Friday, March 28, 2008

Housing Downturn Takes its Toll on Consumers

Happy Friday everybody!

Well there was more data that came out on the consumer and it revealed that they are tired! Feb. consumer spending rose only .1% after rising .4% in Jan. this represented the biggest drop in consumer spending in over a year. An economist take from Bloomberg:

The 0.1 percent rise in spending followed a 0.4 percent gain in January, the Commerce Department said today in Washington. The Federal Reserve's preferred measure of inflation rose at the slowest pace since June.

``With flat real consumer spending, we're going to be in a recession,'' said Brian Bethune, director of financial economics at Global Insight Inc. in Lexington, Massachusetts, who correctly forecast the rise in spending. The inflation number suggest that ``even though there are pressures on import costs, there is very little capability to pass those on to consumers.''

Another sign of the consumer slowdown was seen when JC Penney Co warned that sales were down in the high single digits in the 1st quarter. They reduced earnings estimates by about 30%.

My take:

The weakness in the consumer is pretty much confirming that we are in the middle of a recession. The good news here is that recessions help control inflation because the demand for products drops thus keep prices down.

The tough part right now for companies is inflation is still running high(around 2% in Feb.) which increases their costs and they are unable to pass it on to the weak consumer. This will eat into profits. I noticed this earlier this week when Valero which is a refiner missed earnings on the thesis that gas prices cannot go up much more without effecting consumer demand. This is putting pressures on refiners like Valero to eat some costs in order to keep gas around $3-$3.50 a gallon.

The concern we need to be focused on now is DEFLATION not inflation. This is the scenario the Fed is drastically trying to avoid by injecting massive amounts of money(liquidity) into the system. They need us to continue to spend spend spend like drunken sailors because if we don't then the music stops and the party is over.

The fear of deflation is that the consumer stops spending and borrowing which can turn into a death spiral that destroys the economy. Remember 70% of the economy is based on consumer spending! Without the consumer the economy is toast.


Avl said...

Jeff, great post. You wrote: "...deflation is [when] the consumer stops spending and borrowing ...turn[ing] into a death spiral that destroys the economy. Remember 70% of the economy is based on consumer spending!"

Are we witnessing a new fundamental 'cycle'. For years, we've warned that Consumers consume beyond their means, creating self-strangling debt. Yet, as noted, our current economy now grows only via consumer debt.
So I guess this is a new type of correction..thus completing the cycle. But the wrench in my simplified description is globalization and the tons of (bubble-ized?) funds in China, Arab nations, etc. Maybe that gives us more options at a solution that doesn't heavily depend on an economy designed around strangling consumers with debt.

Rather than say deflation could 'destroy' the economy, I like to use the phrase "reboot the economy."..and hopefully with new & better software (i.e. less consumer debt). So the Great Unwinding Leads to the Great Reboot.

Jeff said...


I think we are heading straight for a new "fundemental cycle". I think this transition will be very painful but needed.

We need a "reboot" but I am afraid it will be a reaction to the economy vs. being pro-active. I hope this reset is not violent but I am afraid it will be.

I say lets reboot or "reset" this economy by having the banks admit their losses and lets start from scratch!

Some type of bailout is where we are heading but I would think it would be limited and focused on certian types of loans.

More on this later!