Autumn chills in the economic
air By Max Fraad Wolff
Naturally, the passage of summer into
autumn entails a chilling of the air. Less natural
and more pronounced this year is the cooling of
the US economy. Profits and GDP (gross domestic
product) growth, as well as housing numbers and
durable-goods reports, point to falling
temperatures.
The pause in Federal Reserve
Bank rate hikes and cooling commodity prices offer
more evidence - if that were necessary. Thus far,
the market response has been August's red-hot index
appreciation. Renewed
geopolitical risk suggested by recent events in
Shanghai, Mexico City, Budapest and Bangkok be
damned, the Dow is in record-breaking mode.
Some of the market's effervescence may
actually be a sign of agreement with my cautionary
thesis in this article. The Dow Jones Industrial
Average is populated by larger, more global and
defensive firms with higher credit ratings than
the Standard & Poor's. Thus some of the
former's rise may be rotation from even more
dangerous positions elsewhere in the US equity
orbit.
Sadly, it seems clear that most are
driven by the Goldilocks outlook. This term was
made popular in 2002. The Goldilocks story
suggests that we will artfully and profitably
dodge both inflation and recession as we hop from
sweet spot to sweet spot for profits and growth.
It is a mutant form of the new economy conception
popularized in the late 1990s.
The United
States does not have to save; it can run huge
external imbalances forever; the Fed can endlessly
run expansionary monetary policy; there are no
equity, bond, or real-estate bubbles; and we can
have rapid growth without inflation. Goldilocks
adherents believe this is being done as we thread
the needle between various risks. How well do the
macroeconomic data confirm this outlook?
Early winter would seem the correct
analogy here. US housing starts, permits, mortgage
applications, prices and housing-company stock
prices are down, while foreclosures are up.
Durable-goods orders fell 0.5% in August, widely
missing a consensus forecast of a 0.5% increase.
Bright spots were autos and defense spending, but
neither is likely to be a source of strength
moving forward.
If you exclude
transportation, durable-goods orders declined by
2%. The Mortgage Bankers Association announced on
September 22 that its seasonally adjusted index of
mortgage applications declined 5% on the week
despite half-year lows in listed mortgage rates.
The 5% one-week decline masked a more worrisome
21% year-on-year slide. Home-sales declines in
August were pronounced in several vital markets.
The California Association of Realtors
reported a 30% drop in sales for August. This is
the largest decline since 1982. The Florida
Association of Realtors reported a 50% August
decline in sales in Palm Beach county and a 6%
fall in the median home price there. The
Massachusetts Association of Realtors revealed a
20% decline in sales and an 8% decline in median
price. It is possible some of this weak
performance is related to the total lack of growth
and dynamism in personal income and spending
growth.
The September 29 Personal Incomes
and Outlays release form the Bureau of Economic
Analysis reveals that August was a low point for
wage growth and personal consumption expenditure.
August marks another month with a negative private
savings rate (-0.5%). [1] This has caused little
concern despite the fact that consumption accounts
for 70% of GDP in the US.
The September 28
release of second-quarter national economic data
for the US has confirmed more skeptical outlooks
and spurred hardened optimists to new levels of
creativity. Consensus estimates from
private-sector economists of 2.8% GDP growth and
advanced estimates of 2.9% growth were
disappointed as the Commerce Department announced
actual growth of 2.6%.
The Fed's preferred
price index for personal consumption expenditure -
excluding food and energy - increased 2.9%, down
3.0%. Thus America's present Goldilocks economy
most recently displayed a 3% drop in the rate of
price increase and a 53% decline,
quarter-on-quarter, in GDP growth. What of
corporate profits, long a bright spot in the US
economy?
Profits from current production
(corporate profits with inventory valuation and
capital consumption adjustments) increased US$22.7
billion in the second quarter, compared with
$175.6 billion in the first quarter.
Current-production cash flow (net cash flow with
inventory valuation and capital consumption
adjustments) - the internal funds available to
corporations for investment - increased $1.1
billion in the second quarter compared with an
increase of $125.3 billion in the first. [2]
It is fair to say that the
corporate-profit picture definitely cooled in the
second quarter. This was particularly true for
non-financial corporations that underwent a
profound reversal of profit fortunes across the
quarter. Reported domestic US profits for
non-financial corporations dropped by $32.8
billion on the heels of a strong $94.5 billion
increase in the first quarter. The profit picture,
while still a relative strong spot in the US
economy, is less hot than it has been.
So
we are left to ponder a widely popular consensus
on the economy that is influencing equity
performance. It runs as follows: eureka! The Fed
has stopped tightening and the US economy is still
growing well and highly profitably. Of course,
growth and profitability are still in respectable
shape - particularly the latter. However, they
have remarkably cooled of late - much like rate
increases. When rate increases slow we celebrate
the end of inflation risk, despite the
price-change metrics reported. When GDP and profit
numbers slow, we refocus on their strength in
long-run, global comparisons. Thus the Goldilocks
consensus is sustained. The economy is not too
hot, not too slow and just right! Remember the
Goldilocks story? Cool days and warm porridge lure
Goldi into the bears' house. There are two endings
to the fairly tale. In the friendly version, she
wakes and flees in terror. In the harsher version,
she is eaten by the bears. Either way, advocates
of the Goldilocks economy may have much to learn
from the fable they have invoked. It might be just
right now, but there is trouble lurking in the
near future. After all, the bears return in all
the versions of the story.
Max Fraad Wolff is
a doctoral candidate in economics at the
University of Massachusetts, Amherst and managing
director of GlobalMacroScope. This work was
written for www.GlobalMacroScope.com.
(Copyright 2006 Max Fraad Wolff. Used
by permission.)
