Last week’s data highlighted the growing gap between the health of businesses and consumers that is starting to contribute to a widening gap in the performance of consumer and business-driven stocks, as well.
The economic reports released last week covering the time period of January and February 2013 for orders of equipment by businesses and manufacturing activity point to strengthening business demand (new orders surged). This may not be surprising, given that corporate profits have risen to record highs and companies are sitting on lots of cash.
On the other hand, the economic data released on consumer spending was weak (2% annual growth adjusted for inflation) and reflected no acceleration over the past year, and earnings reports from big retailers (such as Wal-mart and Target) reflected lackluster consumer demand. This may be not be any new news to some, given the well-known weak income growth and hiring in the United States keeping a lid on consumer spending power and the added drain this year from higher payroll taxes and gasoline prices.
While on the subject of the last week’s data, we do not dismiss Friday’s reading of the consumer sentiment index from the University of Michigan, which showed a modest bump up in February 2013 from January 2013’s reading, but the index remains significantly below the highs of last year and is well below the pre-crisis levels seen in 2007. Sentiment surveys purport to measure how confident consumers are feeling; however, the real pulse of confidence can be measured directly by borrowing. Borrowing against the future to spend today is a sign of confidence – perhaps sometimes misplaced, but confidence nonetheless. While business borrowing has surged back near previous highs, consumers’ demand for credit has flatlined.
In the fourth quarter of 2012, outstanding consumer debt rose a slight 0.3% to total $11.34 trillion, according to the latest report from the Federal Reserve (Fed). But, to put in context, total debt is still way below its peak of $12.68 trillion in the third quarter of 2008 and, most importantly, has barely budged in the past couple of years. In general, consumer borrowing of all types including housing debt has been stagnant, reflecting a cautious consumer.
While in each of the past four years, consumer discretionary sector stocks outperformed the more business-spending oriented industrial sector stocks by a wide margin, they have started to lose their leadership. In the fourth quarter of 2012 and so far this year, the industrial sector has outpaced the consumer discretionary sector as business spending began to revive in the fourth quarter and gain momentum so far this year.
The next fiscal impasse is the expiration of the continuing resolution funding the government on March 27. If unavoided, this may be worse for consumers than the more recent fiscal failure to compromise over the spending cuts known as the sequester that started on Friday, March 1, 2013. As we noted in our State of the Union preview a few weeks ago, a government shutdown may hit consumers since tax refunds may take much longer than usual if IRS workers are furloughed as the seasonal peak for tax filings arrives. In 2012, the average tax refund check was nearly $3,000, and refunds totaled hundreds of billions, according to the IRS. This drag on spending power could be felt since consumers have lacked the confidence to fund spending with borrowing, as noted above. It is worth noting that the deadline is not actually March 27, because the House is in recess beginning on Thursday the 21st of March, and the Senate is only in session until the next day. Assuming Congress sticks to its schedule, this leaves only about two weeks to avoid a government shutdown and the potential consequences.
A stall in the strength of consumer-driven stocks may help to keep the stock market in a range around the current levels. Though the Dow Jones Industrial Average may soon hit an all-time high, we see this as just part of an up-and-down range-bound pattern for stocks this year, echoing what we have seen in each of the past couple of years when a new Dow milestone was reached in February.