The Pause in the Cycle

March 26, 2023

by Stephen Stofka

This week I’ll look at things that are hard to measure and their effect on our lives. Much of human activity is recursive, meaning that the outcome of one action becomes the input to the next iteration of that same action. When we get nervous we may breathe fast and shallow which changes our body chemistry increasing our anxiety and we continue breathing fast and shallow, amplifying the effect. Because of that cyclic process prominent thinkers like Aristotle, Adam Smith, David Ricardo, Karl Marx, and Joseph Schumpeter, among others, have proposed circular models of human behavior.

The 19th century economist David Ricardo modeled the industrial process as a profit cycle. Increasing or decreasing profits mark the division between two phases of the cycle. The first phase is a series of more and higher –

rising profits,
more investment,
leading to more output,
an increased demand for labor,
a rise in wages,
a rise in population and consumption,
an increasing use of less efficient inputs,
higher prices,
then higher interest rates,
and lower profits.

The decline in profits signals the end of the expansion and begins the downward phase, a cycle of less and lower of each of those elements – less investment, output, less demand for labor, lower wages in aggregate, etc. Ricardo assumed that workers received subsistence wages so an individual worker might not work for wages any lower. Like his friend Thomas Malthus, Ricardo assumed that higher incomes would lead to an increase in population. In the early 19th century, less efficient inputs meant less fertile land. As our economy has transitioned to become almost entirely service oriented, the less efficient inputs are labor. It is difficult for a hairdresser or therapist to become more productive.

Since the pandemic companies have been rewarded for raising prices, a strategy Samuel Rines, managing director of the research advisory firm Corbu, called “price over volume” on a March 9th Odd Lots podcast. With this strategy, companies like Wal-Mart keep pushing prices higher, willing to accept lower volume as long as total revenue and profits are higher. After-tax corporate profits (CP) have risen more than 40% from pre-pandemic levels, according to the Federal Reserve.

In Ricardo’s model of the profit cycle, higher prices lead to higher interest rates as investors increase their demand for money to take advantage of the higher prices. In our economy, the Fed controls the Federal Funds interest rate that other rates are based on. As prices continued to rise, the Fed began to lift rates and has raised them more than 4% in the past year. As the Fed raises rates, bank loan officers tighten lending standards, beginning with small firms (DRTSCIS) and credit card loans (DRTSCLCC). The FRED data series identifiers are in parentheses. In the past year, banks have increased their lending standards by more than 50% for small firms and 43% for credit card loans. However, all commercial loans have increased by 15% in the past year and delinquency rates have not changed since the Fed started raising rates. This is part of Ricardo’s model. Investment does not decrease until profits decline. Profits (CP) still grew at 2.25% in the 3rd quarter of 2022. We are not there yet.

In the 4th quarter of 2022, real GDP grew at less than 1% on an annual basis. We won’t have an estimate of 1st quarter numbers until the 3rd week of April but employment remains strong. Since 1980, the population adjusted percent change in employment goes negative or approaches zero just before recessions. In the chart below, notice how closely the employment (blue line) and output series move in tandem. The red line is the annual percent change in real GDP.

We may be approaching the pause point but the point of decline could be six months to a year away. Although the Fed let up on the “gas pedal,” raising rates by ¼% rather than ½%, they showed their commitment to curbing inflation as long as the employment market stays strong. If the Fed had not raised rates this past week, they would have set expectations that they were done raising rates. For now we can look for these signs that the expansion of the business cycle in Ricardo’s model is coming to a close.


Photo by Lukas Tennie on Unsplash

A Virtuous Cycle

August 7, 2022

by Stephen Stofka

July’s employment survey (BLS, 2022) reported a half-million job gains and marked a milestone – the recovery of all the jobs lost during the pandemic. In addition, earlier employment gains were revised higher by 28,000. The BLS survey indicated that only 7.1% of employees worked remotely, a surprising contrast to the amount of attention that the media gives teleworking. Last week, I discussed the dating of recessions. With this report, it is unlikely that the dating committee at the NBER will dub this a recession. Consumption, income, employment and investment are the pillars of this economy and they are doing well, contributing to the current inflationary trends.

