Weak U.S. Consumption Is Restraining U.S. Production

 | Feb 01, 2017 | 10:00 AM EST
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Since the election of Donald Trump the majority of my columns have been dedicated to providing reference, or anchor points, about the structure of the U.S. economy, what they imply about current economic activity and potential, and how it relates to foreign economies, probable domestic public policies and the capital markets in general.

Even as U.S. equity markets, Treasury yields and economic confidence have surged in the last few months, along with expectations for continued strength offered by the FOMC in its December decision to raise rates, two alternative measures -- here and here -- of consumption and production are providing counter narratives.

On the consumption side, the Restaurant Performance Index for December, released yesterday by the National Restaurant Association, continues to show a deterioration in restaurant sales; a trend that began in early 2015.

The lack of growth in that segment has not been lost on investors either, as was evident in the Restaurant ETF (BITE) having been liquidated after only 15 months due to low interest.

I've never been a fan of the restaurant business from an investment standpoint, as I discussed in the column, "Restaurants Reflect Consumption Trends (Literally)," but restaurant sales are an excellent way of determining whether people are really confident about their personal financial prospects versus just stating such.

Putting their money where their mouth is, so to speak.

On the production side, the Chemical Activity Barometer (CAB), is an excellent alternative to traditional industrial production measures. The American Chemistry Council released the January CAB last week showing an increasing trend.

However, just two days later the Council released the Chemical Production Regional Index (CPRI) showing that production had decreased from November to December and was down in every category and region in the U.S. by an aggregate 1.5% in 2016 from 2015.

What's most important to note about this is that it occurred even as oil prices rose strongly throughout the year and the increased Permian basin production buoyed chemical demand during that period. Without that the CAB and CPRI would have performed much worse. 

What's even more important about the decline in the CPRI though is that it occurred during December's cold weather, which caused the Federal Reserve's Industrial Production and Capacity Utilization report, G.17, to surge by the most in 2 years.

Without the cold weather snap that caused utility production to increase that report, the CAB, and the CPRI, would have been worse.

The germane point for investors is that while capital market participants, consumers, and the FOMC, have been expressing increased expectations of accelerating growth, and the media has largely been inanely focused on the Trump administrations initial policy decisions, the real economy is continuing to stagnate.

The dichotomy between expectations and reality of the past few months also caused failed housing sales to spike at the end of last year because the surge in mortgage rates precluded sales from closing.

This is an issue I warned about as mortgage rates started climbing from last summer's lows and last addressed the importance of a month ago in the column, "There's No Pent-Up Housing Demand."

The totality of all of this validates, as I've been warning about for over a year, that production is constrained because consumption is constrained, and consumption is constrained because income and job growth is constrained, and most importantly that net demand is constrained because personal incomes are now fully collateralized to debt service. 

The economic term for that is a vicious cycle.

If the dichotomy between expectations and reality continues the vicious cycle will metastasize further and negatively impact all sectors of the economy.

The way that plays out is that The way that plays out is that increases in the cost of capital can't be passed on to final consumers, which results in compression of capital costs vs. capital returns. Costs rise faster than revenue and earnings. Earnings decrease and cost cuts are implemented, which means job and income growth deteriorates further.

A more incipient issue in the current climate of a rising Fed funds rate, which will be particularly hard on the banks, is the inability to offset decreasing productive loan originations with increases in carry loans made to their largest corporate clients.

In fact, as is probable with the recent surge in corporate debt issuance, companies are in the process of paying down short-term rolling bank loans with longer dated maturities.

The natural corrective measure for this activity is either a forced increase in demand provided by fiscal policy, a reversal of monetary tightening or a reduction in economic activity, equities and bond yields.

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