When Economists Collide – Part II

Invictus is a street insider, a long-suffering “lifer” whose close work with Wall Street research teams gives him unique insight into the current strategist spat.



It was noted back in October that a feud seemed to be simmering between the former Merrill Lynch Chief North American Economist David Rosenberg (now at Gluskin Sheff) and those who succeeded him, Economist Ethan Harris and Strategist David Bianco (who replaced Rich Bernstein).

Often nuanced in nature and discernible only to those who read the research from both shops, the differences occasionally bubble to the surface, as they have in the past few days.  The nub of it, obviously, is that Rosenberg’s outlook is decidedly dour, in sharp contrast to his successor(s), who are much more bullish.

So nuke another bag of popcorn, as the gloves appear to be coming off.

In a research note last week, Bianco asserted that it is an “investor misperception” that the consumer (PCE) is really 70% of U.S. GDP:

Personal Consumption Expenditures (PCE) do indeed make up about 70% of US GDP, making total US PCE or household spending about 15% of the global economy and bigger than the entire Chinese economy (Chart 2). How then can the US economy and the rest of the world grow with the US consumer in retrenchment? To answer that, we take a closer look at the composition of PCE.

Only 25% of personal consumption is discretionary spending

What many investors fail to realize is that the majority of PCE is not made up of iPods, handbags and dinners at the local Outback Steakhouse. Instead, about 75% of household spending is non-discretionary in nature, such as housing, healthcare, energy, food eaten at home and other household staples. We think it is worth noting that most of these non-discretionary items are made in the US.

While there is certainly room to reduce non-discretionary spending, the areas of consumer spending feeling the brunt of higher household saving rates are cars, travel, apparel, restaurants and other discretionary items that make up about 25% of PCE, equivalent to 20% of US GDP (Chart 3) or less as many of these nondiscretionary items are imported. 20% of US GDP is still significant, but far less than the 70% figure that makes the headlines. Another figure sure to make the headlines this time of year is retail sales. The contribution to US GDP from retail sales has actually been declining for over ten years. Excluding supermarkets, retail sales are under 40% of total consumption, or about 25% of GDP.

Bianco’s piece was referenced in last Saturday’s Barron’s.

On Monday, Rosenberg was having none of it:

The “Streetwise” column in the current edition of Barron’s (It’s Still Too Early to Worry Too Much) runs with a series of assertions otherwise dubbed “common misperceptions” — one of them being that the U.S. consumer is really not 70%+ of the economy because “only a quarter of it is truly discretionary.”

We’ll get back to this in a second, but the fact of the matter is that much of what appears to be non-cyclical is in fact, cyclical (like elective surgery in health care; veal chops in the food category, etc). Second, even if this assertion is correct that ‘only’ 25% of consumer spending is economic-sensitive, it begs the question as to why that is important in anyone’s analysis. Is 25% small? If it is, then what is going to be the driver for the economy going forward; government spending? If 25% is small, then how is it that on average consumer spending manages to generate 300 basis points of growth for the economy coming out of recessions — because they are buying more soap and toothpaste with the other 75%? Maybe that 25% (and that number is not correct but it doesn’t matter in any event) is a huge swing factor in recessions and expansions for overall GDP growth. Once again, this is a classic failure to assess the economic shifts at the margin.

Even if consumer discretionary spending is just 25% of the total expenditure pie (and hence 17.5% of GDP), that would still make it the largest cyclical component of the economy — almost double capital spending and exports, just as an example, and almost eight times larger than housing and commercial construction.

Stay tuned.  I expect this one’s not over by a longshot.

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