What Do Others Think About the Economy?

Can he keep flying?          Photo Credit: Freeimages.com/Rob Chivers

About a month ago I published the post What is the Economy’s Condition? trying to answer that question. Two very important sets of variables involving retail sales and industrial production seemed rather flat, not telling a tale either of boom or bust. I described them as “ho-hum”. [Note on 10/30/2015: Apparently I was in error that retail sales have been “ho-hum” in the last four months or so. Although the four month average of retail sales growth from June through September is very close to zero, that growth rate has steadily been declining. See Cognitive Dissonance.] However, a number of other variables such as household debt, federal debt, the labor participation rate, median wages, commodity prices, and export and import indices ranged from merely scary to downright terrifying. In the downright terrifying category are:

• Federal debt that is 103% of GDP
• Median weekly wages of wage and salary workers, which have fallen from about $352 in January 2010 to $336 in June 2015 as measured in real 1982-1984 CPI adjusted dollars. This works out to a 4.6% pay cut over those five years.
• Commodity prices, which are crashing (except for uranium).

Then in our last two posts, Should We Expect Inflation or Deflation? and What Does Falling Money Velocity Tell Us?, we discovered the only reason we have not had appreciable inflation is that M2 money velocity has been persistently falling since the end of the Great Recession. This may be the scariest indicator of all, since falling money velocity means falling economic activity with dollars changing hands progressively more slowly. How much has M2 money velocity fallen? The graph showing this is displayed below.

The M2 velocity is shown in the blue curve and its percent change from a year earlier is in the red curve. It has fallen from a value of 1.75 in the third quarter of 2010 to 1.50 in the second quarter of 2015, a drop of 14% in about 5 years.

All of this looks fairly ominous! Because there is always a chance that I may have missed something and have been giving greater weight to these gloomy statistics than I should, it would be a good idea for us to make a short survey about what others are saying about the economy’s condition. In what follows I will take a look at several internet posts from the U.S. financial punditocracy, some with my point of view and some with the opposite. I will also examine corporate opinions.

The first article I will cover, The U.S. is on a fast track to deflation by Harry Dent, Jr.,  has more or less my point of view. Although he does not distinguish between the part of Quantitative Easing (QE) placed in excess reserves in the Federal Reserve and the portion that leaked to the economy through commercial banks, he does declare the following:

The money the Fed printed has largely gone into financial speculation. It hasn’t performed any real stimulus efforts by expanding the money supply through lending and spending.

So instead of inflation, we’ve seen bubbles pop up all over the financial markets. And they’re just like the ones we’ve seen before when tech stocks blew up. It was the same with real estate to follow… then emerging markets… then commodities… then gold… then junk bonds… then Treasury bonds.

Those bubbles did nothing to create a stronger future.

As I did, he saw the lack of QE and short-term Zero Interest Rate Policy (ZIRP) stimulus as due to the decline of the velocity of the money supply. He goes further, however, and forecasts not just effectively zero inflation, but outright deflation. As long as the deflation rates remain small, the most important effect is the declining money velocity that will create the deflation rate. This is because very low money velocity exists because very few are spending a lot.

The pundits who take a much rosier view of the economic future are well represented by Bryan Rich in the Forbes.com post Four Simple Reasons an Epic Rally is Ahead for Stocks. His four simple reasons are:

1. History: Applying the average long-run annualized return for stocks, which is 8%, to the S&P 500 high of 1576 before the Great Recession, we should have an S&P 500 value of 3150 by the end of next year. The current value as of October 28, 2015 is 2066. It seems to get to 3150 we would have to ignore all the history of the global financial crisis of 2007-2008 and the recession that followed it and the sub-par recovery that followed that.
2. Valuation: Rich states the average PE (price to earnings) ratio based on next year’s S&P 500 earnings estimates is a low 16.2. If only that figure were accurate! But the problem with that is so-called “forward PEs” are based on analyst’s estimates of future earnings, which have always been an exercise in wishful thinking as much as hard analysis. A more accurate picture of aggregate stock valuations is provided by the Shiller Cyclically Averaged PE (CAPE), which currently has a value of 27. Its long-run average is 17.
3. Recession Risk: Based on the Yield Curve, which is an index which compares short-term interest rates to long-term rates and comes in different flavors, Rich claims the probability of an imminent recession is negligible, 3.66% to be precise. The problem with this claim is that it is based on historical data when the Fed had not distorted interest rates and kept them close to zero for such a long time (approximately 8 years!). Nor has the Fed ever held long-term interest rates down for any period of time, long or short. We are literally in uncharted territory.
4. Impact on stocks of rate hiking cycle: Rich stated that historically when the Fed began to raise interest rates after a period of easy money, the stock market performed well. However, the periods in the past when the Fed began raising rates were periods of relative health for the economy. What will happen if the economy is not in such great health? The Fed itself seems to harbor grave reservations on this very question.

I could not resist leaving a comment on this post asking the simple question of how falling money velocity impacted Bryan Rich’s analysis. Every single one of the four other commenters had responses even more biting than mine.

My impression has been that there are more pundits worried about economic decline than expecting healthy economic growth. Examples are here and here and here and here and here and here.

Because the opinions of U.S. companies on the health of the economy are formed in direct contact with the basic economic forces at work, their opinions are far more important than those of pundits. Companies’ opinions, after all, affect their planned investments, and therefore help determine future economic growth, or the lack thereof. The Wall Street Journal (access requires subscription) reports companies are expecting a slowing economy. What seems to be mostly driving these expectations are that quarterly profits and revenues at large American corporations are both about to decline for the first time since the Great Recession. In support of these expectations, the Wall Street Journal provided the chart shown below.

With both profits and revenues falling, the capability of companies to keep their PE ratios from increasing by cutting costs, buying back their own stock, and refinancing debt would appear to be going away. Companies are just running out of rabbits to pull out of the hat. According to the Wall Street Journal, the manufacturing sector appears to be particularly hard hit, although there are signs from decreasing retail sales that companies producing and selling consumer products, such as Wal-Mart are also threatened.

Sadly, my expectations for a worsening U.S. economy do not appear to be limited to me.

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