Here’s a question I have been pondering for quite some time now: How strong is the economy really?
The debate on this subject continues to fascinate me. In one camp, the "Realists," and on the other side, the folks who call the realists the "Pouting Pundits of Pessimism." One has to wonder what leads people to take their intellectual cues from the philosophy of Spiro Agnew — but we’ll save that bit of psychoanalysis for another discussion entirely.
Instead, let’s delve into the details of the differences between the Realists and the Agnew-ites: they stem from the economic data itself; more specifically, the schism is likely based on the "pessimistic" details deep within the data — as opposed to the more "optimistic" headline.
As I’ve noted in the past, strategists and investors should be neither Bulls nor Bears. Instead, they should interpret the data before them without bias. By digging deep down, analyzing what is there, and reaching a well-supported conclusion, we can determine out what’s really going on — and have the most appropriate view of where this economy is, and where it might be heading.
Which brings us to an analysis of the economic numbers. Upon closer review, there are lots of signs of economic slowing present beneath the headline. Of course, no one expects any economy to be perfect – but I would have hoped to see broader signs of sustainable growth across many more sectors, if we are truly in a robust expansionary phase. Instead, the data under review shows developing weakness, a narrow expansion which is dependent upon the wrong sectors at this phase of the recovery.
In a typical healthy recovery, Government spending often leads the way as we come out of the bottom of a recession. Pent up consumer demand then takes over, as shoppers re-emerge from their self-imposed frugality and begin spending again. Businesses ramps up their CapEx Spending and Hiring to meet this new demand. This begets a virtuous cycle that runs on until it eventually shows signs of overheating, which begets Fed rate hikes, which (typically) go too far and cause the next recession. Then the cycle starts over again.
The present cycle has not followed the script. As outlined in the Cleveland Fed’s Economic Trends (November 2005, p. 12) the sectors contributing to GDP growth are rather atypical at this stage of a recovery. Personal consumption continues to increase – despite a decrease in real income and a negative savings rate. Nominal personal saving was a negative $133B in Q3 (that’s a -1.5% savings rate); the U.S. consumer’s spending via debt and savings amounted to an additional 1.4% nominal GDP. Without that profligacy, GDP would have been more like 2.9%. That a third of GDP is based upon consumer borrowing is hardly a sign of healthy, sustainable economic growth.
Despite some rumors to the contrary, Business Fixed Investment also decreased last quarter. At the same time, government spending is still accelerating. And we all know how significant Residential investment has been to the economy – its begun to cool in earnest in Q3. Surprisingly, 4 years into this recovery, GDP growth it is not a function of increasing corporate CapEx. GDP strength is coming largely from real estate driven consumer borrowing and spending, and from Government deficit spending (more borrowing and spending).
Is this analysis a sign of Pessimism? Or are the ugly details beneath the surface being coneniently ignored by optimists? How you answer that depends upon whether you are a "rational realist" than or an "ostrich."
The public hasn’t bought into the happy talk either.The so-called misery index reached a 12-year high of 9.8 in September. Michael Mussa, who served on Ronald Reagan’s Council of Economic Advisers from 1986 to 1988, noted : "If you ask the classic Ronald Reagan question ‘Are you better off now than you were four years ago?,’ a large number of Americans are in fact not better off.’
The American public is hardly a pessimistic lot; they are, however, deeply aware of their own financial situations.
Lastly, a word about Agnew: all his complaints about the "Nattering Nebobs of Negativity" — Agnew’s phrase (via speechwriter Safire) for the critics of his time — proved completely unfounded. The criticism of the Viet Nam War, President Nixon and Watergate turned out, ironically, to be well founded. Agnew resigned in a bribery scandal.
I suspect the present economic critics will be similarly vindicated.