This note was originally published on June 29, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.
“The US government has a technology, called a printing press, which allows it to produce as many US dollars as it wishes at essentially no cost.”
One of the most poignant Hedgeye sayings is “austerity equals civil unrest” and it has become increasingly clear that Obama wants nothing to do with austerity. It’s also clear, judging by developments at the G-20 weekend, that the US is going to try to go it alone with big fiscal imbalances; our submission is that the USA balance sheet can’t sustain the current trend and one of the biggest losers will be the American consumer. As the Bernanke & Co printing press continues to roll on and on, piling debt upon debt upon debt, this can only end badly.
As of the close yesterday, Consumer Discretionary was one of only three sectors up year-to-date (XLY up 2.7%). The other two are Industrials (XLI up 3.3%) and Financials (XLF up 0.7%). While easy comparisons and “corporate” fiscal austerity have helped the performance of consumer stocks, the best days of this cycle are behind them.
I know everyone has a view on the consumer, but there are some changes on the margin that should be considered as we look toward 2H10. One of our 1Q09 Macro Themes was “MEGA” – calling for a MEGA squeeze in consumer stocks with Mortgage Rates going down, the Employment picture turning around, Gas prices declining sharply year-over-year, and Asset prices re-flating. Looking at the data as we emerge from 2Q10, it is clear that the American consumer is now going to get DUPE (d) and is not going to be happy.
Double-Dip: The housing market and the broader economy are on the precipice of a double dip; housing prices have already started to decline and the economy has slowed significantly quarter-to-quarter in 1Q10. The Hedgeye Risk Management Financials team recently presented a very strong case for why the housing market is in trouble. We have high conviction that a double-dip in housing is underway and this will have a serious impact on consumer behavior. Following a decade of out of control spending, the state of the USA’s balance sheet inhibits the country’s ability to navigate the structural issues still present in the economy. A few points to keep in mind include:
(1) The benefits from the current Obama stimulus peaked in the 1Q10 - Slowing GDP growth.
(2) In 2011, taxes are going up and that will hamper economic growth - Slowing GDP growth.
(3) Real estate prices are estimated to decline 20% in the next twelve months - Slowing consumer spending.
Unemployment: Weekly Jobless Claims have not shown any material improvement over the past six months. Private sector job creation remains a concern; private-sector job creation in May decreased sequentially from April. While private sector job creation had been growing for four straight months, it has now come to an impasse as businesses have become nervous about the state of the economy. Unemployment is at an elevated level and indicates a continuing softness in the underlying economy. As census workers are laid off, the rate could jump higher unless other sources of employment pick up hiring drastically. Uncle Sam is running out of crutches (or the political will to supply them):
(1) The Administration failed to get Congress to pony up an extra $50B for unemployment claims - our leveraged balance sheet inhibits the government’s ability to provide stimulus.
(2) A strong dollar policy has proven to help job creation – Bill Clinton and Ronald Reagan were the last two presidents to oversee true job creation and both pursued strong dollar policies - to be sure Obama is debauching the US currency.
(3) As the Double-dip scenario pays out, unemployment will remain elevated and may even go higher.
Prices Paid by the Consumer: While reported inflation by the government looks to be under control, the Hedgeye Inflation Index tells a different story. The Hedgeye Inflation Index focuses on the part of the economy showing inflation that impacts the consumer, specifically the spread between the prices of things they buy and what they earn. Looking out over the next 6-12 months (and even longer) consumers will be paying more to drive their cars, or “bring home the bacon” and to make sure they have health insurance for their family. The issues that arise from the disaster in the Gulf of Mexico will not be solved by the cash flow from BP. The government has been sponsoring cheap gas prices in the US for years and that will come to an end. Once again, the government cannot afford to manage through the issues the country faces due to the leveraged balance sheet.
(1) The Hedgeye Inflation Index turned ugly last week.
(2) The disaster in the Gulf is inflationary and will be a drag on growth.
(3) The prices paid by the US consumer for gas is far below the rest of the world and there is a possibility that the gap could close significantly under pending energy legislation – this would be a massive headwind for the consumer. Some commentators are speculating that prices could rise to meet those paid at the pump in Western Europe – some 50% higher than where they are currently.
Equity and Real Estate deflation: We believe that the debasing of any currency (even the Almighty Dollar) ends badly. A lack of austerity in government policies and an aversion to facing facts among our professional politicians is not helping the long-term outlook for equities. The VIX’s 19% up-move week-over-week, along with the move in the equity market, indicates that political summits are doing little to ease fears. On Thursday the Macro Team is going through our Hedgeye Risk Management Q3 Themes. If you would like access to that conference call, please email firstname.lastname@example.org.
(1) U.S. equity markets have lost $1.78 trillion since April 23 on concern the European debt crisis will spread.
(2) China declined 4.2% last night and is now down 26% year-to-date.
(3) The S&P 500 is down 3.6% year-to-date.
Last week, the University of Michigan consumer confidence index improved for the month of May and yesterday, the government reported that the consumer is spending less than he/she earns. In both cases the market ignored the data and has moved lower. We don’t trust what the government is telling us nor the direction in which the country is headed. The consumer is not stupid and Washington does not get it.
Function in disaster; finish in style