Over the past six months the fundamental foundation under the United States'
MacMansion of equity-market hope has started to heave and buckle. One by one
the supports show signs of aging.
The golden opportunities of the past few years have started to lose some of
their shine. The solutions have been either to ignore unpleasant facts or to
assume they are short-lived and of moderate import. All bad news is exciting as
it suggests that the US Federal Reserve will cut interest rates. All good news
is proof of America's resilient economy in which stocks, growth, opportunity
and optimism spring eternal. Risk premiums are
small, speculative play massive, and triumphalism is the air we breathe.
In this article we offer a structural health report, the sort of undertaking
that no one has had much time for lately. None of this is to say that much is
not well; much is very well. We just happen to believe that admitting all is
not perfect provides insight and value.
Housing
In the one-year period between the first quarter of 2006 and the first quarter
of 2007, the US managed a fall in the rate of home ownership. How is that for a
market entering a rough patch?
While you are to be immediately comforted that the decline was not
statistically significant, we humbly imagine this to be a dramatic indicator of
trouble. Housing and associated industries have played the roles of employer,
lender and wealth-effect sentiment booster to American consumers. It is unclear
if, when, what and from where a replacement sector will emerge.
New housing sales and starts in the US have been below their mid-2006 peaks for
nearly a year. Total construction expenditure is down. Inventories are rising
toward the 1-million-unit level. The US National Association of Realtors
announced a 10.8% decline in existing-home sales in April, with a 0.8% drop in
year-over-year average price.
The US Census Bureau's April New Housing Report showed a
10.6% year-over-year sales decline and a 6.5-month inventory backlog. Using its
data, we find a 4% year-over-year average house-price decline and an 11%
decline in median home price.
A vital sector that lent US citizens hundreds of billions of dollars per year
and accounted for 20-35% of employment growth since 2001 is entering a secular
bear market. I would tell you not to worry about it, but I know you have
already heard that many, many times.
The economy
I should have called this section "Growth? We don't need no stinking growth".
The US first-quarter-2007 real annualized gross domestic product (GDP) growth
rate is firmly in growth-recession territory. Expansion - if you would really
call it that - in the 0.6% range is sub-par and raises serious questions.
Please gaze at the GDP growth chart below and try to spot a pattern. It would
seem that the US is heading back toward recession territory. A large drag from
negative net exports (exports minus imports), inventory declines and housing
downturn have created significant headwind. [1]
Consumer spending is 70% of the US economy, and the most recent numbers
emerging are not the stuff of frothy good times. The June 1 Bureau of Economic
Analysis Personal Income and Outlays Report starts out with a bang.
As the quotation below explains, income - real and disposable - actually fell.
You will be comforted - but you should be terrified - to learn that spending
rose nonetheless:
Personal income (DPI) decreased $9.7 billion, or 0.1%,
in April, according to the Bureau of Economic Analysis. Personal
consumption expenditures (PCE) increased by $52 billion, or 0.5%. In March,
personal income increased $85.9 billion, or 0.8%, DPI increased $71.7 billion,
or 0.7%, and PCE increased $42.4 billion, or 0.4%, based on revised estimates.
And further down on the same page:
Personal outlays - PCE, personal
interest payments, and personal current transfer payments increased $55.2
billion in April, compared with an increase of $44.2 billion in March. PCE
increased $52 billion, compared with an increase of $42.4 billion. Personal
saving - DPI less personal outlays - was a negative $132.8 billion in April,
compared with a negative $67.8 billion in March. Personal saving
as a percentage of disposable personal income was a negative 1.3% in April,
compared with a negative 0.7% in March. [2]
These
numbers are the stuff of real concern. The US housing market is in trouble,
retails sales are flat, and that is what we get when people dis-save at nearly
twice the rate of the previous month. This is a running-on-empty story and
looks set to become a running-into-a-wall story.
Why so little concern? Golden expectations seem to produce a kind of alchemy of
understanding. These leaden numbers suggest a weighted-down public. Through the
magical sophistry of expert opinion, the lead becomes golden opportunity and
impending rebound. When all else fails, we have come to know that credit always
saves the day.
Credit/debt
The areas of massive and growing strength are those tied to and dependent on
credit growth, financial engineering, speculation and expectation. Thus wave
after wave of buyouts and buybacks buoy equity prices.
With each repurchase announcement and buyout deal comes renewed speculation and
buying pressure. Easy abundant credit is required. No matter how low you get
your wage bill, no matter how inexpensively and innovatively you get your
financing, ultimately you still need buyers. Sure, stagnant wages, declining
tax bills and regulatory relief seem grand now, but they risk greater savings
and reduced consumption. For now, debt has filled the gap and, in doing, opened
another grand avenue to profit. So long as this lasts, it supports asset prices
and economic activity.
Already the nimble have begun to realize that the future of lending at high
rates with good repayment levels may well be outside the United States. Over
the past few years, Americans have been consuming 60-70% of the world's excess
savings. The US has 4.5% of the world's population, has 20% of global GDP, and
is now growing more slowly than the European Union, India, China, and much of
Latin America. The US is also far more indebted - thus the growing excitement
about micro-credit and booming consumer-debt markets in Eastern Europe, Asia
and beyond.
We suggest that a rethinking of the news flow and less euphoric perspective may
now be in order. There is little doubt that such a perspective will cost you
some of the remaining upside and dampen spirits. After all, who wants to see
lead where he expects to find gold?
Notes
1. Federal Reserve Bank of St Louis. Updated through May 31, 2007. Click
here.
2. Personal Income and Outlays,
Bureau of Economic Analysis, June 1, 2007.
Max Fraad Wolff is a doctoral candidate in economics at the University of
Massachusetts, Amherst, and editor of the website GlobalMacroScope.
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10.6% year-over-year sales decline and a 6.5-month inventory backlog. Using its
data, we find a 4% year-over-year average house-price decline and an 11%
decline in median home price.
