Economic Activity Is Slowing

 | Apr 25, 2012 | 4:33 PM EDT
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Wednesday's Federal Reserve statement provided no indication that the FOMC has changed its sentiment concerning the U.S. economy. Investors can look forward to parsing the minutes when they are released in the future. But this growing fixation on the Fed's statements and minutes by so many in the financial media and market actors is disconcerting. The majority of the data used is readily available to anyone who wishes to consider it before the Fed does.

One of the most common questions I'm asked is if I still believe the U.S. is headed for a recession this year. The follow-on questions are usually whether or not housing values and mortgages will continue to fall, will there be another round of quantitative easing, and will stock prices fall. The answer to all continues to be yes. I also believe the U.S. dollar will rise and gold will fall.

My rationale is simple: Personal-consumption expenditures represent about 70% of gross domestic product, and consumption leads production and job creation. Historically, consumption increases are apparent first in an increase in housing activity and auto sales. That is followed by increases in other durable goods, which are then followed by all other consumption. This causes capacity utilization to increase, which is typically coupled with an increase in bank loan activity other than for real estate and autos. Then jobs are created and the virtuous cycle begins.

As it stands now, not only is this process not happening, the front of the consumption cycle is continuing to slow. With the exception of an increase in auto sales (attributable to an easing of credit access) housing is not rebounding and durable goods orders are falling.

March's advance report on Durable Goods from the Commerce Department showed the biggest decline in three years, indicating that GDP growth for the first quarter of 2012 is below the fourth quarter of 2011. In other words, the U.S. economy is slowing.

The euphoria over Apple's (AAPL) revenue numbers, however, apparently negated concerns about the durable goods slow down, as stocks, most notably high-end retail, were broadly higher throughout the day Wednesday and more so than the S&P 500.

Apple's halo effect had Ethan Allen Interiors (ETH) up more than 8%, Nordstrom (JWN) up about 2%; Williams-Sonoma (WSM) up nearly 3%, and Whole Foods (WFM) up nearly 1.5%. And many others rose considerably. 

But this presents a bit of a conundrum. Declining durable goods and capital spending in aggregate indicates a slowing economy, yet companies catering to high-income consumer tastes have been doing very well with rising revenues, earnings and stock prices.

In comparison, companies serving consumers of more moderate means have been performing well recently. Sears Holdings (SHLD), although up nearly 3% today, is off by almost 40% in the past six  weeks and has suffered consistently falling revenue for the past three years.

Wal-Mart (WMT) has had grinding revenue and profit increases over the past three years, with declining profits as a percentage of revenue, and its stock price is sideways for the year and down today.

Although Target's (TGT) stock is up about 10% since the beginning of the year, it also has not benefited from Apple's halo today. Its past three-year revenue and earnings rates have been similar to Wal-Mart's.

Other mid-level retailers are showing similar patterns in stock price performance, as well as in revenue and earnings.

Although the high-end retailers should lead the broader consumer staples companies, there should be both correlation and causation evident.

The top 10% of income earners account for about half of all personal income in the U.S. Their consumption and discretionary spending account for about a third of GDP. Spending by this group leads to consumption by the bottom 90% of the population, as measured by income, because their spending is what provides the jobs and incomes for everyone else.

There is a circular issue here that is important to understand. Consumption by the bottom 90% drives the prices of the stocks of the companies that are overwhelmingly owned by the top 10%. 

If the increase in consumption by the wealthiest does not cause an increase in consumption by the rest, the economy cannot grow and net financial position of the wealthiest will slow. That will cause their consumption to decrease, and that sets the stage for slowing economic activity and a recessionary trajectory.

The durable goods and capital spending numbers released today, coupled with still-languishing housing, indicate that this may be what is unfolding now. Results in the next few months will be very important to follow.

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