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It is clear that we have seen an increase in economic activity in the US over the past several months. This is partly due to an uptick in defense spending and an improvement in our trade deficit. A more significant factor has been the increase in capital spending and the rebuilding of inventories by businesses. This is only sustainable if we see consumer demand strengthen, since that is what predominately fuels business revenues and profits. While some incremental consumer demand may be resulting from stock market gains, otherwise known as the wealth effect, the primary fuel for consumer demand is income. Real income growth is where the current economic expansion has consistently fallen short. This is the primary reason why I feel as though the US economy, while continuing to grow, is gradually weakening.
The hurricanes that hit Florida and Texas are undoubtedly responsible for some of the recent increase in economic activity, as they act like stimulus programs in the short term, but at a cost in the long term. The rebuilding effort continues to lead to greater demand for a wide variety of goods and services that would have otherwise not occurred. This is more visible in the auto sector than any other. The longer-term consequence of this in many cases is that consumers and businesses must tap saving or borrow to fund some of their rebuilding efforts, which serves to slow growth in the future.
New and Pending Home Sales
Could investors be reallocating some of their financial market gains into real estate? That’s one explanation for a surge in new home purchases, as sales rose 6.2% in October to an annualized 685k. Perhaps others are relocating from parts of the country ravaged by natural disasters in recent months. Sales are now up 18.7% on a year-over-year basis. New-home construction is clearly contributing to the rate of economic growth in the current quarter.
Yet existing-home sales remain stuck in the mud, as year-over-year we are seeing a decline of 0.9%. The pending-home-sales index has declined in six of the past seven months, which doesn’t bode well for existing sales moving forward.
Auto sales surged due to the replacement demand that followed the hurricanes in Texas and Florida, as can be seen in the chart below. Now we are starting to see activity slow again, with sales in November 2017 falling 1.3% below the level of sales we saw in November of last year. I expect the downtrend in sales, which was abruptly reversed in September, will resume in 2018. This year is likely to be the first full-year sales decline since the Great Recession.
Personal Income and Spending
Personal income rose 0.4% in October, while the Personal Consumption Expenditures price index, or PCE, which is the Fed’s preferred measure of inflation, rose 0.1%. What I find discouraging is that the amount of increase in interest income nearly matched the increase in salary and wages. Real disposable income, which accounts for taxes and the PCE, is barely growing on a year-over-year basis, as can be seen below.
Consumer spending rose 0.3% in October, following September’s auto-led surge in spending of 1.0%. The savings rate, which is at just 3.2%, continues to hover near a 10-year low. With virtually no real income growth consumers are forced to borrow to increase their rate of spending.
The construction-spending report includes the total value of all new construction activity for residential, non-residential and public projects. Construction spending rose 1.4% in October, while the year-over-year rate has gradually decelerated to what is now 2.9%.
While new-home sales have spiked over the past two months, the rate of growth in existing-home sales, auto sales and construction spending continue to decline or weaken on a year-over-year basis. This does not support the argument that the economy is strengthening. Those more optimistic about the US economy, clearly looking through the rose-colored glasses of the stock market, will point to continued job growth and a historically low unemployment rate as evidence of strength. The problem is that the quality of the jobs being created, the participation rate and the lack of real wage growth suggest just the opposite.
I continue to believe that the recent uptick in the rate of economic growth will be short-lived. The majority of the wealth that is being created in our financial markets is far more likely to be saved or reinvested rather than spent. The tax-cut proposals on the table are geared towards returning capital to corporations and the wealthy, both of whom are more likely to save or invest, rather than spend it. Furthermore, our debt and deficit continue to grow unabated, limiting our ability to employ fiscal stimulus measures. While aggregate wealth and income figures continue to grow, the majority of the spoils continue to benefit a small percentage of American households, leaving a growing majority behind. This is why, in my view, the consumer is weakening and the consumer IS the economy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.