By John L. Chapman, Ph.D. Washington, D.C.
The Founder, Chief Investment Officer, and Managing Director of Alhambra Partners, Joe Calhoun, has a favorite saying when it comes to gauging consumer sentiment and its derivative, primary demand: “Watch what they do, not what they say.” Indeed, there is no better illustration of the truth of this axiom than back-to-back news releases this morning: the U.S. monthly retail sales report, followed by the Thomson/Reuters — University of Michigan Consumer Sentiment numbers 90 minutes later.
The retail sales volume was a consensus median expectation of +0.6%, but came in at 1.1% for September, the best report in seven months. This was a considerable positive surprise, and one impetus for a global rally in equities this afternoon: here in the U.S. the S&P 500 rallied up 1.3% on the day for its highest close since August 4.
There were several good aspects to the retail report, and the Commerce Department quoted Macy’s Inc. (M) and Kohl’s Corp. (KSS) as top firms among several who intend to hire significant part-time help beginning next month through the holidays. Ten of the thirteen major retail categories showed increases last month, led by auto dealers and clothing stores. Retail expectation is now leaning toward a decent holiday season after three under-performing years; many retailers have a huge back-loaded percentage of revenues and profits flowing from the last two months of the calendar year, so this is a welcome prospect.
Meanwhile the Thomson Reuters/University of Michigan preliminary index of consumer sentiment decreased to 57.5 this month, from the 59.4 reading of a month ago. The median estimate of those economists who had been surveyed called for a reading of 60.2, so in theory this was a fairly steep downside surprise.
Thomson Reuters went on to explain, however, that the worst news in this month’s survey is the forward expectation sentiment: consumer expectations for what the economy will look like six months from now dropped to 47, the lowest reading since May 1980, in the midst of a short but fairly sharp recession that was near the end of a terrible stagflation back then. This forward number unfortunately has a fairly persistent correlation with what actually happens in terms of the real economy, and so was the opposite takeaway from the Commerce Department report.
Hence our colleague’s concern: what can these conflicting reports tell us about the economy and the markets in the months ahead?
As we have been saying for some time, we do not foresee a recession in the months ahead, and indeed, we have been amused at all the negative chatter about this for months now, reaching deafening proportions of late. For one thing, if we were to fall into recession now, it would truly be the first time in the Fed era that a downturn occurred when monetary policy has been accommodative for the indefinite prior period. That itself is both startling and amazing, but of capital importance in analyzing the near term future.
And as our CIO Mr. Calhoun points out, where does the recessionary story originate in the data? Jobless claims have trended slightly downward in recent months, and the ISM index is rising and still +50. Capital expenditures are rising, especially in high-productivity areas from software to machine tools. The yield curve is appropriately shaped for growth and has steepened lately, albeit in a volatile manner that is subject to hot money flows related to Europe.
A very key metric of general business health, commercial and industrial loans (C&I), has been rising steadily now for 17 months at close to double-digit rates, and shows no signs of abatement. C&I loans are of course strongly correlated with the money supply itself, and have a near perfect co-movement with the business cycle, though in a lag of several months. Hence while it is true that we may be in a recessionary state while C&I loan volume still climbs for some months, none of the other data now — most prominently the money supply itself — are showing evidence of an incipient recession. Imports and exports are still both in a nice recovery, industrial production has held steady (if flat), and personal income and consumption are steady. And lastly, the leading indicator index is still positive.
As for the consumer sentiment number today, it does make sense: the bad reading currently is a direct result of the cacophony of negative chatter that is in universal supply now. But economic agents contine to act according to their personal means and situation, and not with respect to their concern that everyone else around them may not be prospering.
The forward number was alarming, giving portents of trouble in 2012. And indeed, as we wrote this week in analyzing the Federal Reserve’s September 20-21 meeting minutes, the current dour pessimism at the Fed resulting from the global challenges in play at the moment — topped off by a potential disaster in the Eurozone banking system — leaves us concerned that we may well be challenged next year (indeed, we will be; the only question is to what extent).
Of course the ultimate question is, to what degree is this a concern for portfolios; an indelible fact in this business is that the market does not equal the economy. We remain of the view that there is no pervasive rationale for an upturn in growth and profits that would take US equity prices with them. We are, absent any policy shifts emanating out of Washington (that now will likely have to come via an historic electoral shift), in a “trading range” for equities, and as the Fed candidly admitted this week, in for at least two more years of elevated unemployment levels, slow growth, and stagnant incomes. Additionally, we remain vigilant to the prospect of a sudden shock resulting from the Eurozone, including French bank collapses, a Greek default, and also potentially including Italy’s debt blow-up — all of which would impact U.S. equities, bonds, and gold.
In one sense, whether or not the U.S. slips back into the textbook understanding of recession — negative GDP growth that for most people must persist for two or more quarters — is irrelevant, in these sad times of self-induced economic torpor at the hands of a recalcitrant political class. But on the other hand, as Keynes said, part of the challenge of investing and wealth preservation is correctly adducing what everyone else is going to do. A formal declaration of recession would affirm the so-far ephemeral sense of dour economic prospects, and would change behaviors — and asset prices. It is our fiduciary responsibility therefore to continually monitor trends in markets, the broader economy, and the policy world, in order to navigate our way to the sunny uplands of a better economy later this decade — assuming pro-growth policies are in our future.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@alhambrapartners.com.
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