Monday, February 03, 2014 - Another Piece of Cake, Marie?

Another Piece of Cake, Marie?
by Sinclair Noe

DOW – 326 = 15,372
SPX – 40 = 1741
NAS – 106 = 3996
10 YR YLD - .09 = 2.58%
OIL - .78 = 96.71
GOLD + 11.20 = 1258.10
SILV + .17 = 19.44

In economic news, manufacturing activity slowed sharply in January on the back of the biggest drop in new orders in 33 years while construction spending barely rose in December. Maybe it had something to do with the cold weather, maybe it’s just a pause after slightly stronger economic growth in the third and fourth quarters.

The Institute for Supply Management (ISM) said its index of national factory activity fell to 51.3 last month, its lowest level since May 2013, from 56.5 in December. It was the second straight month of slowing growth from November's recent peak reading of 57, which had been the highest since April 2011, and indicated manufacturing was slowing after output grew at its fastest pace in nearly two years in the fourth quarter.

Underscoring the weather impact, delivery delays increased a bit last month, but the biggest red flag was the huge drop in the forward-looking new orders index, which fell to 51.2 from 64.4 in December. That 13.2-point drop was the largest monthly decline in the key component since December 1980.

In a separate report, the Commerce Department said construction spending rose 0.1% in December, slowing from the prior month's 0.8% increase. While private construction spending hit a five year high, outlays on public construction projects recorded their biggest drop in a year, reflecting the drag from weak state and local government spending.

Bad weather also appeared to hurt US auto sales in January, with Ford, GM and Toyota USA reported a slide in sales for the month.

The big economic report this week will be Friday’s jobs report. Last month the jobs report showed an anemic 74,000 jobs added in December. The January report is expected to show a rebound of 185,000 jobs in January.

January was the worst month for the stock market in more than a year. February is off to a bad start.  Even before today’s economic data, there wasn’t much to cheer: pending home sales disappointed, home prices have been softening, durable goods orders were weak, fourth quarter GDP growth was decent – down from the third quarter – and not enough to think the economy is able to run on its own, and the December jobs report was just ugly – it was just one report and not a trend but it was ugly. All this suggests the economy might not be able to handle higher interest rates, and yet the Fed has now cut back on Quantitative Easing bond purchases in its last two meetings; this would theoretically result in higher bond yields, but that hasn’t happened; rates have moved lower and that suggests the bond market is seeing something moving in the shrubs, and it’s not a bull.

Meanwhile, the consumer, and that’s what the vast majority of Americans are now considered, just consuming units, the consumer story is under attack; the middle class is slipping away. Corporate America is now facing the reality of income inequality, and that means the customer base for businesses that appeal to the middle class is shrinking. Spending has shifted upward with some of the retail winners being businesses that cater to the top tier with high-end goods and services, or businesses that try to capture the expanding ranks of cost conscious consumers with discounted goods.

According to a report by the Federal Reserve of St. Louis and Washington University in St. Louis, in 2012 the top 5% of earners were responsible for  38% of domestic consumption, up from 28% in 1995. The current economic recovery has been driven mostly by the top tier; since 2009 inflation adjusted spending by the top 20% has risen 17%, compared with just 1% among the bottom 95%. More broadly, about 90% of the overall increase in inflation-adjusted consumption between 2009 and 2012 was generated by the top 20% of households in terms of income.

As a result, a Four Seasons hotel is experiencing nearly double the growth rate of a Best Western; a restaurant that sells a $75 dinner is experiencing twice the growth in sales of a restaurant that sells a $15 dinner. High end retailers such as Nordstrom and bargain basement retailers such as Dollar Tree have seen their share price double over the past 10  years, while JC Penney and Sears (a couple of stores built on the middle class) have been shuttering stores and scaring investors.

We knew this was coming; about 10 years ago, Citigroup wrote a report in which they supplied a name for an economy that is run by and for the ultra-wealthy; it’s called a plutonomy. There is no average consumer in a plutonomies. There is only the rich and what Citigroup describes as “everyone else”.

There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the non-rich, the multitudinous many, but only accounting for surprisingly small bites of the national pie. The Citi report endorse the inequality and determines that Plutonomists should be targeted as Citi customers. The report states: “The Managerial Aristocracy, like in the Gilded Age, the Roaring Twenties, and the thriving nineties, needs to commandeer a vast chunk of that rising profit share, either through capital income or simply paying itself a lot.

“At the heart of plutonomy is income inequality. Societies that are willing to tolerate/endorse inequality are willing to tolerate/endorse plutonomy.” The Citigroup report warns their wealthy clients that there is a risk that inequality will not be tolerated, but they go on to say they are not concerned: “Perhaps one reason societies allow plutonomy is because enough of the electorate believe they have a chance of becoming a Plutoparticipant. Why kill it off, if you can join it? In a sense this is the embodiment of the ‘American Dream’.”

The reality is that every child that ever played organized sports has a greater chance of becoming Lebron James or Tiger Woods than becoming a Plutoparticipant; a greater chance of being struck by lightning; and your odds are better at hitting the Lotto – which come to think of it is the new American Dream.

Bank of America issued a similar report that concluded the well-heeled might be able to save the economy from a long period of dismally weak consumer spending and that the consumer debt problem is only a problem for the middle class, or what’s left of it.

The Bank of America report was entitled: “The Myth of the Overlevered Consumer” and the Citigroup report was entitled: “Plutonomy: Buying Luxury, Explaining Global Imbalances”. Apparently they decided against the title: “Let Them Eat Cake”.

There are, of course, limits to the amount of cake a plutocrat can eat, and how many bars of soap they will buy, and how many blankets they buy, and how many  shirts they buy (even if they buy the expensive ones), and how much gas they buy for their cars. And this is the reason the economic recover has been tepid and not enough to run without the aid of the Federal Reserve.

And despite this, the Fed decided to taper again. The Central Bank wants out of Quantitative Easing because it hasn’t worked to re-inflate the system, with the exception of Wall Street and to a lesser degree the housing market (although what they actually re-inflated in the housing market was the banks’ balance sheets by siphoning off the toxic mortgage backed securities, but we won’t get into that right now). The Fed must also be concerned that QE has left the stock and bond markets, and the emerging markets, more than a little frothy; not to mention their own balance sheet.

The current market pullback actually takes some of the froth out of risk assets, particularly high yielding credit which is showing very low spreads relative to inflation expectations. The second is to allow the marketplace to replace their bond buying. The Fed still wants low rates, but wants them without as much intervention on their end. The best way for this to happen would be through a risk-off period whereby money flees risk assets to push Treasury yields lower at the same time the Fed is stepping away.

If this pullback turns into a correction the markets are in for even bigger declines, and one thing to watch is this Friday’s January jobs report. Complacency still remains high, even though the VIX, the volatility index, spiked to 21 today. The economy needs to re-inflate. The plutocrats can’t do it; the middle class could do it but the Fed’s QE did nothing to get money onto Main Street. If the deflation trend doesn’t end soon, we could see a wake-up call for the complacent.

And so today, we’ve started to hear hints and calls for the Fed to taper the taper; complaints that the Fed is turning off the free money spigot while Wall Street still wants to dip its beak in the reservoir. And there is a very serious concern that the as yet untested Janet Yellen led Fed might not provide the same backstop as the Bernanke Fed or the Greenspan Fed, both of which maintained an implicit put, which when put to the test proved explicit. And there is a growing realization that the rest of the world can’t or won’t compensate for a little tightening by the Fed. And the market is learning that the economy does matter, the whole economy, not just the top tier. And the market is learning that cause and effect has not been repealed.