Annual gains in private investment topped 18% in the second quarter, besting the 16% gain in 2012:Q1 a decade ago (series notes at end). Businesses invest in people, driving up employment gains. In the graph below, I multiplied the annual gain in employment by 4 to show the correlation between investment and employment.

Higher employment leads to higher incomes. Just as employment has returned to pre-pandemic levels, real (inflation-adjusted) disposable incomes are now at pre-pandemic levels. Disposable income includes government transfers like social security and pandemic stimulus checks. The last stimulus checks went out in March/April 2021, more than a year ago. It’s a good bet that these are sustainable income numbers produced by economic growth, not the result of special  transfer payments.

Higher incomes lead to higher spending. Real (inflation-adjusted) consumption spending marked an annual gain of 1.57% in June and is now up 4.5% over pre-pandemic levels. Consumers have made an abrupt shift from buying goods to buying services. Real sales at restaurants are now 10% above pre-pandemic levels.

To keep up with high demand for goods and clogged shipping ports during the pandemic, Target and Wal-Mart ordered extra and now have more inventory than they would like. Their loss is the travel and leisure industry’s gain. Marriott Hotels (2022) reported a surge in demand this year. In the U.S. and Canada, their leisure traffic is 15% above pre-pandemic levels and their revenue per room is about the same as in 2019.

Higher incomes usually lead to higher savings. In the decade before the pandemic, households saved 6-7% of disposable income. In 2020 and 2021, the savings rate averaged a whopping 20% and 12%. Most of that higher savings was done by households with higher incomes. Congress could have passed a CARES act that sent stimulus payments only to those with lower incomes, but they chose not to. Those additional savings became investment and that brings us full circle to the higher investment and employment – a virtuous cycle that Adam Smith wrote about more than two hundred years ago.


Photo by Markolf von Ketelhodt on Unsplash

BLS. (2022, August 5). Employment situation summary – 2022 M07 results. U.S. Bureau of Labor Statistics. Retrieved August 5, 2022, from

Marriott Internatonal. (2022, August 2). Marriott International Reports Outstanding Second Quarter 2022 results and resumes share repurchases. Marriott International Newscenter (US). Retrieved August 5, 2022, from

U.S. Bureau of Economic Analysis, Gross Private Domestic Investment [GPDI], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 5, 2022.

U.S. Bureau of Economic Analysis, Real Personal Consumption Expenditures [PCEC96], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 4, 2022.

U.S. Bureau of Economic Analysis, Real Disposable Personal Income [DSPIC96], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 4, 2022.

U.S. Bureau of Economic Analysis, Personal saving as a percentage of disposable personal income [A072RC1Q156SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 4, 2022.

U.S. Census Bureau, Advance Retail Sales: Food Services and Drinking Places [RSFSDP], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 5, 2022. Note: I adjusted for inflation using the CPI.

 U.S. Bureau of Labor Statistics, All Employees, Total Nonfarm [PAYEMS], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 5, 2022.

When We Swarm

July 24, 2022

by Stephen Stofka

Economists study individual and group human behavior as we try to satisfy our needs. Sometimes the sum of the quests for individual satisfaction produces an outcome that is unexpected or contradictory to the aims of each individual’s choices. People may synchronize their behavior to a point that their accumulated actions overload a system, causing it to become dangerously unbalanced and lead to a collapse. Our modern communication systems may introduce more frequent panics, more opportunities for reactionary zeal and anger.

During the Great Depression, the economist John Maynard Keynes proposed a Paradox of Thrift. Saving money is a prudent choice for each person but if too many people decide to save money at the same time, economic activity declines. An extreme example is the 2008 financial crisis and recession when millions of people decided to curtail their current spending, the blue line in the graph below, and increase their savings. This is the power of uncoordinated expectations. We act sometimes as if our actions were being choreographed.

