Sunday, June 14, 2009

Market Directions: The Green Revolution?

  • Higher consumer sentiment is not the gateway to recovery
  • Consumer debt reduction continues at high levels
  • The Fed conundrum: fund the government or the consumer
  • Relief is not recovery

Several confidence measures in the United States have returned to the levels they held before the great financial collapse last fall. Do they presage an impending economic recovery?

US Consumer Confidence readings from the Conference Board and University of Michigan have pulled out of their deep post September troughs. The same is true for the Institute for Supply Management's (ISM) manufacturing and services surveys. But these forward looking sentiment statistics contrast markedly with measures that gauge actual economic commitments. The performance of the consumer and manager is much at odds with what they say is their economic view.

The return of these sentiment indicators nearly to pre-collapse levels combined with the massive fiscal and monetary stimulus packaged enacted in the industrialized countries has convinced many equity traders and commentators that the recession has or will shortly ebb and growth is soon to revive. The problem with this scenario is that there are no substantive indicators that agree with the diagnosis.

In August of last year the University of Michigan overall consumer confidence number registered 63, in September the month of the Lehman bankruptcy, it was 70.3. These reading were down from occasions in the low 90s in the early part of 2007. In May of this year confidence had recovered to 68.1 from the mid-50s post collapse; this is the highest indication after September.

The 'expectations' section of the survey experienced a similar rebirth. From 67.2 in September 2008 it fell to a low of just over 50 in February before recovering to 69.4 in the month just past.

The 'current conditions' reading also improved but less than the others. It was 71 in August 2008, 75 in September, suffered a low in November of 57.5 and recovered to 68.3 in April of this year followed by a drop to 67.7 in May.

Readings from the Conference Board show a similar progression. The overall number was 58.5 last August, 61.4 in September and 54.9 last month. The 'expectations' component was 54.1 last August, 61.5 in September, 51 in April 2009 and 72.3 in May. And as with the Michigan survey, 'current conditions' was the most problematic. It was 65 in August of last year, 61.1 in September, reached a low of just below 22 in March of this year and by May had regained only 28.5.

The pattern is fairly uniform. A reviving 'expectations' component pulls the overall reading higher, while the 'current conditions' component is weak, or as in the Conference survey, barely in recovery at all.

The ISM results are similar. The manufacturing survey registered 49.9 in August 2008, 43.4 in September and by May had recovered to 42.8 from the mid 30s in February and March. 'New orders' were the most buoyant scoring a mildly expansionary 51.1 in May, above the 48.2 reading of last August and the sub 30 low of last November.

The non-manufacturing survey composite was 50.4 in the month before the crash, 50 in September, reached a low of 37.4 last November and had regained 44.0 last month. 'New orders' were 49.5 in August, 50.6 in September, dropped to a bottom on 35.6 in November and had bounced to a still contracting level of 44.4 in May.

But these sentiment numbers have not translated into consumer spending or industrial activity. It is as if everyone is saying. Yes, things are better, but I am not spending, I am saving more and I am worried about my job. But if you are asking, yes the overall economy has improved since last fall.

Consumer credit, personal expenditures, industrial production, and capital utilization remain firmly in recessionary territory.

Consumer deleveraging continues apace. Last September American consumers added $6.98 billion in debt to their portfolios. The three month moving average for consumer credit was $3.436 billion in August 2008 and $2.886 in September. In April of this year consumer credit contracted $15.7 billion; in March Americans subtracted $16.5 billion from their debt. The three month moving averages for these months were -$14.366 billon and -$7.533 billon respectively.

Personal expenditures have declined in six of the past eight months from last September. The only positive months were January and February of this year, when spending was prompted by retailers' heavy post holiday discounts. In the eight months before September 2008 the ratio was exactly the opposite, six positive months and two, July and August were negative.

The productive economy is even more depressed than the consumer. Industrial production has been positive in only one month since the beginning of last year, October 2008. Capacity utilization in April was 69.1%, and has dropped even month since December 2007.

And consumers now have a new worry; US Federal deficits have the potential to create an interest rate drag on future economic growth.

Government bond prices have fallen substantially since March putting upward pressure on interest rates in the economy. On Friday the 10 year Treasury closed at 3.83% up more than 1.6% since March. 30 year mortgage rates near 5.4% are almost 0.5% higher than one month ago. Concomitantly the vast Federal funding needs have begun to damage the dollar. The lower the dollar goes the higher reach commodity prices fueling inflation. A sinking dollar driving up crude oil prices belongs to the scenario that gave consumers $4 a gallon gasoline last summer. The Fed will be very hard pressed to keep rates low enough to benefit consumer spending, facilitate government debt sales and restrain fears of future inflation.

Considering the chasm that the world economy has fallen into since last fall, some recovery in sentiment was inevitable. Catastrophe averted is better than catastrophe endured but to borrow a phrase from Churchill, 'We must be very careful not to assign to this deliverance the attributes of a victory. Wars are not won by evacuations'. I suspect that the relief that the world did not end last fall and spring is coloring the expectations of consumers and managers alike. Outlooks are much better; indeed it would be hard to be much worse than the media coverage of the economy last fall. But relief is not migrating from the mind to the pocketbook. More improvement will have to happen, particularly in the job outlook, before the consumers again take up their burdens.

Joseph Trevisani FX Solutions, LLC Chief Market Analyst

FX Solutions

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