FORECASTS & TRENDS E-LETTER
April 1, 2014
Consumer Confidence Up, But Concerns Remain
ValueWalk's Raul Panganiban interviews Kirk Du Plessis, Founder and CEO of Option Alpha, and discuss Option Alpha and his general approach to investing. Q1 2021 hedge fund letters, conferences and more The following is a computer generated transcript and may contain some errors. Interview with Option Alpha's Kirk Du Plessis
1. US Gross Domestic Product Rose at 2.6% Pace in 4Q
2. New Economic Statistic Coming Later This Month
3. “Gross Output” Could Lead to a Value-Added Tax
4. Consumer Confidence is Up, but Concerns Remain
5. President Obama’s Job Disapproval Rating Hits New High
The Conference Board reported last week that its Consumer Confidence Index jumped to 82.3 in March (up from 78.3), the highest reading since January 2008, just as the recession was beginning. But the two underlying components of the Index provided two different perspectives, as we will discuss today.
Basically, consumers as a group are feeling better and more confident about the economy and their present situation. That sub-index has risen pretty steadily over the last two years. However, when asked how they feel about their financial situation six months from now, most consumers are much less confident. About as many expect their situation to get worse as those who expect it to get better. That’s not good.
But before we get to that topic, let’s take a look at last week’s third and final estimate of 4Q GDP which showed a modest increase (2.6%) over the second estimate in February. We now know that the economy stalled a bit in the 4Q of last year, following growth of 4.1% in the 3Q. And it likely slowed even more in the 1Q of this year due to bad weather.
Following that discussion, I want to introduce you to a new breakthrough economic statistic that we’ll be hearing about for the first time later this month. It’s called “Gross Output” (GO) and is a measure of total sales volume at all stages of production. GO is much larger than GDP, the standard yardstick for measuring final goods and services produced in the economy. I’ll explain why GO is being introduced and why we investors need to pay attention to it.
Finally, President Obama’s disapproval rating has soared to a new all-time high, and his approval rating is falling once again. Americans continue to blame him for Obamacare, and 57% dislike his handling of the Ukraine situation.
US Gross Domestic Product Rose at 2.6% Pace in 4Q
The economy grew a little more briskly than the government previously estimated in the 4Q on stronger consumer spending, among other factors. Gross domestic product is the market value of all final goods and services produced within a country in a given period.
The nation’s GDP in the final quarter of 2013 increased at a 2.6% annual rate, up from the previous estimate of 2.4%, the Commerce Department reported last Thursday. That’s the government’s third and final estimate of 4Q growth. The pre-report consensus called for an increase to 2.7% GDP growth.
Consumer spending increased at a better than expected 3.3% annual pace in the 4Q, partly on stronger healthcare outlays, up from the previous 2.6% estimate. Also, state and local government spending and exports rose more rapidly than initially thought. Business equipment expenditures – a key gauge of companies’ appetite for capital spending – also picked up more than previously estimated.
Rising consumer spending underpins many analysts’ expectations for stronger economic growth this year, despite the weather-related disruptions in the first two months. The fading effect of last year’s tax increases coupled with fast-rising stock and home values are boosting spending firepower.
Still, some economists cautioned that meager income growth could act as a curb on consumer spending in the months ahead. Several forecasters said that the 4Q spending bump is not sustainable, and that will almost certainly be true for the 1Q of this year due to the extremely cold weather in January and February.
Declines in housing investment and government outlays were the two biggest drags on growth in the 4Q. Housing investment fell by 7.9%, slightly less than the 8.7% drop previously estimated – its first decline in three years amid rising mortgage rates. Recent cold weather has further chilled home-building activity, though building permits, an indicator of future construction, rebounded in February. Most economists expect the sector to make a positive contribution to economic growth this year, though likely smaller than last year’s.
