While mainstream economists hope that somehow “this time will be different”, the ongoing massaging of economic data through seasonal adjustments to obtain better headlines has not translated into actual prosperity. Of course “reality” is a cruel mistress and despite ongoing hopes and overstatements, “fantasy” eventually gives way.
The chart below shows the S&P 500 index with recessions and notations as to when the National Bureau of Economic Research dated the start of the recession.
There are three lessons that should be learned from this:
- The economic “number” reported today will not be the same when it is revised in the future.
- The trend and deviation of the data are far more important than the number itself.
- “Record” highs and lows are records for a reason as they denote historical turning points in the data.
The last two-quarters of economic growth have been less than exciting, to say the least. However, these rather dismal quarters of growth come at a time when oil and gasoline prices have plummeted AND amidst one of the warmest winters in 65-plus years.
Why is that important? Because falling oil and gas prices and warm weather are effective “tax credits” to consumers as they spend less on gasoline, heating oil and electricity. Combined, these “savings” account for more than $200 billion in additional spending power for the consumer. So, personal consumption expenditures should be rising, right?
What’s going on here? The chart below shows the relationship between real, inflation-adjusted, PCE, GDP, Wages and Employment. The correlation is no accident.
Economic cycles are only sustainable for as long as excesses are being built. The natural law of reversions, while they can be suspended by artificial interventions, cannot be repealed.
More importantly, while there is currently “no sign of recession”, one has to ask what exactly is going on with the main driver of economic growth – the consumer?
The chart below shows the real problem. Since the financial crisis, the average American has not seen much of a recovery. Wages have remained stagnant, real employment has been subdued and the actual cost of living (when accounting for insurance, college, and taxes) has risen rather sharply. The net effect has been a struggle to maintain the current standard of living which can be seen by the surge in credit as a percentage of the economy.
To put this into perspective, we can look back throughout history and see that substantial increases in consumer debt to GDP have occurred coincident with recessionary drags in the economy.
No sign of recession? Are you sure about that?
Furthermore, the recent decline in rates likely suggests a much weaker economic environment than is currently expected. The last time that rates were this low, and potentially heading lower, was during the economic slowdown in 2012, which bordered on a recession. The difference is that in 2012 the Federal Reserve was in extreme accommodation mode, profits were growing and multiples were expanding. That is not the case today.
In July, the BEA will negatively revise the economic data going back over the last eleven years.
According to breitbart.com:
During 2012 and 2013, when the U.S. economy had what some have referred to as a micro-recession, the overstatement of real GDP growth ballooned to about $275 billion. Despite over $100 billion in revisions to real GDP growth in 2014 and 2015, the overstatement continued to grow to $324 billion, or 2 percent of GDP.
Importantly, these aren’t the only forthcoming revisions. The extremely warm winter weather is currently wrecking havoc with the seasonal adjustments being applied to the economic data. This makes every report from employment, retail sales and manufacturing appear more robust than they would be otherwise. However, as the seasonal trends turn more normal we are likely going to see further negative adjustments in future revisions.
Here is my point. While my call of a forthcoming “recession” may seem far-fetched based on today’s economic data points, it should be remembered that no one was calling for a recession in early 2000 or 2007 either.
The takeaway of all this is the risk to equities may be higher than currently expected. If rates, economic data trends and valuation reversions are sending the correct message, the forthcoming negative revisions to the underlying data will derail the current bullish thesis of a profits recovery in the making.