The Economy - Consumers Still in the Dumps

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 19, 2010

IN THIS ISSUE:

1. Weak Economic Growth to Continue

2. Consumer Confidence Remains in the Dumps

3. Unemployment Rate Continues to Disappoint

4. Fortunately, Not All the News Was Bad

5. 2010 Federal Budget Deficit Hits $1.3 Trillion

6. Don’t Forget the “Debt Commission”

Introduction

In today’s letter, we begin with a look at the latest economic reports which have been mostly disappointing over the last few months. I will share some specific new forecasts on the economy going forward through the end of this year and next year.

We’ll also discuss the recent fall in consumer confidence, why that is happening and what it means for the economy. As part of that discussion, we will look at the latest CEO Confidence Index, which took a big hit in the 3Q.

From there, we will analyze the latest disappointing employment numbers for September and why they could get even worse just ahead. Fortunately, not all the economic news of late was negative. I’ll show you a few bright spots as we go along.

Finally, we will revisit President Obama’s “Debt Commission.” It appears that this 18-member, supposedly bipartisan group is having serious difficulty agreeing on how to reign-in our runaway budget deficits ($1.3 trillion in fiscal 2010). Surprise, surprise!

Weak Economic Growth to Continue

At the end of September, the Commerce Department released its third and final report on 2Q Gross Domestic Product showing that the economy grew by an anemic 1.7% (annual rate). To put the extent of the recession in perspective, here are the quarterly GDP numbers since it began:

2Q 2008	+0.6%	3Q 2009	+1.5%
3Q 2008	-4.0%	4Q 2009	+5.0%
4Q 2008	-6.8%	1Q 2010	+3.7%
1Q 2009	-4.9%	2Q 2010	+1.7%
2Q 2009	-0.7%	3Q 2010	+1.2% (est.)

The so-called “Great Recession” was the worst since the Great Depression, with GDP falling for four consecutive quarters. In the post-WWII era, recessions have been followed by strong rebounds in the economy. While the latest recession officially ended in June 2009, according to the National Bureau of Economic Research, the recovery since then has been quite disappointing, and we now appear to be headed on a downward track once again.

While we won’t see the government’s first estimate of 3Q GDP until October 29, many forecasters are now revising their GDP estimates downward. Last week, for example, Macroeconomic Advisers – a widely-followed forecaster – cut its estimate of 3Q GDP from 1.6% to 1.2%. The question now becomes, will we fall back into a double-dip recession.

One of my favorite services I subscribe to is Blue Chip Economic Indicators (Aspen Publishers), which surveys 50 leading economists and forecasters each month and then calculates a “consensus” of their views on a variety of questions. In their latest report, the consensus is that the US economy will not fall into a double-dip recession. Their consensus forecast is that GDP grew by 1.9% in the 3Q, and that it will expand by 2.3% in the 4Q.

As for 2011, the Blue Chip Economic Indicators’ consensus expects the economy will expand by 2.5%. And remember, this is a consensus of 50 economists and forecasters, with some more optimistic and some more pessimistic.

On the bright side, perhaps, none of the 50 forecasters predicts a double-dip recession next year. I say “perhaps” because contrary opinion would argue that if 50 leading forecasters believe we won’t see a double-dip recession next year, then we probably will. In any event, suffice it to say that the US economy will almost certainly disappoint again next year.

Consumer Confidence Remains in the Dumps

As we all know, consumer spending accounts for apprx. 70% of GDP. On September 28, the Conference Board reported that the Consumer Confidence Index unexpectedly fell 4.7 points to 48.5. The pre-report consensus suggested the number would be in line with August’s 53.2 reading.

The following chart from Market Harmonics illustrates just how dramatically consumer confidence has fallen over the last decade. The plunge from the late 2007 peak to the March 2009 valley was the largest since records have been kept. While the index has recovered since March 2009, notice that it is still well below the low after the 2001-2002 recession. Notice also that the index has fallen in two out of the last three months, and the increase in August was quite modest.

Consumer Confidence Index

S&P 500 Index Nearest Futures

Notice how eerily similar the trend in the stock market has been over the same period of time as the Consumer Confidence Index chart above. Such is life when consumer spending makes up apprx. 70% of GDP.

Lynn Franco, the Director of The Conference Board Consumer Research Center noted: “September’s pull-back in confidence was due to less favorable business and labor market conditions, coupled with a more pessimistic short-term outlook. Overall, consumers’ confidence in the state of the economy remains quite grim. And, with so few expecting conditions to improve in the near term, the pace of economic growth is not likely to pick up in the coming months.”

