Last week, for the second week in a row, economic data were almost uniformly bearish. GDP was not revised upward despite my hopes and forecasts. Durable goods orders looked weak, pending home sales fell, and initial unemployment claims made another move up.
While poor weather and the shock of the natural disasters in Japan certainly didn't help matters, it is hard to argue that there was a lot of underlying strength. In fact, consumer strength in the December quarter looks largely like a mirage, driven by unbelievable strength in auto sales in the December quarter that quickly reversed itself in the March quarter. Consumer spending has barely budged from its 2% growth rate during each of the seven quarters of this recovery.
Consumer Incomes Looking Soft
Perhaps the most disappointing news last week was the sharp downward revision to the estimate of consumers' real disposable income for most months of the fourth quarter of 2010 and the first quarter of 2011. It now appears that real incomes went almost nowhere in the first quarter even as consumer spending managed small increases.
That means consumer savings rates are falling again. It also means the tale of two recoveries continues. Lower-income consumers continue to be shellacked by higher food and gas prices, while those in the upper brackets are feeling flush from recent stock market gains, improved bonus prospects, increased dividend income, and a job market that has stabilised if not improved.
Even as Wal-Mart (WMT) struggles at the bottom of the economic ladder, the high end of the market continues to boom. A week ago I wrote that Saks (SKS), a high-end retailer, was intentionally raising price points. Last week, Tiffany's (TIF) was one of the biggest stock market gainers as the company reported above-expectation earnings and raised guidance for the quarters ahead.
Wealthy Consumers Are Driving This Recovery
The high end is sustaining us now, for better or worse. That is why consumption continues to move upward even as incomes for the masses are stagnating. The good news is that I think the wealthy could spend even more than they do today. The bad news is that we are now more dependent on a fairly narrow group of people than we have ever been. And these are people that don't have to spend if they don't want to. If the mood of the big spenders were to become more cautious, the economy could change in hurry. The best-case scenario for the economy is for oil and commodity prices to keep falling as they have for most of May. That would effectively lift the spendable income of the lower end of the market. But we also need high-end consumers to keep spending, which seems relatively dependent on continued gains in the stock market.
My 2011 3.5% GDP Forecast Is Looking Too Aggressive
My GDP growth estimate of 3.5% now appears a bit suspect based on the lack of an upward revision of the first-quarter GDP estimate and lacklustre income data for the opening months of 2011, including April. A combination of lower inflation (due to lower oil prices) and rising equity prices could perhaps produce a 3.5% real growth rate for 2011. At the moment, this seems like a best-case scenario, with something in the 2.5%-3.0% range seeming more realistic if oil prices stay where they are and equity markets muddle along at best.
However, I really need to see at least another month's worth of employment and inflation data before I make a formal reduction. Exogenous factors like the Japanese earthquake and volatile weather conditions need a while to work through the system and the government's statistic mills as well.
It's Too Early for This Cycle to Be Over
Frankly, I have been worried about rising inflation and its impact on consumer spending for many months. However, I have kept my GDP estimates relatively high compared with most other economists. I am a huge subscriber to the theme that once an economy is put in motion, it is nearly impossible to reverse. Consumer spending begets more production, which brings more employment (and therefore income), which leads to more spending--a truly virtuous cycle. And these cycles tend to last five years or more on average (this recovery is just now approaching its two-year mark). Based on the depth of the recession and a potentially dramatic improvement in the housing market in 2012 and 2013, this recovery isn't over by any stretch of the imagination. But that's not to say a little inflation, poor consumer confidence, a falling stock market, and some large income disparities won't scare us into a few quarters of very slow economic growth.
Despite the Data, Consumer Moods Are Stable or Improving
While GDP growth has clearly slowed, some of the anecdotal evidence doesn't seem to match some of the more negative macro data. The weekly retail reports have shown exceptionally consistent 3% or more year-over-year growth (including the latest week) with barely a wobble.
Although not necessarily a great forecasting tool, most of the consumer confidence reports have been picking up steam even in the face of sloppier economic data. Friday morning, the University of Michigan Consumer Sentiment Survey jumped to 74.3 in May from 69.8 in April compared with consensus estimates of 72.5.
Even an exceptionally non-scientific analysis of chit-chat at my son's graduation parties, the barber shop, and on airplanes seems to indicate an improving mood. My office contacts at Morningstar seem to hint that mall traffic (if not puchases) remains incredibly strong, almost Christmas-like. Perhaps I am just picking up on the phenomena that the upper income strata are doing better; nevertheless, the improvement in mood is palpable to me.
Slowing GDP Growth in the First Quarter Stands at a Measly 1.8%
For many weeks I (and almost every other economist) had been projecting that GDP growth in the first quarter would need to be revised sharply upward from the anaemic 1.8% initially reported last month. I was wrong.
Yes, many retail categories were revised upward, but a combination of gasoline sales, auto sales, and utility usage were revised downward by a roughly equal amount. Falling gasoline and utility sales isn't all bad. It means consumers are driving less as a result of higher prices rather than cutting back on other categories. Down the road, that means less oil imports, which is a very good thing, potentially aiding GDP growth in the months ahead. Adjusted for price, gasoline usage has been down two quarters in a row. Depressed usage of energy-related products by businesses, government, and consumers depressed the first-quarter GDP calculation by 0.6%.
The revision did little to change my original analysis, decent consumer and business spending, higher (but still too low) inventories were key positives in the quarter. Higher imports, lower government spending (mainly defence), and the weather-affected construction industry all weighed on the GDP calculation. Most of these negatives will reverse themselves in the second quarter, creating the potential for an increasing GDP growth rate for the second quarter. That rate could easily exceed 2% if the auto industry production issues discussed at the end of this report don't weigh too heavily on the economy.