These paradoxes introduce contradictions that challenge our assumptions and ideologies and cause a lot of disagreement among economists and the public. In an EconTalk (2009) podcast, economist Steve Fazzari explained the immediate consequences of the Paradox of Thrift. In an effort to save money for college, a family foregoes their weekly meal out at a nearby restaurant. At the first occurrence, the family saves money which they deposit in a bank savings account. The next day the restaurant owner must withdraw that same amount from the restaurant’s savings to make up for the lost revenue. In that immediate time frame, there is no increase in savings/investment and this violates the ideologies of some listeners. As the pattern continues, the restaurant owner will adjust her expectations for revenue and lay off some workers. The podcast listeners interpreted Fazzari’s analogy in several different ways. They could not agree on what a short time frame is or the scope of the story.

We see and hear words and events differently yet sometimes respond in a seemingly coordinated fashion. Our panicked response may cause or amplify the very thing we fear. In September 2008, banks and investment firms lost trust in the soundness of each other’s assets. The loss of confidence caused the value of those assets to plummet, actualizing the fear. The Fed and central banks around the world struggled to contain the panic as the global financial system seized up like an engine without oil. In March 2020, central banks were better prepared, flooding the markets with liquidity at the onset of the Covid-19 pandemic. Still we swarmed onto the streets, emptying shelves of merchandise ahead of lockdowns.

Every culture has its account of the consequences of humankind’s hubris, a lesson in the perils of our own arrogance. The Bible accounted for the variety of languages with the story of the Tower of Babel. Our phones connect us to the information hive, instantly relaying breaking news in our language of choice. The internet brings us together and drives us apart. As our communications become more rapid and extensive, we increase the likelihood of global panics, an unplanned reaction to some event. Fringe groups become more adept at coordinating their anger and actions like they did at the Capitol on January 6th. Our culture evolves with our technology but our laws are slow to adapt. Our mechanism of lawmaking, adapted to a horse and buggy age of communication, will have to be redesigned before it breaks apart our society, our culture and our union.


Photo by Ante Hamersmit on Unsplash

EconTalk. (2022, April 21). Fazzari on Keynesian economics. Econlib. Retrieved July 23, 2022, from

The Parade Goes Bye

Millennials have witnessed several market selloffs where investors put every kind of asset in their wheelbarrow and bring them to market. Stocks and bonds, equity and debt assets, are supposed to have different risk profiles that are uncorrelated. No matter. Into the wheelbarrow they go. What was valuable a few months ago has become infected with fear, a saleable surplus. The market is neither equitable nor smart, but it is efficient at distributing surplus. Investors sold their fear and bought cash. Cash represents certainty, the antidote to fear.

Last year private investment was 19% of the economy, near the top of the historical range of 15-20%. At that level, investment competes with consumption for real resources. The graph below compares consumption and investment as a percent of output. The blue line is investment, including residential housing, the red line household consumption.

Investment looks to the future and is more volatile because it rides on the bumpy road of expectations, a central component of human behavior. People respond not to their current environment but to a forecast of their environment, the uncertainty of further interest rate hikes to combat inflation. The expectation of rising interest rates reduces investment and that helps reduce inflation and the rationale for the Fed’s raising of interest rates – a case of simultaneous causality.

The rise and fall in inflation lags changes in investment by about three months. That does not indicate an “investment causes inflation” causality but signals that they are running around the economic racetrack together. Rising investment brings jobs and higher wages and more spending income. An interruption in the supply chain causes a divergence between supply and demand, between investment and consumer spending. That divergence causes inflation.

A surplus of misplaced investment needs to be redirected to other parts of the economy. Some investment cannot be redeployed and is lost. As the level of investment falls from 19% to 15%, the economy experiences negative growth – a recession. The market distributes saleable surpluses; it doesn’t correct the causes of the surpluses. People, institutions and policies produce surpluses and it is they who have to correct those surpluses. Why doesn’t the market distribute excess wealth? It does, but not where some people would like. People respond to shortages, inequalities of circumstances. The market responds only to surpluses.

In some cities there are a lot of homeless people crowding downtown streets. There is a surplus of little used backyard space to house the homeless. Is there a surplus of homeless people or a shortage of housing? At the heart of a persistent problem is a shortage.