Growth in the 4Q slowed from its 4.1% rate in the 3Q, though a measure of underlying economic strength improved. Growth of final sales of domestic product, a measure that excludes volatile inventories, accelerated to 2.7% from 2.5% in the 4Q. For all of 2013, the economy grew at a 2.6% nominal rate, slightly more than the 2.5% previously estimated. That followed growth of 2.8% in 2012 and 1.8% in 2011.
The economy gained momentum in the second half of last year, but much of the expansion was the result of aggressive inventory stockpiling by businesses. That led to a reduced need for firms to replenish shelves in the January-March quarter. That plus the unusually cold and snowy weather in January and February is expected to have yielded slower growth early in 2014. The first estimate of 1Q GDP will be announced at the end of April.
Yet many analysts expect the economy to pick up steam the rest of the year due to higher household wealth, lower debt and an accelerating housing recovery. That remains to be seen.
In other economic news, the Consumer Confidence Index rebounded strongly in March, as I will discuss below, rising to 82.3 from 78.3 in February. While that’s encouraging, the University of Michigan’s Consumer Sentiment Index was virtually unchanged for March at 80.0, up from 79.9 for February.
Personal income rose a better than expected 0.3% in February, following a rise of 0.2% in January. Orders for durable goods rose a solid 2.2% in February, up from 0.9% in January. Leading indicators rose 0.5% in February, up from 0.1% in January.
This morning, the ISM manufacturing index for March came in at a disappointing 53.7, slightly below the consensus of 54.1. On Friday, we’ll get the unemployment report for March which is expected to dip from 6.7% in February to 6.6% according to the pre-report consensus.
Important New Economic Statistic Coming Later This Month
As noted above, the Commerce Department’s Bureau of Economic Analysis (BEA) will give its first estimate of 1Q GDP on April 30. But the BEA is also scheduled to release a breakthrough new economic statistic for the first time on a quarterly basis. It’s called “Gross Output” (GO), a measure of total sales volume at all stages of production. GO is much larger than the size of GDP, the standard yardstick for measuring final goods and services produced in a year.
This is the first new economic aggregate since Gross Domestic Product (GDP) was introduced over fifty years ago. Many argue that it’s about time we had a new measurement of spending throughout the entire production process, not just final output. GO is a move in that direction.
GO attempts to measure total sales from the production of raw materials through intermediate producers to final retail. Some forecasters believe that GO is a better indicator of the business cycle. GO is a measure of the “production” economy, while GDP represents the “consumption” economy. Both are essential to understanding how the economy works.
In short, by focusing only on final output, GDP underestimates the money spent and economic activity generated at earlier stages in the production process. It’s as though the manufacturers and shippers and designers aren’t fully acknowledged for their contribution to overall growth or decline.
While the chart above is a year old, it gives us some idea of how GO is larger than GDP, both in positive years and negative years. You can see that GO was far more negative than GDP in 2009 during the recession. That’s because GO takes into account all areas that were affected throughout the supply chain, whereas GDP only counts the drop in final sales.
Gross Output Could Lead to a Value-Added Tax
Let me say at the onset, I have not heard or read anyone who is predicting that the new GO numbers, which we’re supposed to get for the first time at the end of this month, might be a Trojan Horse for a new “value-added tax” (VAT) at some point.
The value-added tax is exactly what its name implies. It is a tax on the value added at each stage of the production of goods and services. For any firm paying the VAT, the “value added” for a particular item is the amount by which the sales price of the product exceeds the cost of all products purchased to make that item.
Because the tax is paid at each level of production, and often not itemized on the final bill to consumers, some try to characterize the VAT as a tax on business. But most analysts agree that the value-added tax is essentially a sales tax on consumer purchases that is collected in stages.
Because Gross Output will be measuring the increased value of products at each stage of production, it will make it very convenient to introduce the value-added tax at some point. And with Gross Output being significantly larger than GDP in most years, lawmakers could well see it as a source of much greater tax revenues. Politicians always look for ways to raise taxes without having to increase the official marginal tax rates.
