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The government recently
reported that the U.S. economy grew at an annual rate of 2.2 percent, below
the expected 2.5 percent rate. The jobless rate has declined, but mainly
because so many job seekers have given up in their search for a job. The
economic recovery, in other words, isn’t as strong as it appears on the
surface.
The recovery to date
since March 2009 has mainly been a product of loose monetary policy and the
subsequent surge in the profits of corporations with global exposure. While a
few domestic industries have done well (e.g. the auto industry), many others
have struggled, including the pivotal housing construction industry.
The pillar industries of
the U.S. domestic economy remain weak, so what’s keeping the economy
afloat? In a word, retail. As Zacks analyst Sheraz Mian observed today in his
blog, “While ‘headline’ growth rate missed expectations and
dropped from the preceding quarter’s level, the composition of growth
improved. Weak spending by governments and businesses offset surprise
strength on the consumer spending front to give us the negative
surprise.”
The latest quarterly
economic research by Zacks is important to our narrative, so I’m
quoting it at length:
“Consumer spending,
which accounts for close to 70% of the economy, increased by 2.9%, compared
to the 2.1% increase in the fourth quarter. Households spent more on
non-durables and services compared to the fourth quarter, driving the strong
PCE gain. The major negative contributor to growth during the quarter was
government spending, which declined 5.6% in the quarter following a 6.9% drop
in the fourth quarter. Contribution from state and local governments was also
negative.”
This is the first early
warning signal that deflation is on its way again, though we may not see it
in its fullest extent until next year. Much of the strength in the economic
and financial market recover since 2009 was predicated on government spending
coupled with central bank policy. With the Fed no longer pursuing
quantitative easing and government spending on the wane, the economy will
sooner or later run out of steam as we head closer to the final “hard
down” years of the 60-year cycle in 2013-2014.
Zacks further observed:
“The deceleration
in business spending during the quarter does not look promising.
Non-residential fixed investment was down 2.1% in the quarter, compared to
the 5.2% increase in the fourth quarter.
“Corporate spending
on software and equipment decelerated materially from the fourth
quarter’s 7.5% growth pace to an increase of only 1.7%. Inventories
were less of a growth contributor to growth this quarter, adding only 0.59%
compared to the 1.8% growth contribution in the fourth quarter.”
It was easy enough for
Wall Street to ignore the slowdown in government and corporate spending. What
really got investors excited this week was the quarterly increase in consumer
spending. Consumers in recent months have spent more money than they have in
the 3+ years since the credit crisis. There is no better example of this than
Amazon.com (AMZN), whose net sales increased 34% in the first quarter to
$13.18 billion. Amazon’s stock has been rewarded for this and is up
nearly 20% in the last month alone.
Putting aside
Amazon’s stellar sales numbers, investors ignored the fact that
Amazon’s net income has been on a decline since early 2011. According
to Wall St. Cheat Sheet, “Net income [for Amazon] has dropped 41.2%
year-over-year on average across the last five quarters. Performance was hurt
by a 72.7% decline in the third quarter of the last fiscal year from the
year-earlier quarter.”
In a previous commentary
we talked about the Amazon/Apple ratio. As I wrote back in February,
“There is typically a sympathetic price performance between both
stocks. But when one of these stocks gets out of line with the other one, a
correction typically follows in which the stock that has overshot on the
upside (in this case AAPL) comes back closer into line with the
laggard.”
I should add that if a
significant correction doesn’t occur in the outperforming stock, the
only way the underperforming can re-establish sympathy with the other stock
is by rallying to “catch up” with the over performing stock. In
recent weeks, both these outcomes have taken place as Apple’s stock has
declined while Amazon’s has vigorously rallied. The following graph is
a simple comparison of the stock prices for tech leader Apple Inc. (AAPL) and
online retailer Amazon.com (AMZN). It illustrates the extreme divergence of
the two stock prices since December 2011 and the subsequent reversion to the
mean which is now underway.
