices are actually up at Wal-Mart. And not just
from food. Looking at the latest Commerce Department data, we find that
US import prices are up 15% year over year. Even taking out gasoline,
prices are up 6.2%. And it is somewhat surprising that it is only 6.2%.
Because the dollar has fallen by more than 6%. The Chinese
ambassador to the US, Mr. Zhou Wenzhong, recently pointed out that the
Chinese renminbi has appreciated almost 19% since July of 2005. I have
been writing for years that the Chinese would allow their currency to
appreciate slowly and steadily for their own purposes and on their own
schedule. They need to do so in order to contain their own rising
inflation. Look for it to rise another 10% by the middle of next year.
that because of the rise of the renminbi, the prices for oil and food
imports in China have risen 20% less than for US consumers. And the
prices they charge us for their goods are only about 4% higher. But
that meager growth is up from only 1% last fall. Those (notably
economics-challenged Senators Schumer and Graham) who have been
pressing for China to allow its currency to rise are going to find that
such a rise ultimately means higher prices for US consumers. Be careful
what you wish for, Senators. You just might get it.
consumer spending is not just due to gas and food. There is also a
psychological component. Frederic Mishkin, one of Ben Bernanke's
colleagues at the Fed, has done research that suggests the "typical
American family will cut its spending by up to 7 cents for every dollar
in housing wealth it loses. Given a 20% fall in prices, this adds up to
a nationwide reduction in consumer spending of about $350 billion a
year, or 2.5% of the U.S.'s gross domestic product. That's a big number
- more than enough to tip the economy into recession." (Conde Nast)
that's if the fall in prices is only 20%. I continue to put forth the
proposition that we are going to see a slow Muddle Through Recovery, as
the boost we got from Mortgage Equity Withdrawals during the last
recession will not be available this time.
Accounting for Inflation
beauty is in the eye of the beholder, inflation is in the eye of the
statistician. Because the number you end up with is dependent on the
models and assumptions you choose. As the chart below shows, there have
been two major revisions to how inflation is figured, one in 1983 and
another in 1998. (Thanks to Barry Ritholtz at The Big Picture for this
Note that using the same methodology as was used in
1983, inflation would be around 11.6% today. Before 1983, the BLS used
actual home prices to account for inflation. After that time, they used
something called Owners Equivalent Rent or OER. This is the theoretical
price a home would rent for. There are sound reasons to use OER and
equally good reasons to use actual home prices (as is done in Europe).
But both methods have flaws. You just have to pick a methodology and
stick with it.
And there are reasons to think that OER may not
rise as it would normally do in this part of the cycle, because so many
homes which cannot sell are being rented out, and rent prices might not
rise as much as in past cycles.
actual home prices is only useful in an average sense over long periods
of time. If you own a home with a 30-year mortgage you bought ten years
ago, then you have not experienced price inflation for ten years. You
have seen the value of your home go up, but that is not (necessarily)
inflation. Your mortgage is the same. And a first-time buyer today has
the potential to see a 30-50% deflation in home prices from a year ago
if he is in the right area, like Florida or California.
the OER tries to measure what a house would rent for. If someone pays
more than that rental price, then there is some other factor at work.
The Bureau of Labor Statistics suggests that this other factor is
investment. If someone pays more for a house than the equivalent rental
price because it is perceived as a good investment, then you are
measuring apples and oranges. The OER tries to take out the investment
Because the government agencies use OER, inflation was
understated in the recent housing bubble. As home prices drop, OER
would normally overstate inflation somewhat. If we had used actual home
prices then inflation would have been overstated in the last six years,
and now the CPI would be turning negative, even as gas and food are
As I said, neither method is perfect. Over
very long periods of time, either will give you reasonably accurate
data. But over a time period as short as a few years, let alone a few
months, there can be considerable "noise."
Also, notice in the
chart that in 1998 the Clinton administration adopted new
methodologies, among them hedonic pricing. Hedonic pricing suggests
that as a product or service improves, the price for the equivalent
item in today's market will fall. As an example, if we buy a computer
that is twice as powerful as it was a few years ago, the statisticians
assume that prices have fallen even if we pay the same for the computer.
the same way, if in one year you had to pay extra for features like
power steering or power windows in a car, and a few years later they
were considered standard, then once again the price would be deemed to
have gone down, as you were getting more "value" for your dollar. This
is considered to be the case even if in actual dollars you paid more
for the car.