Consumers’ assessment of current conditions weakened further in September. Those saying business conditions are “bad” increased to 46.1% from 42.3% in August, while those claiming business conditions are “good” declined to 8.1% from 8.4%. Consumers’ appraisal of the labor market was also less favorable. Those claiming jobs are “hard to get” rose to 46.1% from 45.5%, while those stating jobs are “plentiful” decreased to 3.8% from 4.0%.

Consumers’ expectations also took a turn for the worse in September. The percentage of consumers expecting business conditions will worsen over the next six months rose to 16.4% from 13.4%, while those anticipating business conditions will improve declined to 14.9% from 16.9%.

Along with the Consumer Confidence Index, the Conference Board also conducts a monthly survey of business leaders to formulate a CEO Confidence Index. While this index was unchanged in the 2Q of 2010, it declined in the 3Q. For the quarter ended September, the index fell to 50, down from 62 in the 2Q (a reading of more than 50 points reflects more positive than negative responses).

Lynn Franco of the Conference Board noted: “CEO confidence has cooled considerably in the second half of 2010, as has the U.S. economy. And, expectations are that this slow pace of economic growth will continue into early 2011. Regarding capital spending plans, the news was a bit more favorable with three out of every ten chief executives saying they had increased capital spending plans since the start of this year, a significant improvement from last year when only 7% reported increases.”

CEOs’ appraisal of current economic conditions was much less favorable in the 3Q. Less than one-third said conditions have improved compared to six months ago, down from about two-thirds last quarter. In assessing their own industries, business leaders’ appraisal was also considerably less positive. Now, only 38% say conditions are better, compared with 61% last quarter.

CEOs are much more pessimistic about the short-term outlook. Only 22% of business leaders expect economic conditions to improve in the next six months, down from 48% last quarter. Expectations for their own industries are also downbeat, with only about 28% of CEOs anticipating an improvement in the months ahead, down from 43% in the 2Q.

Other surveys of business leaders indicate that the uncertainty surrounding healthcare costs, energy costs (cap-and-trade), more government regulation and the fate of the Bush tax cuts are primary forces affecting both CEOs and consumer confidence.

The Unemployment Rate Continues to Disappoint

Non-farm payrolls plunged in September more than forecast as continuing fiscal retrenchment by state and local governments forced agencies to cut employment while private employers failed to generate enough jobs to grow the economy.

Employers cut 95,000 jobs last month, according to Labor Department figures released on Friday, October 8. Private businesses added 64,000 jobs, a continuation of steady private employment growth. But government agencies cut 159,000 jobs, roughly split between departing federal Census Bureau workers and state and local cuts.

The overall unemployment rate remained at 9.6% in September, a figure little changed from January. The total number of unemployed persons was 14.8 million, according to the Labor Dept. The number of long-term unemployed (those jobless for 27 weeks and over) was 6.1 million at the end of September, or 41.7% of total unemployed. If these workers and those who are under-employed are included, then the real unemployment rate is around 17%.

Of course the latest figures are preliminary and subject to revision. In a troubling sign, the decline in employment previously reported in July and August was revised to reflect an additional 12,000 jobs that were cut in July and 3,000 in August. Also, in the 12 months ending in March, the Labor Department revised its previous estimates of private payrolls, showing that businesses shed an extra 371,000 jobs more than previously reported.

Economists had expected private payrolls to rise by 75,000 in September, according to a survey by Bloomberg News and Mark Zandi, chief economist at Moody’s Analytics. The economy needs an additional 150,000 jobs a month to bring the unemployment rate down. Most forecasters do not expect the economy to be adding that many jobs a month until sometime in the second half of 2011, if even then.

Fortunately, Not All the News Was Bad

While the majority of economic reports have been negative over the last few months, there have been a few bright spots. On September 23, the Conference Board reported the Leading Economic Index (LEI) rose 0.3% in August, following a rise of 0.1% in July and a decline of 0.2% in June.

The Conference Board Leading Economic Index Increases in August

Ken Goldstein, an economist at the Conference Board noted: “While the recession officially ended in June 2009, the recent pace of growth has been disappointingly slow, fueling concern that the economic recovery could fade and the U.S. could slide back into recession. However, latest data from the U.S. LEI suggest little change in economic conditions over the next few months. Expect more of the same – a weak economy with little forward momentum through 2010 and early 2011.”