The dichotomy between
Apple’s and Amazon’s stock price is instructive on more than one
count. While sales growth for both behemoths has been impressive, profit
margins for Apple have been considerably higher than for Amazon. Moreover,
the P/E ratio for Apple is significantly less than that of Amazon. Thus, two
of the biggest “story stocks” in the market today are actually on
divergent paths in terms of earnings growth and valuation.
The divergent paths of
Apple and Amazon serve as a microcosm for the divergence between the
corporate earnings recovery since 2009 versus the weak “recovery”
in household incomes. Below is a chart showing the long-term trend in real
median household income from 1967 to 2011, courtesy of Hoisington Investment
Research.
 
The above chart shows
that over the past 40 years, real (inflation adjusted) median household
income is an excellent recession indicator. Six out of the last six
recessions that have occurred since 1967 were preceded by a fall in household
incomes. As Robert Campbell of The
Campbell Real Estate Timing Letter (www.RealEstateTiming.com) observed: “During the downturn that occurred
from 2007 to 2011, household income fell to its lowest level since 1995. This
represented a fall of 11%, the steepest (and fastest) fall since at least
1960.”
Campbell’s
conclusion based on the above chart is that the statistical evidence strongly
favors the bet that housing prices likely haven’t hit bottom yet. We
can go one step further and say that the falling household income trend
points to the fact that the economy hasn’t recovered yet. Moreover,
since corporate profits are to a large extent predicated on consumer
spending, the corporate recovery since 2009 is most likely living on borrowed
time unless we see a dramatic reversal in the household income trend.
While cyclical recoveries
in consumer spending may keep the recovery alive for a while longer, a truly
lasting recovery can only come at the expense of stronger household balance
sheets. As with Amazon vs. Apple, something has to give in this divergence
between strong corporate income and weak U.S. household income.
Gold ETF
Political uncertainty in
Europe over the debt crisis pushed stocks and commodities lower earlier this
week with gold getting caught in the cross-hairs. Investor concern over the
euro-zone debt drama has resulted in a bid to raise cash by investors with
equities as well as hard assets exchanged for dollars. The U.S. dollar index
has risen for the last seven consecutive days on the back of the rush to get
liquid. There’s an old saying in the financial market, to wit:
“When they back the truck up, all the girls go.” That means even
a traditional safe haven like gold can be sold off when investors start to
panic.
There are two responses
that are typically made by analysts and advisors after a poor showing like we
saw on Tuesday. The first reaction is to throw in the towel and capitulate
with advisors telling their clients to “sell everything” in
anticipation of even further declines. The other response is to assume prices
can’t possibly go any lower and to advise clients to “buy with
both hands.” Based on my reading of the indicators it’s still a
little too early to start banging the gong for a bottom, but there is reason
to believe we’re not far from seeing a buying opportunity.
The first clue that gold
isn’t far from a bottom is found in the relative strength line for the
gold ETF (symbol IAU). When a market (in this case gold) begins showing
relative strength versus the S&P 500 Index, it suggests the smart money
traders have taken an interest in the stock or commodity in question. Our job
as independent traders is to follow in the footsteps of the smart money crowd
whenever possible.
Following is the relative
strength (RS) line for the iShares Gold Trust ETF (IAU) since the beginning
of this year. Notice the negative divergence in the RS line versus the higher
high the IAU made in February, which warned of potential weakness in the gold
market. Since then the RS line has mostly trended lower up until recently.
Although IAU on Tuesday
made its lowest close since the first trading day of 2012, the relative
strength line didn’t go lower. This is a small improvement to be sure,
but a positive step in the right direction in any case. This early sign of
relative strength isn’t good enough to hang our hat on and issue a buy
signal for gold, but it does suggest that given perhaps a few more weeks, the
gold market could be strong enough to begin a new bull run. To get a
confirmed buy signal in the gold ETF we’ll need to see the relative
strength line break out above the dashed line shown in the above chart. This
would tell us that gold has once again returned to a strengthening position
relative to the S&P.
Gold & Gold Stock
Trading Simplified
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