A monetarist like Milton Friedman claimed that inflation was a surplus of money in the system. He argued the root cause of high and erratic inflation in the 1970s was the Fed feeding too much base money into the system. This is “high-powered” money that banks multiply when they make loans. In the peak of the oil shock and recession of 1973-75, the percentage of base money to GDP (bmg) was almost 7%. This level, far above the historical average of 5%, looked like a likely target as the cause for inflation. In the recovery after the financial crisis, bmg was nearly 23% in 2014, more than three times higher. Inflation was low – too low. Cautious bank management had parked that high-powered money at the Fed as excess reserves. The percent of deployed bmg never reached 8%. Today bmg is at 25% but the deployed level of base money has not reached 10%.

Although the Fed controls the money supply, over 4,000 banking institutions control the effect of changes in the money supply. They direct credit to where they think the losses will be the least and the gains the most. Total bank credit is up more than 9% this year and is at 68% of the economy, a historic high. Growth in businesses loans remains negative after the pandemic and at the level of loans outstanding at their historical norm of 10% of the economy. Consumers have a surplus of purchasing power that the credit market is distributing. Where does that money go? Consumers take the money they get from the banks and spend it at their local businesses. Those businesses do not have to go to the banks to get money as long as their customers have access to bank money and the businesses can attract the customers.  

By now Millennials feel like bystanders at a long parade, looking down the street for a empty space that signals the end. 9-11, housing crash, financial crisis, slow recovery with too much unemployment and not enough inflation, then an overheated housing market, a once-in-a-century pandemic and now a period with too much inflation. The oldest Millennials are just approaching middle age and might be wondering if the last half of their lives is going to be as eventful as the first half. No, of course not. Everything will be fine as long as you don’t answer the phone or open the door or say, “I’ll be right back.” It’s just a scary movie.


Photo by Norbu GYACHUNG on Unsplash

Base money is the FRED Series BOGMBASE. Bgm is BOGMBASE / GDP. Deployed bgm is bgm – excess reserves EXCSRESNS / GDP. That series was discontinued in 2020 at the start of the pandemic.

Gross Private Domestic Investment as a share of GDP is FRED Series A006RE1Q156NBEA. Consumption is DPCERE1Q156NBEA.

Total bank credit is TOTBKCR. Business loans is BUSLOANS.

Slow Growth

April 21, 2019

by Steve Stofka

Happy Passover and Happy Easter. Now that tax day is past, let’s raise our heads and look at long-term growth trends of real, or inflation-adjusted, GDP. For the past seventy years real GDP has averaged about 3% annual growth. In the chart below, I’ve charted the annual percent change in a ten-year average of GDP (GDP10, I’ll call it). As you can see on the right side of the graph, growth has been below average for the past decade.

In 2008, growth in the GDP10 crossed below 3%. Was this due to the Financial Crisis (GFC) and the housing bust? No. The GFC barely figured into the computation of the ten-year average. The housing market had been running hot and heavy for four to five years, but this longer-term view now puts the housing boom in a new perspective: it was like lipstick on an ugly pig. Without the housing boom, the economy had been faltering at below average growth since the 1990s tech boom.

The stock market responds to trends – the past – of past output (GDP) and the estimation of future output. Let’s add a series of SP500 prices adjusted to 2012 dollars (Note #1).

For three decades, from the late 1950s to the mid-1980s, the real prices of the SP500 had no net change. The go-go years of the 1960s raised nominal, but not real, prices. Investors shied away from stocks, as high inflation in the 1970s hobbled the ability of companies to make real profit growth that rewarded an investor’s risk exposure. From the 2nd quarter of 1973 to the 2nd quarter of 1975, real private domestic investment lost 27% (Note #2). In less than a decade, investment fell again by a crushing 21% in the years 1979 through 1982.

In the mid-1980s, investors grew more confident that the Federal Reserve understood and could control inflation and interest rates. During the next decade, investors bid up real stock prices until they doubled. In 1996, then Fed chairman Alan Greenspan noted an “irrational exuberance” in stock prices (Note #3). The “land rush” of the dot-com boom was on and, within the next five years, prices would get a lot more exuberant.