Again, you can make a rational and serious economic
argument for hedonic pricing. And believe me, many economists do. But
those changes, along with others, have lowered the official rate of
inflation. And since many government benefits are also tied to the
official rate of inflation, the current methodology has lowered
government expenses as well, including inflation adjustments for Social
Security and pensions.
At one time, you could make a good case
that the inflation numbers overstated inflation. But I am not persuaded
that is the case anymore, even though many economists still argue that
point. The CPI is more or less accurate ON THE AVERAGE. But that may
not be the case for you. Your actual rise (or fall) in the level of
your expenses may be more or less than the average.
But we do
notice the increases more. The Bank Credit Analyst has a very
interesting chart in its recent May issue. It shows that the
high-frequency spending items like gasoline, food, education, and
medical care make up 50% of the Consumer Price Index. These are items
which we buy on a regular basis. And they are going up at a weighted
average rate of 6.8%, a lot higher than the 4% for the CPI as a whole.
20% of the CPI which are low-frequency items like furniture,
appliances, vehicles, and so on are actually falling at a -0.7% rate.
Since OER (equivalent rent) is roughly 30% of CPI and is rising at
2.8%, even as home prices fall the overall rate is about 4%.
tendency to notice the price increases in more frequently purchased
items more than the drop in less frequent expenditures is known as
salience. What we see every day is more visible to us and is on our
minds. And because the reality is that those prices are rising much
faster than headline inflation, we tend to think inflation is
I can look at my credit card bills and know that my
restaurant bill is rising at much more than 4% a year. I do not think I
am eating all that much better, and am actually eating less food in an
attempt to hold down my weight. My travel expenses are up by more than
the 5-7% in the BLS numbers. Those prices, and the price of turkey, are
in my face constantly.
The Fed at the Crossroads
blues singer Robert Johnson was said to have sold his soul to the devil
at the crossroads outside Rosedale, Mississippi, to be the best blues
The Fed is also at a crossroads. What's the price
for low inflation and a booming economy? Can you have both in today's
environment without a deal with the devil? And can even Old Slewfoot
deliver on such a dream?
Inflation is uncomfortably high at 4%.
Even core inflation is well above the 1-2% comfort zone. But the
economy is soft and getting softer. Even with the stimulus package
kicking in this quarter, consumer spending is likely to be weak. There
are some at the Fed who would like to raise rates as soon as possible
to deal with inflation, but the economy is not cooperating. The housing
crisis just keeps getting worse, and the credit crisis is causing banks
to tighten lending standards on every manner of credit, even with Fed
fund rates low. LIBOR and other credit costs and spreads are not
dropping as one might have thought they would in response to low Fed
fund rates. Tax receipts are slowing well below projections, especially
sales tax receipts.
Let's look at some of the pressures on the
economy. According to the National Small Business Association, more
than 5,000 firms filed for bankruptcy in April 2008, the most in any
month since new bankruptcy laws took effect in 2005. The data also show
that in the first quarter of 2008 13,155 businesses filed for
bankruptcy, an increase of nearly 45% from the 9,103 business
bankruptcy filings during the same period in 2007.
suggest that the leap in bankruptcy filings is a result of the troubles
that started with subprime mortgages and other financial instruments of
Wall Street, which are now trickling down to Main Street. The ensuing
credit crunch, skyrocketing commodity prices, and dormant consumer
sales are likely culprits for pushing many more businesses to the brink
of bankruptcy throughout 2008.
The debt of 174 large US companies
is trading at distressed levels, at well over 10% above comparable
treasuries. Diane Vazza, S&P's credit chief, says defaults are
rising at almost twice the rate of past downturns.
European banks and financial institutions have 'enormous losses' from
bad loans they haven't yet recognized and may have a harder time wooing
sovereign-fund rescuers, Carlyle Group Chairman David Rubenstein said.
on information I see,' it will take at least a year before all losses
are realized, and some financial institutions may fail, Rubenstein
said... He didn't name any companies." (Bloomberg)
& Co.'s chief executive said Monday that while the crisis in the
credit markets appears to be three-quarters over, he believes a US
recession is just beginning.
