Real Data Interlude I: Econ-ecostructure (GDP to Trade)
Now even Schwab has called March 9 as a market bottom (we'll revisit that) and suggested buying
the dips; all based on the hypothesis that we've seen so many green shoots that the worst is over. As we keep saying there's at least two huge problems with telling the difference between them and yellow weeds. First off is what does the data really say and second what's the long-term outlook. When everybody from Bernanke to the CBO to the acronymics (OECD, IMF,World Bank) tells us that the long-term outlook is very week for years somethings wrong. We visited this point in a prior post on deconstructing GDP (Will The Real Economy Stand Up? : GDP, Consumption, Investment) but thought we'd take another detour into the real data and try and offer up some foundations. Just for the record YoY GDP dropped much worse in Q1 than in Q4, as you can see from the table below.At this point in case you're wondering why do I care - we'll let the cartoon composite speak for us and our arguments subliminally. Judging from friends, neighbors and acquaintances it pretty well captures the general response. The sad fact is that much of this was avoidable but that's a long-term structural statement so never mind. The sadder fact is that most of it was dodgable if you'd paid attention to the warning signs. And that didn't require major national policy changes - just a good dashboard of properly filtered and structured indicators.
ADP Private Employment: Real Trends 
Also just for the record everybody got all excited about ADP's private employment report but the reality is that, again YoY, it went down -2.4, -2.9, -3.4, -4.0 and -4.3% YoY in the last five months. Not only wasn't that good news from last month to this but that looks like an accelerating downtrend to us.The key problem is quick hit headlines and sounds bites that report on the MtM instead of the YoY changes. To try and show you what the reporting covers vs. what we think you should be looking at we've built this chart of the MtM changes annualized vs. the YoY% changes. Take a moment and see how warm and fuzzy you feel about all that; us, we go back to the cartoon as capturing the spirit of the moment. The Zeitgeist is shock and awe but we're probably all too burned out by adrenaline surges to panic anymore. So we thought we'd dig thru the real data and trying and frame the situation a little better in a couple of posts. This one will give you some background on the structure and components of the economy and we'll follow it up for each of these components with a post comparing QtQ vs YoY as soon as tomorrow's employment numbers come in.
Surveying the Real Data
But before doing the graphics thing for the components let's at least start with this summary table of the major elements to be watching. Pretty dry and boring right - just a table of meaningless numbers ? Maybe, but look around you, talk to your neighbors, ask yourself about your job and your kids futures and the meaing may get clarified and more important. We jokingly said one time that economics was the largest experimental science in the world...and we're all the lab rats. Some of the key things to watch (think of them as the scientists anal thermometers if you like) are red-highlighted and reinforce points we've been making for a long....g time. The only slightly bright spot is Real Wages which is up because Inflation has dropped so far and fast. We expect the continuing decline in Employment, which went down -3.1%, to reverse that trend. Employment is yellow highlighted because it was one of two early warning signs of the slowmotion slowdown (try a search on that term here to see how many times for how long it's been showing up) and the beginnings of a downturn. The other being the obvious Residential Investment, which leads the cycle, has been bad going to worse since early '06 and got worse this last quarter - despite the headlines. Take a look at the last columne where, except for Wages, every single number got much worse than in the prior quarters. Real GDP dropped -2.6% vs .9%, Capex and Industrial Production went in the tank and so on.
The Economic Ecology: Structure and Components
Before we get to the YoY vs QtQ debate de-construction let's put some foundations in place. So much of what you hear not only misses the real trends but isn't set in any kind of context, let alone an accurate one. The top sub-chart shows each major component as a % of the economy with Consumption on the r.h. scale, for about three decades. Notice that it ran about 67% until the investment boom of the Tech Bubble but actually went up to about 73% after the crash on the back of the Housing ATM. Talk about a House of Cards or building on sand - the economy tanks and you spend more by borrowing ? Notice the evil twin that resulted - Net Exports were about 0% as Imports balanced Exports until the Consumption Borrowing Bubble led to a huge surge in imported consumer goods. The bottom sub-chart zooms in a little to a shorter timeframe and breaks out some of the detail. After the break we'll break down each of these components yet again and you might want to pay attention because some of the results could surprise you. For example Gov't spending is a big chunk but it's not the welfare queens. The other little item of interest to note is that it went down during the '90s which led the reduced deficits and boom times of the Clinton Era. What was behind that.
Breaking Down Consumption
Starting with the big kahuna, Consumption, let's break it down into it's major pieces of Durables (things like cars, TVs, washing machines, lawnmowers, etc.), Non-Durables (gas, towels, laundry soap, food, etc.) and Services (Healthcare, insurance, fedex shipments, movies and so on). Services are 40% of the economy and about 70% of Consumption while Non-durables are about 20% and Durables are about 10%. When you look just at the later two in separate detail the patterns get more interesting. Durables were at 6% but climbed to 10% - now how much of that tells the story of the decline of manufactured things over the post-war period and the impact of globalization and huge price drops during the '90s ? Who did that benefit the most ? There's some real indicators here if you stop to think about which industries and companies go into which of these major components too. With Services so high that points you to looking at Healthcare, Technomediatainment, etc. for example. Put on your investor and employee or job-hunter hat when you look at these charts. What's P&G make and what kind of secular trend is it selling into ? During the '50s it was a steller growth company as people got washing machines and bought soap for them. Now ?