The exuberance was well deserved. With the Fed’s steady hand on the tiller of money policy, the ten-year average of GDP growth rose steadily above its century-long average of 3%. A new age of prosperity had begun. In the 1920s, investment dollars flowed into the new radio and advertising industries. In the 1990s, money flowed into the internet industry. Construction workers quit their jobs to day trade stocks. Anything less than 25% revenue growth was the “old” economy. The fledgling Amazon was born in this age and has matured into the powerhouse of many an internet investor’s dream. Thousands of other companies flamed out. Billions of investment dollars were burned.

The peak of growth in the ten-year average of GDP output came in the 1st quarter of 2001. By that time, stock prices had already begun to ease. In the next two years, real stock prices fell almost 50%, but investment fell only 12% because it was shifting to another boom in residential housing. As new homes were built and house prices rose in the 2000s, long-term output growth began to climb again.

From the first quarter of 2006 to the 3rd quarter of 2009, investment fell by a third, the greatest loss of the post-war period. In the first quarter of 2008, growth in the GDP10 fell below 3%. In mid-2009, it fell below 2%. Ten years later, it is still below 2%.

The Federal Reserve has had difficulty hitting its target of 2% inflation with the limited tools of monetary policy. There simply isn’t enough long-term growth to put upward pressure on prices.  Despite the low growth, real stock prices are up 150% since the 2009 lows.  A prudent investor might ask – based on what?

The supply side believers in the Trump administration and Republican Party thought that tax cuts would spur growth. In the first term of the Obama administration, believers in Keynesian counter-cyclical stimulus thought government spending would kick growth into gear. Faced with continued slow growth, each side has doubled down on their position. We need more tax cuts and less regulation, say Republicans. No, we need more infrastructure spending, Democrats counter. Neither side will give up and, in a divided Congress, there is little likelihood of forging a compromise in the next two years. The stock market may be waiting for the cavalry to ride to the rescue but there is no sign of dust on the horizon.

Economists are just as dug in their ideological foxholes. The Phillips curve, the correlation between employment and inflation, has broken down. The correlation between the money supply and inflation has also broken down. High employment but slow output growth and low inflation. Larry Summers has called it secular stagnation, a nice label with only a vague understanding of the underlying mechanism. If an economist tells you they know what’s going on, shake their hand, congratulate them and move to the other side of the room. Economists are still arguing over the underlying causes of the stagflation of the 1970s.

A year ago, I suggested a cautious stance for older investors if they needed to tap their assets for income in the next five years. The Shiller CAPE ratio, a long-term evaluation of stock prices, is at the same level as 1929. At current prices in a low growth environment, stock returns may  struggle to average more than 5-6% annually over the next five years.



  1. Adjusted for inflation by the Federal Reserve’s preferred method, the Personal Consumption Expenditures Price Index (FRED series PCEPI). Prices do not include dividends
  2. Real Gross Private Domestic Investment – FRED Series GPDIC1.
  3. A video of the 1996 “irrational exuberance” speech

The Future is Past

June 21, 2015

Returning to our Heaven On Earth scenario: why can’t the government just print up a bunch of money and give it to people?  Centuries of historical data shows that inflation inevitably results when governments do this.  However, the Federal Reserve has pumped in almost $4 trillion dollars in the past seven years and no inflation has resulted.  We saw that the Federal Reserve has been offsetting the lack of private spending, particularly the lack of savings that is devoted to investment.

Whatever we don’t consume is called savings.  Savings can be put to two different uses:

1) Invest in Yesterday’s spending, or debt.  This can be either our own debt or the debt of others.  We might pay down a credit card balance we owe or a mortgage.  We might buy a corporate or government bond.  Savings, checking and money market accounts are an investment in debt.

