The recent economic reports have been mixed. The stock market seems to have embraced the strength and ignored the weakness. The bond market typically approaches the information in a more balanced way. How might the differences between the two markets be resolved?
It’s worthwhile to look at many of the economic numbers on an unadjusted basis. There are clear seasonal patterns in employment, consumer spending, production, and so on. We are less concerned with the seasonal swings and more interested in the underlying trends. However, the seasonal adjustment often exaggerates what would normally be minor effects from the weather. Last year, for example, an exceptionally mild winter pulled forward seasonal job gains that would have occurred in the spring and early summer. Giddy market optimism about strong job growth eventually gave way to renewed doubts about the recovery when the seasonally adjusted payroll figures slowed. Average temperature and precipitation were near normal this February, but weather appears to have been milder than usual during the job market surveys. We could see a similar pattern this year – not to the same degree, but in a similar direction. As a general theme, one should take February economic figures with a grain of salt.
Retail sales were stronger than expected in February, but unadjusted sales are usually near their seasonal low. There’s always a pullback following the holiday shopping season and the spring sales promotions have yet to pick up. February retail sales results varied widely across sectors. Restaurant sales fell for the second consecutive month.
One often talks about “the consumer,” but there’s no such thing. As a rule of thumb, the top 20% of income earners account for about half of personal income and half of consumer spending. Spending for the top 20% of households shouldn’t be affected much by the payroll tax increase, delayed tax refunds, or higher gasoline prices. Moreover, stock market wealth gains will add somewhat to spending. Note that the stock market wealth effect on spending is relatively small, but a large enough change in wealth can certainly move the needle on spending. The wealth effect is also asymmetric. A 20% rise in stock market wealth may add about 0.6% to spending, while a 20% decline might reduce spending by about 2.0%.
For the other 80%, the payroll tax increase and higher gasoline prices matter a lot. Recall that, for a household making $60,000 per year, the payroll tax increase reduced spending by $100 per month. The payroll tax reduction of the last few years was perhaps the most unadvertised tax cut in history. Most people were unaware that the cut had occurred, but the added take-home pay helped support consumer spending growth. Many workers were unaware that the payroll tax rose in January. Hence, the impact on consumer spending is likely to show up with a lag. In addition, higher gasoline prices normally have a lagged effect on spending. Gasoline prices may be falling now, but the full impact of the rise in February has yet to be felt.
While inflation has remained relatively low over the last few years, it has been high enough to offset gains in nominal average hourly earnings. Inflation-adjusted wages have trended roughly flat over the last several months. That implies relatively little fuel for consumer spending growth for the 80%.
The stock market tends to be more extreme than the bond market. The economy is seen as either roaring or falling apart completely. Mixed and moderate growth, varied across time and sectors, is not what the stock market wants. In contrast, the bond market seems to synthesize the data a lot better. The mixed nature of the recent numbers suggests “more of the same” – a gradual recovery, but still a bit less than hoped for.
© Raymond James
