Capital and Consumer Spending

If I hit my thumb with a hammer, maybe it won’t hurt this time.  Not likely.  Last week I noted a warning sign in non-defense new orders for capital goods, excluding aircraft.  As I noted previously, aircraft orders are volatile; they may be up 30% one month and down 30% a few months later because orders for planes are placed in rather large blocks with the actual delivery of the aircraft occurring over many months.

A few days ago the most recent durable goods report came out for September, showing a continued decline in the year-over-year gains for new orders.  Declines like this have preceded the past two recessions.

We like to think that this time may be different. Our imagination is capable of soaring the heights of creativity in art and science.  In the economics of our personal lives, it can lead to fanciful thinking.  Fanciful notions led many to buy houses with little money down at the height of the housing boom, thinking that somehow they would refinance when mortgage payments escalated after a certain period.  Magical thinking induced many to increase their credit balances far beyond their means to pay, thinking that they could pay down their credit balances by refinancing their homes.  No matter how much homes went up in value, housing prices would continue to rise.  Then they didn’t.

The chart below shows the housing inflation.  Recessions in the latter part of the past century had caused housing starts to decline to 400,000 before recovering.  In the 2001 recession, easy money and loose standards for mortgage securitization curbed the natural decline.  The bill eventually came due in 2008.

Single family homes create jobs; the market has shown life recently but is still very weak.

The Conference Board’s Consumer Confidence index rose 9 points to 70 in September and is about the same level as this past February, when confidence started sliding to a summer low point of 60.   The new consumer survey is due to be released next week and analysts are predicting another increase of 3 to 4 points. Consumers are feeling upbeat but the decline in new orders shows that businesses continue to be cautious as the prospect of rising taxes and budget cuts next year dampens any optimistic planning.  The slowdown in Europe and Asia contributes to the gloomy reading of Moody’s Business Confidence survey.  Rising consumer confidence before the critical Christmas shopping season may alleviate the pessimism of businesses if consumers actually open up their wallets and spend but retailers have not been building inventory ahead of the shopping season.

While these two forces tug at each other, a prudent investor might exercise some caution.

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