Household and business non-financial credit market debt is more than $21 trillion.  Included in that amount is $9.3 trillion in home mortgages.  Most of us who buy a home don’t think of it as “yesterday” spending.  To us it is an investment in our future.  However, the purchase of a home consists of two components:
1) the transfer of the replacement cost of the dwelling – yesterday’s spending adjusted for the change in price of the labor and material to build the home.
2) Someone else’s profit, and this is the key component of these two types of spending, yesterday and tomorrow.  Whether buying a new home or existing home, we are buying the costs and profit of the builder or previous owner.

Below is a chart of household and business non-financial credit market debt as a percentage of GDP.  From 1980 through the end of 1994, the SP500 index quadrupled from 110 to 470, an annual gain of a bit over 9.5% per year.   In the mid-1990s, household and business debt started a steep climb to 140% of GDP by 2007 and this probably pulled in more savings to service that debt. In the next 15 years, the SP500 grew by only 233%.

But wait!  That’s not all! – as the late night commercials remind us.  Governments at all levels borrow savings from private households and businesses.  The current total is about $16 trillion.

Adding the $16 trillion government debt to the non-fianncial debt of the private sector totals $37 trillion of yesterday’s spending that needs to be fed with today’s savings..

2) The other option for savings is to invest in equities – Tomorrow spending – and the profits generated from that spending.  We might buy stocks, real estate or some other physical asset which will generate some production, a profit, or a capital gain from an appreciation in the value of that asset.  The World Bank estimated the total market capitalization in the U.S. in 2012 at $18.7 trillion.  Add on 33% or so since then to get an updated total of about $25 trillion.  We could debate the valuation but it is clear that debt – investment in yesterday’s spending – is clearly winning the race against investment in the profits of tomorrow’s spending.

If future growth looks modest it is because we are still in a defensive posture – weight on our back foot, so to speak. Low interest rates encourage investment in Tomorrow spending and the Federal Reserve has kept rates low to encourage us to lean in, to shift the weight, the energy of our investment from the past to the future.

Diminished Expectations

February 3rd, 2014

The SP500 has been hovering over a support trendline in the 1760-1775 range, with buyers coming in at 1775.  At 1750, the market would have corrected 5%, a fairly normal occurrence.  Market watchers have been concerned that the market has not experienced one of these small “shaking of the tree” corrections since May/June of 2012.  Disappointing earnings and revenue reports from bellweather companies, together with selling pressure on some emerging market currencies, have made traders nervous.

The market is composed of buyers and sellers responding within varying time frames.  In a short to mid term time horizon, one person might pay more attention to turbulence in emerging markets or the latest corporate reports.  A mid to long term investor might pay more attention to rising industrial production, healthy GDP numbers, consumer spending and income, and declining unemployment.


Apple forecast lower than expected revenues for the coming quarter in the China market.  The announcement prompted an 8% decline in the company’s stock.  Facebook reported blow out revenue growth of 63% in the past quarter, causing the stock to rise about 16%.  FB’s active user base has more than doubled in two years.  Despite the robust growth, the sky high valuation of the company reminds me of some internet stocks in the late 1990s.  The stock has a Price to Sales – not Price to Earnings – ratio of about 15 to 1.  Google has a track record of strong revenue and earnings growth and sports a richly valued price to sales ratio of 6.4.  Does Facebook’s short track record deserve a valuation that is more than twice Google’s?  In 2000, Microsoft had a price-sales ratio of 23 to 1. Fourteen years later, Microsoft’s stock sells for 30% less than it did in 2000.  In 2000, Cisco had a price to sales ratio of 30 to 1.  Cisco’s revenues were growing 50% a year.  “The stock is cheap,” some said.  Fourteen years later, Cisco sells for less than a third of what it did in the heady days of rapid growth.  A word of caution to long term investors.

Amazon reported “only” a 20% increase in quarterly revenue during the busy 4th quarter Christmas season. This is five times the sales growth of the overall retail industry so a casual observer might think that the stock enjoyed a healthy bump up in price, right?  Wrong. After rising 50% over the past year, the company’s stock was priced to perfection. The disappointing growth particularly in overseas markets prompted a lot of selling and an 8% decline in price on Friday.

