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Spending Rises But Is It A Sign Of A Stronger Economy?

  • Written by Syndicated Publisher No Comments Comments
    May 6, 2014

    Last week we saw the first estimate of the first quarter’s gross domestic product which grew at an annualized rate of just 0.1% or just .025% for the quarter. However, what was crucially important was where that smidgen of growth came from. As shown in the chart below had it not been for the 3% surge in personal income expenditures that actual economic growth rate would have been a -1% annualized.

    PCE-BreakdownByMajorSector-050114

    Mainstream economists and analysts immediately jumped on this surge in consumer spending as a sign that the underlying economy was actually much stronger than the data showed. However, that spending was NOT broad based. As shown in the next chart, the increase in consumer spending was the only offset to weakness in every other major subcategory of the GDP calculation.

    PCE-NetChg-Cont-GDP-050114

    While the “harsh winter weather” was used as the scapegoat for the weak economic report, the broad weakness in other areas like the plunge in exports should raise some concerns.  (Exports make up roughly 13% of economic growth versus the much more focused on housing contribution of 3%.)

    All Spending Is Not Created Equal

    Where money is spent within the economy has a huge impact on both the strength and sustainability of growth. Spending that has long lasting impacts on economic growth by stimulating further spending or employment is much more preferable over spending that diverts consumptive capabilities.  For example, spending by businesses to build or expand production, which fosters employment, is much more preferable that dollars spent on food services which has a much lower “multiplier effect” in the economy.

    Let’s take a close look at the surge in services spending over the last quarter.

    (Side note: This is why the majority of hiring continues to focused on services related jobs and generally never exceeds the rate of population growth.  As the population grows, demand on services increases incrementally. However, low wage paying and temporary service jobs do not foster higher levels of spending in areas that promote sustainable economic growth.)

    PCE-Services-MajorSubCat-050114

    The chart above shows the percentage contribution of each major sub-category of services spending as it relates to the net dollar change in total personal consumption expenditures (PCE) over the last quarter.  As you can see, the majority of spending was concentrated in housing, utility costs and healthcare.  Spending in these areas have a large impact on the household budget and diverts spending from going to other areas of the economy.

    However, let’s drill down into these major categories and look at the contribution from some selected subcategories to try and get a better handle on where money is being spent specifically.  The next chart shows selected sub-categories of services spending as a percentage contribution to the total quarterly percentage change in PCE.

    PCE-Services-Selected-SubCat-050114

    What we now can clearly see is the “weather effect” on consumers.  As the cold winter blasted through most of the mid-west and northeast, it required greater consumption of electricity and gas to heat homes.  Furthermore, cold weather leads to more illness, accidents and other health related issues which increased outpatient service costs and hospital stays.

    This increase is spending in these areas will likely fade in the months ahead as the weather warms. However, what most economists are hoping is that as the warmer weather prevails spending will return to other areas of the economy such as durable goods, inventory restocking and net exports. If the current projections of 3% economic growth is to occur in the second quarter, it will require a rather sharp rebound in economic activity in the next couple of months.

    I expect that the first quarter GDP estimates will be revised upward over the next two months as more data becomes available.  Furthermore, as I have discussed previously, the last four years have seen repeated draw downs in inventories that lead to an inventory restocking cycle. This has been repeatedly misconstrued by economists to be an economic recovery story. This can be clearly seen in the chart of the Chicago Fed National Activity Index below:

    CFNAI-3month-Growth-042214

    While the recent uptick in some of the monthly economic reports is encouraging, it is likely temporary in nature. Corporate earnings reports, while beating much lowered estimates, continues to show weak top line revenues. This is clearly indicative of weak consumer demand which will continue to weigh on employment, wage growth and overall economic activity.

    That conclusion was reflected in a recent National Association of Business Economics (NABE) survey:

    8 of 10 companies do not expect wages to increase over the next three years.The survey indicates that 80% of businesses see wage growth adjusted for inflation to rise between zero and 3%. Despite the flat wages, it would actually be an improvement over the last three years. From 2011 to 2013, private industry inflation adjusted earnings fell by 0.7%, according to the Bureau of Labor Statistics’ Employment Cost Index.”

    While consumer spending certainly saved the economy in the first quarter of this year, the sustainability of that spending is questionable. Furthermore, given that spending was focused on more mandatory (electric bills and hospital costs must be paid) rather than discretionary areas does not suggest that consumers are more financially well off.

    With the economic recovery now almost six years into recovery it has become a “foot race” to the finish line. With asset prices at elevated levels in anticipation of an economic revival, the failure of such a resurgence could lead to a significant disappointment for investors. Of course, the next couple of months will tell us much as the Federal Reserve continues to peel away their support and markets begin to reprice to economic reality

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.
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