"'Even if the capital markets crisis
resolves, it does not mean that this country will not go into a bad
recession,' said CEO James Dimon, whose bank saw its first-quarter
profit fall by half due to the recent collapse of the US mortgage
market. 'The recession just started."
Raising interest rates in
this type of environment would be very difficult. Seemingly everyone
now reveres Paul Volker. But many forget, as Charles Gave points out,
that he put the country through two severe recessions, bankrupting many
Latin American countries because of the high interest rates on the
loans they had made in US dollars at much lower initial rates (shades
of 'teaser rates'), which resulted in the technical bankruptcy of every
major US bank. Those were not pleasant times, especially in Latin
America. Be careful what you wish for.
If Ben Bernanke and the
Fed governors decided to pull a Volker and raise rates in order to
combat 4% inflation, there would be lynch mobs forming.
is not clear that inflation would respond to rising rates without a
severe slowdown and an even worse recession. Oil prices would not
respond to interest rates. Inflation, as Friedman tells us, is always
and everywhere a function of money supply, and the money supply is not
growing at anywhere near the rates of the 1970s. Oil is a function of
supply and demand, spurred on by speculation. You can deliberately slow
demand by tanking the economy, but are lower gas prices worth an 8%
Likewise with food. Food price increases are
due more to government policy (as in ethanol and subsidies) and
increased demand for higher-quality foods, especially protein, from
developing nations. I have yet to see a persuasive argument that food
prices would respond to higher interest rates by courteously going
lower. Unless, of course, you put the world economy into a severe
recession. That would reduce demand for higher-quality foods. Again,
not a wise policy.
Given that, the markets seem to be telling us
that inflation in the future will not be the problem that the headlines
suggest it is today. Let's look at this note and chart from Charles
Gave of GaveKal (www.gavekal.com):
"The next question is the
behavior of prices in the future. And to gage this, I will review two
tools: one is the ECRI future inflation gauge of the University of
Columbia, and the other is the expected inflation for the next
ten years as derived from the differences between a classical bond and
an inflation indexed bond.
[Note: the red line is the ECRI gauge (left scale) and the grey is the expected inflation measure (right scale).]
least that can be said is that neither the forecasting tool of the
Columbia University (which peaked at the beginning of 2006), nor the
expected inflation are showing any signs of panic. We certainly do not
see any significant rise in any of these two tools similar to the ones
we saw from 1998 to 2000 or from 2002 to 2006. So maybe, just maybe,
what we are seeing today is a change in relative prices (food and
energy higher, housing lower) and not a general rise in the inflation
I would not be surprised at all to find that inflation is
not the problem it is today, by this time next year. In fact, given
that we are seeing two bubbles burst and a recession and slow recovery,
all of which are by definition deflationary, it would be odd if
inflation got worse from here. Stranger things have happened, but the
odds favor a view that inflation pressures will ease.
line? I think the Fed will be on hold for a rather long time. We are in
a Muddle Through Economy. Even if the economy gets worse, as Jamie
Dimon predicts, the problems in the economy would not be helped by
lower rates. And until the economy starts growing at a rate above 2%,
it will be difficult to justify raising rates in the face of such slow
growth. And given the pressure on consumer spending and housing prices,
I think the recovery that should begin later this year is going to be a
rather tepid one.
Sell In May and Go Away
studies show that since World War II, as much as 99% of stock market
returns have been generated between November 1 and May 1. Good friend
and fishing buddy David Kotok of Cumberland Advisors sums it up nicely:
to the Ned Davis (NDR) database, starting in 1950, $10,000 invested in
the S&P 500 Index every May 1st and then liquidated every October
31st would only be worth $10,026 today. That's right: had you stayed
out of the stock market from November through April and only been in
the market from May through October, you would have had no change
during the last 57 years. 21 of those years would have been negative;
36 were positive. This happened during the same period that stock
prices were rising about 75% of the time and markets made extended
"Consider the results of the reverse strategy. Buy
the S&P 500 Index on November 1st and sell all your stocks on May
1st. The outcome is dramatically different. Your original $10,000 would
now be worth $372,890 as of April 30th closing prices in 2008. Out of
the 58 periods you would have had positive results in 45 of them and
negative results in only 13 years."