As I noted last week, many retailers will report quarterly earnings in February.  Many companies get a sense of the bottom line that they will report before the official release of quarterly data.  If there are material differences between consensus expectations and forecast results, a company will issue a revised forward guidance.  Wal-Mart did so this past week, revising its revenue and earnings forecast down for the fourth quarter and lowering earnings projections for the coming year.  The company cited a much greater than forecast impact from November’s reduction of the food stamp program.  The severe storms in December also had a material impact on sales.

In the past two months, Wal-Mart’ stock has declined 8%.  Let’s think about that for a moment.  The market value of Apple and Amazon declined 8% in one day.  It takes two months for Wal-Mart’s stock to decline by the same percentage.  Individuals who invest in companies like Apple and Amazon have to be able to take abrupt market gyrations in stride.  Companies are essentially stories.  Some like Apple and Amazon are stories of growth.  There comes a time when the story changes, as it did for Microsoft and Cisco more than a decade ago.  Apple’s story has been “under construction” in the past 18 months. Since the beginning of 2008, Wal-Mart’s stock has risen 56%, Apple’s is up 150%, and Amazon’s market price has soared more than 6 times.  Growth companies offer rich rewards for the investor who has the time to  follow the story, but it can be difficult to know when the story is changing.

During the past 3 weeks, Home Depot has lost about 6% after gaining 35% since the beginning of 2013.  This giant has one foot in the home construction and remodeling sectors, one foot in the retail sector.  The decline reflects lowered near term expectations for both construction and retail.  Consumer spending has risen steadily but incomes are flat.


December’s report of new homes sold was disappointing.  After rising above an annual level of 450,000 in the fall, sales have fallen closer to the 400,000 mark.

 Some blame the particularly harsh December in the east, some blame the weak labor report released in early January, others blame the low supply, still others blame rising mortgage rates. The Case Shiller home price index shows a year over year gain of almost 14% in metro area homes, indicating relatively healthy demand.  However, the latest Consumer Confidence survey reports a decline in the number of people planning to buy a home.  On an ominous note, pending home sales in December declined more than 8%, the worst monthly decline in almost four years.  Without a doubt, the severe winter weather in the eastern U.S. was a big factor but it is difficult to assess how much of a change.  This is the second report – employment was the first – that was far below even the lowest of estimates.

The link between employment and new home sales is counterintuitive; changes in new home sales anticipate changes in employment.

In a 2007 paper presented at a Federal Reserve conference, economist Ed Leamer demonstrated that changes in residential investment, a relatively small component of the economy, indicate coming recessions and recoveries.  The National Assn of Homebuilders estimates that each new home generates a bit more than three full time jobs.

Residential investment includes new homes, remodels, furniture and appliances.  Eventually residential investment reaches a point where it is contributing too much to the economy. As that percentage begins to correct to more normal levels, the contraction tugs on the total of economic growth.

As you can see in the chart above, a sustainable “sweet spot” is in the 4 to 4-1/2% of GDP range but residential investment is still less than 3% of GDP.  In past recessions, residential investment has helped recovery.  This time is different.  Housing’s less than normal contribution to the nation’s GDP has dampened overall growth.


The first estimate of GDP growth for the fourth quarter was a rather remarkable 3.1%.  Although this was in line with estimates, I was concerned that the severe winter weather in the east might have more of a negative impact.  A version of GDP that reflects domestic consumption, Final Sales of Domestic Product, showed a modest 2.1% growth in the 4th quarter, reflecting the impact of the weather, I think. The third quarter growth rate was revised to 4.1%, up substantially from the initial estimate of 2.8%.  The hope is that this is now a 4% growth economy and the first quarter of this year may hold some welcome surprises as delayed economic activity in the 4th quarter is rolled into this year’s first quarter.  As I noted a few weeks ago, the wave like trend of the CWI composite index of manufacturing and non-manufacturing indicated a slight lull in these winter months before another peak in early to mid-spring.


