The U.S. consumer is under attack and the bullish case for equities is becoming less and less defensible.
By Howard Penney, Hedgeye
The rose-tinted view that has driven the S&P 500 to current levels is becoming more and more difficult to justify. As uncertainty around the Middle East mounts, highly significant factors behind the global economy, such as oil, are becoming more and more of a concern for investors. The revolution sweeping through the Middle East is driving oil prices higher as the timeline, geography, and repercussions of the political turmoil remain in flux.
With its downgrade of Spain's credit rating earlier this week, Moody's reminded us of the significant problems with the Eurozone's sovereign debt issues. And last night's earthquake in Japan only adds to the global uncertainty.
Here in the U.S., inflation is a tax on the consumer and, as such, the broader economy. In fact, I would posit that inflation (inclusive of things people actually buy, like gasoline, food and clothes), is a more devastating drag on the consumer than allowing the Bush tax cuts to expire. Inflation is taxation without the consent of the vast majority of those affected.
With the past two years having seen the second largest upward two-year move in equities since the period from 1953 to 1955, inflation is derailing the markets -- some to a greater extent than others. In the end, as in 2008, risk is always on and it is always interconnected. As oil climbs higher, threatening growth at a time the U.S. economy can ill-afford it, the recovery scenario that has been priced into the markets starts to look less impenetrable, less defensible.
Currently, my attention is firmly focused on the consumer. The spread between consumer expectations and present situation sentiment is at peak levels. Employment has been improving on the margin but, as I see it, two factors along the risk spectrum could spoil the U.S. equity market party that has been raging since 2010: Gasoline prices can keep rising and interest rates can go up. The magnitude of a possibly interest rate increase is unknown but (think Volcker) there is precedent for sharp, short, expedient increases in interest rates when inflationary pressures merit it.
The pressure for the US to raise interest rates is growing by the day. Jean-Claude Trichet is telling the world that Europe is ready to raise rates and Timothy Geithner no doubt is begging them not to. One small reason Europe needs to raise interest rates is the fact that European gasoline prices are at an all time record of $8.632 per gallon. European Central Bank Governing Council member Axel Weber has stated that, "Inflation may be more sustained and more fundamental than the ECB's latest projections suggest" and that he sees "considerable future price pressures."
This divergence in rhetoric between the USA and EU poses an interesting dilemma for investors. We know from experience that any faith in policymakers in Brussels or Washington being able to manage through this situation seamlessly is gravely misplaced. We were reminded of this last week on CNBC when Alan Greenspan said, "The one thing we all pretend we can do but we can't, is forecast."
Here in the U.S., the consumer is now under attack as inflation squeezes like it's 2008. Consumers may still maintain a rosy outlook, but mounting costs at the grocery store and at the pump will almost certainly recalibrate their expectations.
After losing some momentum in recent months, the recovery of new vehicle sales regained steam in February. Having said that, GM (GM) and Ford (F) stock can't get out of their own way; GM is down nearly 15% year-to-date and is trading below the $33 IPO price. Is consumer pent-up demand supporting the rise in vehicle sales? The stocks of the automobile makers are telling a different story.
Yes the labor market momentum is building, as expected payroll gains strengthened measurably in February, following the weather-induced weakness in January. The unemployment rate was a surprise at 8.9%, but it is likely an aberration as more discouraged workers than previous months did not enter the labor force. We see an intermediate-term bottom in the unemployment rate.
The gradual improvement in the labor market is benefiting consumer income trends. Real disposable income growth late last year was the fastest since the fall of 2007. The rate of growth is still far from robust; there are two factors that are limiting income: (1) the selective nature of the recovery, and (2) declining government support.
Despite a surge in personal income growth, real spending declined in January. Real personal consumption expenditures slipped by 0.1%, marking the first decline since April 2010. Nominal spending rose by 0.2%, which was about half of the average pace from the previous six months.
The inflation tax will likely erode optimism as reality for the US consumer sets in. According to the latest American Pulse Survey of 5,224 respondents, 80.3% of registered voters agree that the increase in gas prices is one of the worst problems affecting the United States. The survey asked respondents to list the worst problems currently affecting the United States, and registered voters mentioned in order of frequency: unemployment (80.4%), rising gas prices (80.3%), weak economy (70.6%), national debt (69.4%) and rising food prices (61.9%).
The U.S. consumer is under attack and the bull case for equities to withstand escalating input costs is becoming less and less defensible.
Also on Fortune.com:
Protectionism is only useful when you have something to protect. What good are higher import tariffs now that there are few if any domestic manufacturers to reap the benefits? One thing for sure, Obama's push for exports with Mr. Locke is stillborn.
Situation is worse than even this analysis. Multinationals heavy in the Dow and in the NASDAQ tech side are dependent increasingly not only on exporting (losing/killing) our domestic manufacture and design capability, but in selling overseas as well, allowing them easy roads to escape any and all US taxation and support of other sectors like transportation services and the like. Truth be told, the capitalists have shown their true colors with "free trade": they've sold us into slavery as we compete with the poorest nations and people for income. The republican free trade mantra was and is just a way of villifying Unions to retain profits. Had those profits been plowed back into domestic capital expenditure there might have been a defense for their actions, but they weren't. They were flushed to sovereign wealth and hedge funds as dividends, used to speculate in such brilliant devices as credit default swaps and used for capital outlays to move jobs, brick and mortar offshore.
Now, better still, the middle class is being sold on blaming the dwindling remaining illegal immigrants and democratic tax and spend idiots (like the truly spendthrift Barney Frank and the liberal parrots Nancy Pelosi and Harry Reid) for what they have done with their electronic money sleight of hand: they have irretrievably mortgaged the American dream for all of us. All hail Goldman Sachs, the real executive branch of the US government.
The party will end for some and begin for others as it becomes recognized that while protectionism is bad, outsourcing is worse and protectionism is the only defense against outsourcing. It's but a matter of when it occurs, in time to help millions of families suffering loss of dignity and sustenance or when those profiting from our trade imbalance begin to suffer from such and their lobbyists demand and ensure they receive protectionism. Place your bets!
There was a party? Where was I?
I believe Doug Kothof is right. Those saying a few years ago "we'll have a service economy and everything will be fine" were lying to cover their dreams of getting rich on Asian slave labor-made goods sold in western markets at a discount to free labor-made goods. All such people are traitors but instead of hanging them most of us just dream of being rich like them - and we give them nobel prizes or other high honors. How disgusting! How hopeless for the free world.
Wow. Well said Doug.
I just bought F at the open for 13.92. For me the party is just starting.
The bigger problem is the loss of jobs to outsourcing. Without enough exportable value (products) to sell, we have to borrow the $700 million we send to OPEC alone each DAY.
And the nail shops, police, army, health care, fast-food joints, etc., don't produce value or good jobs. All the paper-shuffling in the world doesn't compensate for our loss of a manufacturing base.
We need TARIFFS to protect our manufacturing, and to eliminate "misery products" from slave-labor countries that unfairly compete with good American working folks.
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