David goes on to show research at www.cumber.com
as to why he thinks you should hold off on selling. I disagree, but
then the stock market has been confirming David's position. My thought
is that the Continuing Crisis will put pressure on corporate earnings
throughout the summer, with more earnings disappointments at the end of
Earnings disappointments are the stuff of bear
markets. Richard Russell, one of the more astute market observers and
in the past a serious bear, thinks we are now in a bull market. Dennis
Gartman is now a bull. How do you argue with such astute traders?
am sure Larry Kudlow will argue that the markets are telling us a
recovery is imminent because the markets are rising. Nevertheless, I
think this could be a very rocky summer for the markets in general. I
look back to 2001-02 and find three bear market rallies of 20%. The
market evidently did not know as much as it thought. But then, what do
I know? If you have specific stocks you like, or are a trader, then
that is fine. But for those whose only real equity choice in the
retirement plan of investment in a long-only index, I would find one of
the other options in bonds
South Africa, Flowers, and On the Road
Africa was wonderful. I so enjoy the country and the people. The game
runs were excellent at Sun City, as was the resort. I highly recommend
it. And thanks to Prieur du Plessis and Paul Stewart at Plexus for
being such great hosts.
And now I must tell a story about
assumptions, and how they can rise up and bite you. It seems I left a
bag on the American Airlines flight which I took to connect with South
African Airways at Dulles in Washington, DC. It had my shoes, belt, and
ties in it. So, I got to Johannesburg without the basics. On Monday
morning I rushed to the local mall, walked into a well-known men's
clothing store, and bought a belt and ties, paying for them with my
personal Citibank credit card. I did not like the shoes in that store
and went to another one and chose a nice Italian pair, as there were no
other options and time was running short. I tried to use the same
credit card, but it was turned down this time. I then used my Citibank
business card, and promptly forgot to call Citibank to see what the
The next Sunday, at a gift shop at the Cape of Good
Hope, my business credit card was turned down. I pulled out my
emergency-use-only, don't-leave-home-without-it American Express card
(I don't get miles from them I can use). I then called Citibank, and
they said they just wanted to make sure I had the card in my possession
and was using it. They then reactivated it. I asked them to do the same
for my personal card.
They looked up the number and then said I
needed to talk to the fraud department. I was then asked if I had
charged a rather large sum of money for flowers. I informed Citibank
that I had not. They said the store was trying to run the charge every
day. We both assumed that someone at the first men's store had stolen
my number and was using the card to run a scam, buying flowers that
they could sell on the local street for cash. I was glad that Citibank
was on top of things. When I got back in the office today, my new
personal card was waiting.
As I was activating it, I told Tiffani
to come in and began to tell her the story, with embellishments, of how
I was almost the victim of fraud. Why would anyone think I would spend
such a preposterous amount of money on flowers? And I am afraid I used
that story in the last of my presentations in South Africa, talking
about the need for credit research and liquidity (you would have needed
to be there to see the real relevance).
said Tiffani with a Dad-has-done-it-again smile and a don't-tell-me
shake of her head, "that was the florist for my wedding, and we have to
make a deposit. We couldn't figure out why the card was not going
through." I just dropped my head and gave the Dad sigh. I guess I do in
fact spend mad sums of money on flowers. And I will enjoy every minute
of them. August 8 is just around the corner.
I am off to La Jolla
for a quick trip Monday and then back the next day, hoping to get some
writing done next week. Look for a very interesting Outside the Box on
Monday evening from my friends at Casey Research. They provide some
very sobering data on the energy market.
We have not yet found
the lost bag at Dulles. While the shoes and books can be replaced, the
bag is actually a delegate bag from the 1996 Republican National
Convention and has some personal sentimental value. I hope it can be
Have a great week. And avoid assumptions.
Your wiping the egg off his face analyst,
56 percent of Americans believe their current economic standard of
living is declining, according to a national poll this month by the
Sacred Heart University Polling Institute in Connecticut. That number
is up from 24 percent in 2006. Only 38 percent of respondents said
their standard of living is improving, compared with 72 percent in
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