Consumer Confidence rose to 80, the lower bound of what I consider healthy.  This index fell below 80 in the early part of 2008 and did not get above that mark till this past summer, then fell back in the fall.  A separate Consumer Sentiment survey from the U. of Michigan showed a similar reading at slightly above 81.


January’s monthly employment numbers will be released next Friday.  I ran a chart of those not in the labor force as a percent of those working.  Thirty years ago, the economy was coming out of the most severe employment recession since the Depression.  It is rather disturbing that this ratio continues to climb to the nose bleed levels of that recession thirty years ago.


The harsh winter weather may be affecting consumers more than businesses.  Chicago and the upper Midwest region got creamed with cold snap after cold snap in December yet industrial production figures for the month are still robust, declining somewhat from the incredibly strong readings of the past few months.

Investment, Savings and Income

August 18th, 2013

Gross Private Domestic Investment (GPDI) consists of capital spending on factories and equipment, improvements in rental properties, and changes in inventory.  Changes in GPDI reflect expectations by the business community.  Companies and landlords continue to increase investment after the precipitous fall of 2008.  Below is the long term view.

Let’s zoom in on the past five years to show some comparisons.  In 2010 there was a slight decline in investment.  In 2011 and 2012 came short periods of a levelling off of investment.  So far this year, the trend is upward.


Declines in investment accompany recessions but do not consistently precede recessions.  However, declines in the year over year (y-o-y) percent change do signal an aggregate caution among businesses.  The attentive investor would do well to notice these signals.  Investment growth remains positive.

Percentage changes in investment and the market loosely track each other, as we can see below.  Both investment and the market ride on anticipation of future business conditions but the market reacts and overreacts much more than investment. I dampened the percent change of the market to show a bit more clearly both the correlation and the divergences.

The y-o-y gain in investment has been positive since the latter part of 2009, indicating that business owners and managers have enough confidence in future business to increase their investment. A key component of the business landscape is the willingness of consumers to buy.  This past Tuesday came the monthly report on Retail Sales showing a .2% monthly gain for total retail sales, including food services.  At an annualized growth rate of 2.4%, sales  are positive but annualized gains of 3% or more would indicate strong consumer demand.  So far this year, earlier forecasts of negative real retail sales growth in response to sequestration policies have proved unfounded.  Below I’ve excluded the food services component which accounts for approximately 10% of retail sales.

When we look at retail sales as a percent of GDP, the total economic activity of the country, retail sales excluding food is still below 20 year averages.

Adjusting for inflation and population, we can see that it is food services that continues to show strong growth over a two decade period.  While the recession put a dent in that growth, it is more than 25% higher than it was two decades ago.

Each month the U. Of Michigan releases a consumer sentiment survey.  This past Friday’s report showed a surprising fall in sentiment from 85 to 80.

In the U.S. we can take a rough reading of the willingness of consumers to spend by looking at savings patterns – we don’t save as much.

We are down below a 5% savings rate again, indicating that people are confident enough to spend most of their income.  That is one reading.  Another is that many households have responded to the increase in the Social Security tax this year by reducing their savings.  The lack of savings by Americans has a long history.  Before the Social Security Act was passed in the 1930s, George Washington Carver wrote: “We have become ninety-nine percent money mad. The method of living at home modestly and within our income, laying a little by systematically for the proverbial rainy day which is due to come, can almost be listed among the lost arts. ”  Perhaps that is why some felt that Americans had to be put on a mandatory retirement program called Social Security.

The upward spike in savings at the end of 2012 has been attributed to higher dividend payouts and bonuses in anticipation of the “Fiscal Cliff” in 2013.  Per capita Disposable Personal Income continues its subdued but steady march upward, also rising dramatically in the last part of 2012 as a one time anomaly before the onset of higher taxes and sequestration.

On an inflation-adjusted basis, we are 10% higher than we were ten years ago.

But a longer term picture is a bit more sobering.  The decades longs rising trend of real income has clearly plateaued since the recession began at the end of 2007, over five years ago.

The recession has been a sobering experience for everyone, including the business community. While the growth signs are mildly positive, an underlying watchfulness seems to be the order of the day.