Farr: Reading the Tea Leaves
Yesterday, Philadelphia Fed President Charlie Plosserquestioned the wisdom of the Fed's interest rate pledge for another reason. According to the Wall Street Journal, Plosser "opposed the decision largely on economic grounds, believing a strengthening economy simply doesn't need that level of monetary support for so far into the future." We have the utmost respect for President Plosser, who incidentally will be speaking before me at the "2012 Economic Forecast" at the University of Delaware on February 14. But is he correct in his analysis that the economy continues to gain momentum?
In our December 21 market commentary, we reviewed the recent economic data in an effort to determine whether or not the economy is indeed strengthening, as many have suggested. We posited that although data on manufacturing, housing and employment had improved over the prior weeks, the fate of the economy will ultimately rest on the consumer's willingness to open her purse strings. We suggested that the moderate strength in holiday shopping was due to steep retailer discounts, a drop in gas prices, pent-up demand, and a drop in the savings rate. We further said that these temporary drivers would not be sustainable given the consumer's continuing need to rebuild her balance sheet. We expected the savings rate to shortly resume its upward trend.
So what has the economic data thus far in 2012 been telling us? We would highlight a few important recent data points:
- The fourth quarter GDP report released last week was uninspiring, at best. While the economy grew at its best pace since the second quarter of 2010 at 2.8%, an increase in inventories provided the majority of the growth. Consumer spending, representing 70% of GDP, grew at just 2.0% compared to the consensus estimate of 2.4%.
- On Monday of this week we received data on Personal Income and Personal Spending. While Personal Income rose 0.5% in December (slightly better than expected), Personal Spending was flat. As we expected, the net effect was an increase in the savings rate (personal savings as a percentage of after-tax income) to 4.0% from 3.5% in November. Higher savings equals weaker economic growth in the near term.
- Consumer confidencefell in January to 61.1 - well below the consensus estimate of 68.0.
- The S&P Case Shiller 20-City home price indexfell more than expected in November, with 19 of 20 cities in the index posting sequential decreases. As we have said many times in recent years, housing is the lynchpin of the economy and is a central target of the Fed's loose monetary policy.
- Perhaps most importantly, the Fed remains unconvinced about the strength of the recovery. The forecast for low rates through 2014 as well as hints of a possible QE3 make it clear that the Fed believes there is work left to do.
The main ingredient to the economic recovery, aside from stabilization in housing, is a healthy increase in incomes. If income were to grow at a robust pace, the consumer would have enough money to continue spending while also putting more away in savings. And while December's 0.5% increase in Personal Income was welcome, the longer-term trend has not been good. Furthermore, nobody is expecting much out of Friday's January jobs report, especially after today's ADP reportsuggested the addition of only 170K private sector jobs last month. The government report on Friday is expected to show that non-farm payrolls grew just 145K in January, which is just barely enough to offset the growth in the labor force and hardly enough to ensure robust growth in Personal Income.
We should note two things. First, while an increase in the savings rate is not good for near-term economic growth, it is completely necessary for the long-term health of the economy as we continue the process of deleveraging. Second, and at the risk of being repetitive, the kind of lackluster economic growth we are now seeing is not necessarily bad for stocks, especially given the Fed's "commitment" to keep interest rates low for so long. High-quality, blue chip stocks continue to appear attractive for long-term investors, especially in light of the yields available on bonds.
Please tune in to CNBC tonight to watch me on the Kudlow Report, which airs at 7:00.
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.