The LEI tends to be more forward looking and is significantly influenced by interest rates and interest rate spreads, both of which have been very positive this year. This fact has some analysts focusing more on the Coincident Economic Index (CEI), which is an indicator of how the economy is doing at present. After reaching a bottom in June 2009, the CEI has been essentially flat over the summer.

The LEI report for September is due out this Thursday, and the consensus forecast is for another rise of 0.3% to 0.4%. If so, that would suggest the economy might improve modestly in November and December. Let’s hope so anyway.

On another front, retail sales have increased the last three consecutive months, despite the weakness in consumer confidence. The Commerce Department reported that retail sales rose 0.6% in September following the rise of 0.7% in August. For the 12 months ended September, retail sales were up 7.3%.

Auto and gas sales remain the strongest segments in retail. Car dealer sales were up 19% in September year over year, aided by the start of the new model year, while gas station sales were up 8.2% y/y. Most analysts see moderate retail growth going forward into the holiday season, which forecasters predict will see a modest increase of between 2% and 3% above last year’s sales. Most forecasters expect retail sales to increase only about 2% in 2011, which would still be below the levels in 2006 and 2007.

2010 Federal Budget Deficit Hits $1.3 Trillion

The Congressional Budget Office announced last week that the budget deficit for fiscal 2010 (ended September) was just under $1.3 trillion, which was actually slightly smaller than the CBO’s previous estimate. It was the second largest budget deficit in the post WWII era, down $125 billion from last year’s record deficit.

Source: CBO

The CBO estimates that the 2010 deficit was equal to 8.9% of GDP, down from 10.0% in 2009. The national debt now stands at a staggering $13.6 trillion. It will be interesting to see the CBO’s upcoming projections of the annual deficits going forward now that the official number for fiscal 2010 has been released.

Don’t Forget About the Debt Commission

We don’t hear much in the news about President Obama’s National Commission on Fiscal Responsibility and Reform, better known as the “Debt Commission.” Obama formed this commission by Executive Order back in February after the Senate refused to pass a law to that effect.

The Debt Commission is said to be bipartisan as it includes both Democrat and Republican members. The commission has 18 members and is co-chaired by former Republican Senator Alan Simpson and President Bill Clinton’s former Chief of Staff, Erskine Bowles. The Executive Director is Bruce Reed, a Democrat who was a policy adviser to President Clinton. Overall, the commission includes 10 Democrats and 8 Republicans.

The Commission is charged with proposing recommendations designed to balance the budget, excluding interest payments on the debt, by 2015. In addition, the Commission shall propose recommendations that meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government.

The Commission reportedly meets as a whole once a month while Congress is in session. There are several “working groups” that meet more frequently. The Commission will vote on a final report containing a set of recommendations to achieve its mission no later than December 1, 2010.

When President Obama organized the Commission back in February, he hailed that the members would be bipartisan and work together to find a solution to our runaway deficits. It is interesting, however, in that he insisted the Commission’s final report will require the approval of at least 14 of the Commission’s 18 members. If the final report gets the necessary 14 votes, it will automatically be sent to the House and the Senate for a vote.

You may recall that when President Obama formed the Commission, he instructed the leaders and the members that “everything has to be on the table.” Everything, in this case means tax hikes, including a Value Added Tax, spending cuts and changes in entitlement spending – including Social Security, Medicare and Medicaid.

Back on July 11, the Co-Chairmen, Simpson and Bowles, acknowledged that they were having a tough time reaching an agreement. “There are many who hope we fail,”Simpson said at the closing session of the National Governors Association annual meeting in July. He called the 18-member Commission “good people with deep, deep differences” who know the odds of success “are rather harrowing.”

I don’t pretend to know whether the Debt Commission will succeed in getting enough votes (14) to pass a final report, but it will be a very big deal either way. I merely revisit this issue this week as a reminder to my clients and readers, since we hear very little about it.

December 1 will be here before we know it, and I would caution, lastly, that the markets could be very crazy from now until then, especially with the election in two weeks.

Editor’s Note: If you were not able to attend our webinar last Thursday with Wellesley Investment Advisors and its founder Greg Miller, you can now view the webinar at our website.

Click here to view the Wellesley webinar recording.

If you are worried that your bond portfolio will get hurt whenever interest rates start to rise, I highly encourage you to seriously consider Wellesley.

Very best regards,

Gary D. Halbert

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