Again, I have not heard anyone suggest this idea yet, and it will be very interesting to see how the media reacts to this new economic metric later this month. But I will not be surprised if the subject of a new value-added tax comes up before long. Just keep in mind that you heard it here first!
Consumer Confidence is Up, but Uncertainty Lingers
As noted earlier, the Conference Board reported last week that its Consumer Confidence Index jumped to 82.3 in March, the highest reading since January 2008, just as the recession was beginning. But two internal components of the Index – the “Present-Situation Index” and the “Expectations Index” provided two different perspectives, as we’ll see in the charts below.
While consumers have become more confident in the present, they have not become more confident about the future. While their optimism now is much higher than it was at the depth of the financial crisis in 2009, it remains below the levels seen as recently as last summer.
The Present-Situation Index has been rising fairly steadily since it hit bottom at the end of 2009, although it slipped slightly in March, according to the preliminary figures. But the Expectations Index, based on consumer forecasts for six months later, remains well below where it was in early 2011, when enthusiasm grew over prospects for recovery.
The Present-Situation Index is based on answers to two questions. The first asks if current business conditions are good, normal or bad. In March, nearly as many Americans characterized the conditions as good (22.9%) as saw them as bad (23.1%), with the rest somewhere in between. Not since the beginning of 2008 has that difference been as narrow.
The second question asks about the state of the job market. Respondents are given three choices – that jobs are “plentiful,” that they are “not so plentiful” or that they are “hard to get.” There, the improvement has not been as visible. But there has been a steady decline in the proportion of people who think jobs are hard to get, from nearly half of respondents at the worst to about a third in recent months.
The proportion who say jobs are plentiful was only 13.1% in March. That was down a little from the previous month, but otherwise was higher than at any time since 2008. The point is, good jobs are still hard to find.
Things Are Getting Better but Very Slowly
Americans view the current economic situation more favorably than at any time since early 2008, before it was clear that a recession had begun. But their confidence that the economy will improve in six months has not risen as rapidly and there is now less optimism than there was last summer.
The Expectations Index is based on three questions, and the answers to them have bounced around in a range for the last couple of years. Two of the questions are shown in the charts above, each reflected by the percentage that expects improvement, less the percentage that expects things to get worse.
On business conditions, Americans expect improvement by a margin of 7.4 percentage points, with 18.1% saying conditions will improve and 10.7% forecasting the opposite, while the majority expects no change. On employment, the margin is a negative 4.1 percentage points, with 13.9% expecting more jobs and 18% expecting fewer.
For both those questions, the current views are much more optimistic than they were at the depths of the recession, but they remain within a range that has now held for two years.
The third question for expectations, not shown in the charts, concerns whether people expect their own income to rise or fall in the next six months. The latest figures show a bare plurality expects improvement, while a plurality expected things to get worse as recently as December. Those in the middle expect little or no change.
In all, the view from Main Street seems to be that the economy is slowly improving, but with little confidence that the improvement will last.
President Obama’s Job Disapproval Rating Hits New High
A big reason why consumers have little faith that the economic recovery will last is the growing disapproval of President Obama and his anti-business policies at home and anti-American foreign policies abroad. A new Associated Press survey in late March found that Obama’s job disapproval rating rose to a new high of 59%, with only 41% approving. That’s the APs second lowest approval rating for Obama since he took office.
The president’s latest problems, other than Obamacare, appear to be related to foreign policy: The poll shows Americans disapprove of his handling of the situation in Ukraine 57-40 and disapprove of how he handles relationships with other countries 58-40. As recently as January, Americans were evenly split on Obama’s diplomacy skills, so the latest numbers are a stark deterioration.
While Obama’s 59% disapproval rating is still below that of former President George W. Bush in late 2008, it is nonetheless a chilling number for Democrats who are running in the mid-term elections in November for House and Senate seats. I’ll save that discussion for another time.
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Consumer Confidence Up, But Concerns Remain via forecastsandtrends