posted on 19 June 2016
by Lance Roberts, Clarity Financial
Over the past several years, I have repeatedly discussed the ongoing detachment between the economic reports versus what was happening in the actual underlying economy.
Last year, I wrote:
The importance of a liquidity trap can not be dismissed as the feedback loop of monetary interventions negatively impact growth by misallocated capital to non-productive uses.
Despite mainstream economists hopes that somehow "this time will be different," the ongoing massaging of economic data through seasonal adjustments to obtain better headlines did not translate into actual prosperity. Of course, "reality" is a cruel mistress and despite ongoing hopes and overstatements, "fantasy" eventually gives way.
The chart below shows the S&P 500 index with recessions and when the National Bureau of Economic Research dated the start of the recession.
There are three lessons that should be learned from this:
Economic Growth Not What It Seems
The last two-quarters of economic growth have been less than exciting, to say the least. However, these rather dismal quarters of growth come at a time when oil prices and gasoline prices have plummeted AND amidst one of the warmest winters in 65-plus years.
Why is that important? Because falling oil and gas prices and warm weather are effective "tax credits" to consumers as they spend less on gasoline, heating oil and electricity. Combined, these "savings" account for more than $200 billion in additional spending power for the consumer. So, personal consumption expenditures should be rising, right?
What's going on here? The chart below shows the relationship between real, inflation-adjusted, PCE, GDP, Wages and Employment. The correlation is no accident.
Economic cycles are only sustainable for as long as excesses are being built. The natural law of reversions, while they can be suspended by artificial interventions, can not be repealed.
More importantly, while there is currently "no sign of recession," what is going on with the main driver of economic growth - the consumer?
The chart below shows the real problem. Since the financial crisis, the average American has not seen much of a recovery. Wages have remained stagnant, real employment has been subdued and the actual cost of living (when accounting for insurance, college, and taxes) has risen rather sharply. The net effect has been a struggle to maintain the current standard of living which can be seen by the surge in credit as a percentage of the economy.
To put this into perspective, we can look back throughout history and see that substantial increases in consumer debt to GDP have occurred coincident with recessionary drags in the economy.
I Told You So
So, why all the rehash of commentary from the past three years. Simple. Because, of the following:
This announcement of negative adjustment to GDP is obviously no surprise to regular readers of this newsletter. Since the beginning of this year, I have been hammering on the problem of seasonal adjustments.
Here is my point. While my call of a forthcoming "recession" may seem far-fetched based on today's economic data points, it should be remembered that no one was calling for a recession in early 2000 or 2007 either.
Furthermore, given the weakness in corporate profits and declining return on equity, it is extremely likely the current economic estimates are substantially weaker as well. This suggests that by this time next year, we will once again find out the economy was as weak as corporate profits were already suggesting. Unfortunately, by the time the data is adjusted, and the eventual recession is revealed, it won't matter as the damage will likely have already been done.
While being optimistic about the economy and the markets currently is far more entertaining than doom and gloom, it is the honest assessment of the data and the underlying trends that is useful in protecting one's wealth longer term.
Is there a recession currently? No.
Will there be a recession in the not so distant future? Absolutely.
While calls for a "massive recession" may very well turn out not to be true, even a mild recession could have a substantial impact on personal wealth given the current deviation in prices from long-terms norms.
Getting to say "I told you so" isn't the point of this missive. What is important is understanding that "bullish exuberance" will likely meet its same fatal ending as it always has. Understanding that "risk" is simply a function of how much you will "lose" when you are eventually wrong is the key to surviving the next major market downturn.
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