LT Business Cycle De-construction: Time to Pay the Piper
Well in case you hadn't noticed today was a bit bad in the markets, led down by the financials as the realities of the dreaded credighetti monster re-surfacing, with more bad news from LEH, FNM and FRE. The latter were down 22% and 25% respectively. As were Financials (-3.6%) and Consumer Discretionary (-1.7%) in general. Not surprising in light of our thinking but the really interesting headlines were on Lowe's, which closed up slightly (.16%) on better than expected earnings. Consider the following headlines (from Marketwatch, AP) and especially the emphasized line:
Housing malaise eats into Lowe's net Lowe's Cos. said Monday that its second-quarter profit fell 7.9%, hurt by the housing market downturn, which cut into demand for cabinets, countertops and other big-ticket purchases. Results, however, exceeded analysts' estimates, thanks to strength in seasonal sales as homeowners restored lawns and outdoor landscaping after last year's drought in much of the country. The No. 2 home-improvement retailer also benefited from the U.S. government's stimulus checks, which aided its comparable sales by as much as 1.5 percentage points, more than it projected. It also gained unit market share at its fastest pace in eight quarters as many independent operators closed shops, Chief Executive Robert Niblock said on a conference call with analysts.Despite better-than-expected results, Lowe's third-quarter profit forecast missed analysts' estimates as the retailer expected a continued challenging housing market into 2009, especially in regions such as California, Florida and the Gulf Coast. It also said it is evaluating the number of stores it plans to open for next year in light of the current sales environment. It said it will announce the final number next month. Sales rose 2.4% to $14.5 billion as the company opened in more locations. Same-store sales, or sales at stores open at least a year, dropped 5.3%.
Along with a lowered outlook you'd think that would hardly be a reason to bid up the stock. As usual what we think is going on is that the lack of grasp on the nature, timing, structure and lags in the business cycle completely escape everyone in general. For example the new meme is that while the world is headed in the tank the US is potentially headed back up. BtW - that differential explains the dollar bounce along with interest rate gaps...watch out. But other than that one line nobody gave the most important retail statistic much attention.
Let us offer up another stat that will be completely ignored - no coverage whatsoever. Real weekly wages were updated by the BLS after the CPI release. Guess what...they were down -3.1%. In fact for the last six months the figures are: -1.4, -.8, -.9, -.7, -1.1,-2.5 and -3.1% ! Remember our "Tipping Point" discussion - well it certainly looks like it's here IOHO. We're going to spend the rest of this post digging thru some big picture economic data to try and read ourselves into a more realistic, data-grounded context. Hopefully in such a way that you can reach your own conclusions.
GDP vs Consumption
Let's start with a comparison of GDP and Consumption (PCE) back to 1980. Take a gander at this little chart which shows the YOY% change in the two. If there's any doubt about this being cyclic speak now. We'll draw your attention to the teeny little tail where both, but especially consumption, have dropped below the trendline. Now ask yourselves - what recent data you've seen, or read here, would indicate that's going to turn around ? We think the more relevant question is what will the downturn look like - '01, '91 or earlier ?
Recession vs Growth Recession
You might recall that the Fed's current published forecast calls for growth thru 2010 of less than 2% - in fact they're counting on it to reduce inflationary pressures. When the economy grows at less than its' full employment potential think of that as a "growth recession". More importantly translate that out of geekspeak and into pain indicators. That means lost jobs, lowered spending, bad earnings pressures, you name it. Just to put that in context we ran back to 1960 or so and ranked downturns as Recessions (<0%), Week Growth Recessions (0-1%) and Growth Recessions (1-2%). And ended up with this fascinating chart. Note: if you believe our measures we almost experienced a growth recession at the end of '06 but were saved by the oil price drop and saw one again this last couple of quarters. But we are, in fact, now in a growth recession !!
If you'd really like to dig a little more into what's going on we put together some more economic cycle charts running back to 1960 where possible so you can see how the economy (GDP), Consumption and Investment relate and what links to what in the lag structure. We also - and this is especially important - look at the key drivers of future consumption demand. Which are growth in employment and real wages. Like we said at the start that news is getting worse fast. See what it means and keep reading (and of course click to enlarge the charts).
BtW - the most interesting and potentially useful chart on Wages, Employment and future demand is the last one :) !
Consumption and Employment
Here's a composite chart that takes GDP, Consumption and Employment back to 1960. If that doesn't look like your perfect theoretical business cycle then we give up. We think it's beautiful - though scary. Notice that, in general, Consumption tends to trigger an economic downturn though not always. And go down proportionately as far - which it did not do because of the Housing ATM. The piper is playing and we avoided a major downturn with his music after the Tech Bubble. But now he's coming to get paid. When you look at Employment though you can see he already collected part of his fees. Employment dropped relatively farther during our "mild" '01 downturn than in previous ones and never recovered as well. And we wonder why people have been "whining" for the last few years - makes sense now doesn't it ?
Investment
If Consumption is the engine of the economy the accelerator that speeds it up or slows it down is Investment. And for almost every period and cycle since the end of WW2 there's been a regular and predictable relationship between the economy and Investment. Unfortunately that afore-mentioned Housing ATM was part and parcel of a Housing Bubble unlike anything we've seen. In fact anything I've heard about forever. And we're in the process of an unprecedented bust that'll stretch out for at least another couple of years. So, congratulations. We're all the proud parents of two back-to-back bubbles that are going to burst with unfortunate consequences. Notice that Investment follows along quite nicely with GDP thru this whole period - except for the last few quarters when it's pulling down and away much more rapidly than you'd expect. When we breakdown investment into its' Capex and Real Estate components you can see why. RI is tanking big time. But here's the real rub - that we know about. If the Economy tips over what happens to Capex ? And Tech Spending ? And.....tech company revenues, profits, earnings and stock prices ? Now there's an interesting question.
Wages, Employment & Consumption
The critical question is what's going to happen to consumption ? Will the engine get starved of fuel ? Well, judging by the changes in real wages it's already beginning to be. If employment tips over, as one would expect, you can count on it. Take a look at this composite which shows the key indicator - W+E vs Consumption on the bottom and the pieces (Real Wages, Employment) on top, since 1960. W+E looks to be dropping like a rock - or more importantly like it has in other previous, serious downturns. When you look just at Wages that's the primary current reason. Though we will point out that YoY Employment went negative with the last month's payroll data. And bear in mind the Birth-Death adjustment is still adding in more "virtual" jobs than the actual data. When some real data gets collected and the model's parameters get refreshed we're all likely to be in for some very unpleasant surprises.