Some Economic Adages No Longer Apply

 | Aug 15, 2014 | 9:00 AM EDT  | Comments
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There is a flow to economic activity, expansions and contractions, and to the way it relates to monetary and fiscal policy and to the capital markets. There is a choreography to it that although is dynamic also has fundamental patterns that can be anticipated. This is one reason economic data points are considered to be leading, coincident or lagging indicators.  

With respect to economic activity, the meta-narrative concerning expansions and contractions in the economy start with retail consumption. The most important consumer item is housing. That is the reason for the adage "As goes housing, so goes the economy."

That adage has two subcomponents that are critical to understand. First, although first-time homebuyers are the engine that drives broad consumption patterns for everything else, they are not the starter of that process. That responsibility rests with the consumer of high-end properties. And the reason that is so leads to the second point. Increases in broad-based consumption start with increases in consumer spending by the wealthiest.

The consumption by the wealthy has historically been the catalyst for increases in income by those of lesser economic means, which affords them the opportunity to increase their consumption. If you want to predict what Wal-Mart's (WMT) sales will be in six months, look at what Tiffany's (TIF) sales are today.

Another subcomponent of "As goes housing, so goes the economy" is "As goes California housing, so goes U.S. housing".

For the past several decades, California housing has led the rest of the country with a pattern of increases in sales volume and asset appreciation that has then been followed by similar increases, though to a lesser degree, along the urban centers of the East Coast, and then moving inland and converging at the Mississippi River.

The California housing volume and appreciation then reaches a peak and rolls over, and the rest of the country follows, except that the peaks and troughs in California by volume and price have a larger amplitude than those in the rest of the country.

Within the past five years, the beginning of this process has been in force. Sales and price points for high-end California residential properties have rebounded and led to increases in sales of mid-tier properties. This has been followed by a pattern of the same along the urban centers of the East Coast.

Along with this, more broadly there has been an increase in consumption by the wealthiest. This has not, however, resulted in the usual transference into the consumption by those of lesser means.

I last discussed this subject in January, in the column "Retail Stocks Highlight the Economic Divide." In that column I discussed the pattern of equity performance. The stocks of companies that cater to wealthy consumers outperform those of companies that cater to the less wealthy.

Since this pattern has continued for the five years since the last recession was officially dated as having ended by The National Bureau of Economic Research, concerns are growing about the possibility that the typical economic flow is broken and that the economy is indeed experiencing a structural change.

Put another way, all of the common adages I listed are proving to be not applicable now. Increases in California housing activity have led to increases in high-end East Coast housing, but this activity has not been transferred to or been the catalyst for an increase in first-time homebuying nationally.

Increases in consumption by the wealthy that has allowed for increases in stock prices of the companies catering to them has not been transferred to or resulted in the same for the stocks of companies serving those of lesser means.  

This pattern is over five years old now, and there are few signs that the economy is beginning to reorient to the typical high-end consumption leading to low-end consumption flow, which leads to the virtuous cycle of economic activity. But the stock market, as broadly measured by the various indices, is exhibiting a collective and singular belief by investors, speculators and traders that a return to the norm is either imminent or unnecessary for stocks to continue to appreciate.

The belief that economic activity may be unnecessary for stock market performance is grounded in the ubiquitous meme today that monetary and fiscal authorities can and will supply whatever financial support is required to offset the underperformance of the private sector of the economy.

That is not possible.   

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