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For this month's Wealth IQ Report, we examine retail sales data and understand how it might be showing some positive signs of an economic recovery.
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Grasping the magnitude of this recession
Most economists agree that this current recession began sometime between December 2008 and January 2008. Fifteen months later and we're beginning to grasp just how large this financial downturn is. Since World War II, the average peak to trough decline in real gross domestic product (GDP) during a recession has been approximately 1.9%. The last two recessions - in 1990 and 2001 - were much softer with declines of 1.3% and 0.2%, respectively. This recession, on the other hand, should see a contraction of real GDP on the order of 2.5%, making it the most severe recession since 1981.
2008-2009 Recession Forecast Compared to Prior Recessions
Investors Flee Financial Markets, Lose Net Worth
American families have responded quickly to sharp declines in house prices, substantial losses of financial assets, and dramatic increases in unemployment. In Q4 2008 alone, U.S. households liquidated a record $931 billion of financial assets, according to the Federal Reserve's Flow of Funds Report. They dumped mutual funds, corporate bonds, and even Treasury securities, which had previously been considered safe havens.
Clearly, there was no joy for those families that pulled out of financial markets. Significant declines in financial assets caused a $5 trillion drop in household net worth in Q4 2008, a level not seen since 2004. As expected, the magnitude of wealth loss has had an obvious short-term negative impact on spending, as retailers across the country experienced double-digit declines in 2008.
Consumer Spending Points to Positive Signs, Though
During past economic downturns, tracking consumer spending has been a reliable indicator of when a recession has hit its "bottom". During the "peak to trough" phase of a recession, both wages and consumer spending drop immediately and often drastically. However, at some point, wages begin to stabilize while spending continues to decline. This imbalance creates an increase in consumer spending power, which ultimately leads to an increase in spending - the first step in any economic recovery.
To understand the above concept in layman's terms: There are goods and services that people want but have denied themselves because they either didn't have the money before or they were simply worried about spending the money they had. During this same period, retailers have usually discounted prices or created some value-add in an effort to stimulate sales. Eventually, those people who are still employed begin to realize they have money to spend, and the goods and services they want are attractively-priced. Once they start spending again, an economic recovery begins.
It may be too early to suggest a pattern yet, but early consumer spending data is encouraging. In February, retail sales fell 0.1%, but rose 0.7% if auto sales are excluded. Happily, both figures were greater than expected, particularly since February's sales gains came on top of upward revisions for January. Total sales for January now show a gain of 1.8% versus the initial estimate of 1.0%.
New data suggests that consumer spending could post an annualized gain of between 0.5% and 1.0% in the first quarter. While this is a modest increase, the positive increase in consumer spending even before tax cuts take effect is good news.
In the past, spending recoveries that got started before the implementation of tax cuts were strengthened when the lower taxes kicked in and boosted spending power. Of course, given current tight credit conditions, and general investor malaise, no one expects a significant uptick in spending. But, with billions of stimulus dollars in the pipeline and pent-up purchasing demand building every day, a modest gain in consumer spending is looking plausible.
Revised Economic Projections
In our January 2009 Market Commentary, the general consensus of the three economists we profiled was that the U.S. economy should see a rebound beginning at the start of Q3 2009. Based on current data, we believe the U.S. economy may continue to contract through Q3 2009, and that the rebound may be more gradual than previously thought.
From an investing perspective, it's important to remember that financial markets have already discounted this recession. Market volatility will likely remain high until there is greater clarity. The extraordinary measures adopted so far will take time to work, but the amount of liquidity flooding the system should eventually help free up credit markets, which is critical for businesses to begin spending again. Consequently, for investors who have a long-term perspective and a stomach for short-term volatility, the current market environment may represent an opportunity.
As always, your questions and comments are appreciated.
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Disclosures
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of an investment in debt securities will change as interest rates fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. Investments in high-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income.
The opinions in the preceding commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole.
This material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict performance of any investment. Investing involves risk, including possible loss of principal. Investors should consult with a financial advisor prior to making an investment decision.
Diversification does not guarantee a profit or protect against loss in a declining market.
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