The Accelerator: Investment
If Consumption is the engine that drives the economy then the governor that speeds up or slows down the trend is Investment which consists of three major pieces. Capital spending on software and equipment - interestingly enough up until the '90s that was just Equipment but now Software is the dominant capex component. Structures are commercial real estate - plants, warehouses, ports, off-shore drilling equipment, etc. You know the thing that all the headlines tell us is cliff-diving and we're all surprised (despite for example Calculated Risk's multi-year warnings). And then there's Residential Real Estate. During the '90s Investment climbed from 12% to 18% of the economy, first on the back of Tech investment during the late '90s. But instead of falling back as it should have with the bust it fell and then climbed back on the back of real estate speculation, which climbed from 4% to 6% of the economy. Seems like such a small gain for such a ginormous problem. It took us about 10 years to work down the excess capacity that resulted from over-investment in Technology. How long will real estate have to run BELOW 4% to get us back to a natural level of Housing ? Let's hope it's not ten years but it sure could be. Those Homebuilder stocks might not be such a good investment idea after all - nor anybody who's selling into those markets, Lowe's or HD for example, or home furnishings, appliances, etc. Closer to home what might that say about Housing values and prices ?
The Little Engine That Did: Trade
Trade has become an increasingly important part of the US economy. Back in the '50s and '60s it was 4-6% of GDP yet made up the largest piece of world trade flows. Over the next three decades it slowly climbed until it was about 10% of the US economy. Then, all of a sudden, it zoomed to about 14%. But up until the late '90s the trade balance was about 0% until all of a sudden it started a rapid deterioration. Trade is everywhere and always beneficial to everybody, even the companies and people who are displaced, as long as they can find a better use for their efforts. And we do it every day - you don't make your own shoes or cars, cut your own hair and grow your own food. Being able to swamp the value of something you do well and can focus on for things other folks specialize in and can do better makes us all better off, at least in the long-run. When you take the deficit apart into it's two pieces (Services and Goods) it turns out that we've enjoyed a surplus in Services for a long time and that the sole source of the overall deficit is the goods deficit. Which in turn is largely two things - Oil and Consumer goods (remember those durables) that we borrowed on the artifically inflated values of hour houses to buy. As consumer demand has tanked so has the overall deficit. Now here's an interesting conudrum - in the last 10 years we've seen the largest improvement in worldwide Poverty in human history but that was built on the backs of export oriented economies by folks like Japan, Taiwan and China. What happens to the Developing world and all those Emerging Markets investments if/when the American consumer shifts back to being a saver ? Now there's a fascinating question.
Consumer Behavior Shifts
Consider this chart that compares GDP growth rates to the proportion of Consumption in the economy to start seeing some answers. It turns out that the proportion of the economy going to Consumption has been steadily shifting upward for almost five decades, but accelerated post-2000 during the downturn. Now there's another conundrum for you. Simply fascinating. The other question this raises is the role of Consumption vs Investment in long-term economic growth, prosperity and social well-being. The more you consume then obviously the less you invest and the less you invest then the less you grow. For the US to get back to a prosperous society we're going to have to shift to a nation of savers that puts it's savings into productive investments. People have noticed that income distribution become more and more unequal in the '80s, '90s' and the '00s and that the bulk of the gains thruout that period flowed to the upper income groups. We don't exactly recall the statistic but something like 70% of the gain went to the top earners. If we'd like to get back to a healthier society....well the possible implications are obvious aren't they ?
Rules of the Road: Government
Have you ever stopped to think how much fun it would be if every morning you woke up and the rules for driving changed. Or worse had to be made up on the fly with every car you met on the street or highway ? Sort of like the fun it is in a giant mall parking lot where your risk of being run over by some blind and oblivious person is pretty high - speaking from experience. The larger and more complex a society the more it needs mechanisms and institutions for organizing things as well as providing public services. People forget, or never learned, that government investment in Transportation for example made this economy what it is, from the early canals to the railroads to the interstate and airways systems. Did you know for example that most of the major airlines built their intital route structures around the early airmail routes ? Or that Trucking moves about 70% of the inter-city freight traffic in this country ? How productive would our economy be without railroads and long-haul trucking ? Not very. To take another example thruout human history cities were always deathbeds because the population concentrations encouraged diseseases. The Romans got around this problem with good plumbing and water engineering but the West didn't get back to that happy status until the late 19th century and the development of massive public health programs.
To satisfy those demands, no matter who was in office or what the zeitgeist was, the US has spent about 20-22% of GDP on Defense, State and Local government and Non-Defense government activities. Of that State spending has been 12% or so of the economy or about 60% of the total. No matter what the mythologies of the Reagan revolution it's your local schools, libraries, snow-plowing, cops and traffic lights that absorb the bulk of the spending. As it should be given what we think government ought to be doing. As for Federal spending about 60% of that was Defense at the beginning of the '90s. In fact overall Federal spending saw a massive drawdown in Clinton's years on the backs of the so-called Peace Dividend, as it turns out from looking at this chart, cutting non-defense spending like he was a die-hard Republican. Interestingly enough both started to surge in Bush's early years as the War on Terror led to increased defense spending. Even more interestingly non-defense spending surged as well ! Now what was that all about we wonder ?