Monday, March 30, 2009

Sunday Night Economic Assessment

A big jump in consumer confidence & spending was implied last week as the Consumption Index surged, breaking out above the Production Index, and nearing its own highs since its Dec-2008 bottom... as consumers appeared to gain confidence as their ultimate "money supply" measure (the stock market) increased.

The Production Index, on the other hand, drifted lower early in the week before flattening the last 3 days... presumably in reaction to the previous weeks implied consumption. The Production Index remains above its February 13th recession-bottom, and given the sudden strength of the Consumption Index last week, should see renewed gains shortly, continuing the week economic recovery we appear to be in.

The best way to visualize the function of these two Indexes, is to visualize a dog on a leash, with the leash representing consumer spending, and the dog representing industrial production.

Wherever the leash goes, the dog will ultimately go. The dog may fall behind the leash and be dragged ahead, or the dog may run ahead of the leash and be held back by the leash, but ultimately the dog will go in the same general direction & speed of the leash.

It is the same way with consumption and production. If industrial production jumps ahead of consumer spending, then inventories build, clogging stores and warehouses, prompting purchasing managers to curtail orders, ultimately slowing production. If industrial production falls behind consumer spending, store inventories shrink, prompting purchasing managers to increase orders.

It is the consumer, the spender, that leads the way into and out of recessions, not industry. Industry serves the consumer (remember the old addage... "The consumer is always right"). It is the desire to profit off of increased sales, the desire to avoid carrying costs of increased inventories, and the desire to grow sales through increased quality & marketability, that will always drive industry.

Now, just for fun, lets throw a third element into our dog-leash analogy... a fire hydrant.
As the dog represents industrial production, and the leash represents consumer spending, the fire hydrant will represent capital inducements... items such as tax incentives, interest incentives, credit-offers, and the like.

As the dog sees the fire hydrant, it may want to run ahead (or to the side) towards the fire hydrant, or it might want to stop at the fire hydrant, or it might want to go back to the fire hydrant. But (in this analogy) the leash is pulled by a strong, irrisistable force, and although the dog may take interest in the fire hydrant, the leash still will control the dog.

So it is in industry. Companies may be induced by tax incentives and offers of credit made possible by bank bailouts. Productive capacity may even be saved momentarily through government bailouts. But unless demand increases, businesses cannot increase production. And if demand decreases, businesses will be forced to curtail production.

Business incentives have a place when demand is increasing rapidly, and are good at coaxing industry along to increasing productive capacity, but in this stage of the business-cycle incentives do little to reduce recession. They are long-term instruments which kick in only later on, when economic recovery kicks in to elevate production up toward productive capacity.

There is a real danger here. We are spending much time and rescources (at the governmental level) on bank and corporate bailouts and "stimulous" programs that ignore the consumer. All these may be well and good (I am neither criticizing or praising them) for other purposes.

But in terms of inducing consumer spending to lead us strongly out of recession, the only thing I can see (in a positive sence) is a stock market rally that is dulling consumer fear.

We have a tough quarter for earnings upon us as 1st quarter earnings reports start in a couple of weeks (will be worse than fourth-quarter 2008) and we are not far from being off 10% (year-over-year) on the Production Index.

The worry here is that poor 1st quarter earnings prompt a stock-market sell-off (removing the only real "stimulous" that is out there), pulling the legs out from under the stock markets. Then we get "lucky" (in the worst sence) and we just reach that "off 10%" number in GDP for the first quarter (meaning the word "depression" gets used 50,000 times on the nightly news).

In all we need either lots of luck (not good for a trader to rely upon), or we need for the government to get smart on consumer stimulous (less good for a trader to rely upon than luck). This is not an easy time to be a trader, and one has to be careful at what he does.

As a Christian, I can see more need for prayer right now than at any other time... both personally and for our country and world. We really are at a crossroads.