Category: Chart of the Week

More Headwinds for Economic Growth?

On September 25, the Bureau of Labor Statistics released its final report on 2011 consumer expenditures. Although the information appears somewhat dated as we are practically entering the fourth quarter of 2012, the trends discovered in the analysis should have a material impact on GDP in the coming years, especially considering the importance of consumption to total GDP growth.

On September 25, the Bureau of Labor Statistics released its final report on 2011 consumer expenditures. Although the information appears somewhat dated as we are practically entering the fourth quarter of 2012, the trends discovered in the analysis should have a material impact on GDP in the coming years, especially considering the importance of consumption to total GDP growth.

At the broadest level, consumer spending rose 3.3% in 2011 which was preceded by a 2.0% decrease in 2010. Given the importance of consumer spending to GDP, the increase does benefit the overall outlook for economic growth. However, the spending increase of 3.3% narrowly surpassed an increase in the prices of goods and services which grew by 3.2%. So although consumer spending has increased, an upswing in prices has blocked consumers being much better off on a net basis.

More important – and the focus of this week’s chart – is how the increased spending dovetails with consumer incomes. If income increases do not move in at least lockstep with consumption increases, consumers will be squeezed at the margin and therefore spend a greater proportion of their incomes. As a way of investigating this, the chart above depicts the income before taxes and average annual expenditure per individual consumer over the last three years. The important relationship to note is the income level percentage change. Incomes increased only 1.93% year over year, while the expenditures rose 3.3%. When incomes are exceeded by expenses, it will be hard for the consumer to sustain this pattern without taking on debt of some kind.

The trend in the graph above – expenditures growing faster than incomes – is a cause for concern. Incomes are not increasing substantially, expenses are increasing, and consumer debt levels have increased year over year. Consumers will not be able to sustain this level of spending without greater incomes or increased debt. Unless this trend can be reversed, this is another reason to expect sub-par economic growth over the next few years.

Source: Bureau of Labor Statistics, Federal Reserve

Improvement in Housing Market?

This Chart of the Week examines home builders’ expectations of the newly built single family home market measured by the NAHB/Wells Fargo Housing Market Index. The HMI is based on a monthly survey conducted by the National Association of Home Builders.

This Chart of the Week examines home builders’ expectations of the newly built single family home market measured by the NAHB/Wells Fargo Housing Market Index (“HMI”). The HMI is based on a monthly survey conducted by the National Association of Home Builders. The index measures home builders’ perceptions of current sales, sales expectations for the next six months, and traffic of prospective buyers for newly built single family homes. An index value over 50 signifies more builders consider sales conditions good rather than poor.

While still below 50, the HMI has increased over the last five months and is now at a level of 40, which was last seen in June 2006. The improvement in builders’ confidence along with a gradual upward trend in existing home sales and stabilization of home prices are signs of modest improvement in the housing market after a historic collapse from the 2008 financial crisis. Historically low mortgage rates and attractive price opportunities have helped to stabilize the current housing market. However, a number of challenges remain, including high unemployment, a large number of looming foreclosures, strict credit standards, higher required down payments, and current underwater mortgages for would be buyers.

Impact of Government Transfer Payments on Disposable Income

This week’s Chart of the Week shows the impact of government transfer payments (Social Security, Medicare/Medicaid, unemployment insurance, veterans benefits, food stamps, training & education programs, etc.) on disposable income (defined as personal income minus personal income taxes) in the U.S. over the past several years.

This week’s Chart of the Week shows the impact of government transfer payments (Social Security, Medicare/Medicaid, unemployment insurance, veterans benefits, food stamps, training & education programs, etc.) on disposable income (defined as personal income minus personal income taxes) in the U.S. over the past several years.

As the chart illustrates, since the recession began in December of 2007, real disposable personal income in the U.S. has increased from $9,974.7 billion to $10,354.8 billion (an increase of 3.8%). However, when excluding government transfer payments, real disposable income has decreased from $8,203.4 billion to $7,979.3 billion (a decrease of 2.7%). There are several reasons for the discrepancy between discretionary income and discretionary income excluding transfer payments, but the two primary reasons are: the U.S. economy has approximately 3.5 million fewer jobs now than in December 2007, and the population of the U.S. is aging. The loss of 3.5 million jobs results in both a drag on income (fewer people working results in lower incomes) and a boost in government transfer payments (fewer people working results in increased payments for unemployment insurance, food stamps, Medicaid, and job training programs.). The aging population of the country drives a boost in spending on programs such as Social Security and Medicare.

Over the past 30 years, government transfer payments have represented 13.9% of total personal income in the U.S. From January 2008 to July 2012, government transfer payments have represented 17.4% of total personal income in the country. Given the persistently high unemployment rate, the current budget deficit, the looming fiscal cliff, and the potential for cuts to government transfer payments in the near term, it is important to understand where the growth in government transfers has come from. The table below shows the current breakdown of government transfers by category as well as the average from January 2008 to present and the 30 year average.

Breakdown of Government Transfers

Social Security

Medicare/
Medicaid

Unemployment
Insurance

Veterans’
Benefits

Other*
Current

32.7%

42.0%

3.4%

3.2%

18.8%
Jan 08-Present

31.8%

41.7%

4.9%

2.6%

19.0%
30 Year Avg.

36.2%

39.3%

3.6%

2.7%

18.2%

* Other includes programs such as welfare payments, food stamps, earned income tax credits, job training, and disaster relief.

As the table shows, part of the increase in government transfers are cyclical in nature and come from programs such as unemployment insurance, food stamps, and job training. These programs have begun to shrink and should continue to shrink as the economy improves. However, the aging population of the country will have a significant impact on the largest components of government transfers, Social Security and Medicare. These problems are structural in nature, and as the population continues to age, spending on these programs should continue to increase. This means that unless there are significant cuts to Social Security and Medicare, it is likely that government transfer payments will remain at this elevated level well into the future.

U.S. Manufacturing Data Hints at Slowing Economy

Our first Chart of the Week for 2012 covered the ISM Manufacturing Index, with December’s value of 53.9 indicating signs of economic expansion (above 50) and a positive outlook heading into 2012. We revisit the ISM index this week to gauge the current health of the manufacturing sector.

Our first Chart of the Week for 2012 covered the ISM Manufacturing Index, with December’s value of 53.9 indicating signs of economic expansion (above 50) and a positive outlook heading into 2012. We revisit the ISM index this week to gauge the current health of the manufacturing sector.

As indicated by the chart below, the ISM stayed above 50 through May, indicating further expansion in the manufacturing sector and therefore legitimate reason for optimism regarding economic growth. However, the past three months have seen manufacturing face some headwinds, with the index falling below the 50 mark with the release of the June data at 49.7. Given the latest August release, the ISM has been below 50 for the past three months, indicating an ongoing drag to economic growth from a slowing manufacturing sector. Unfortunately, the lack of sustained expansion in the manufacturing sector is likely to contribute to the currently high unemployment rate as factories are hesitant to hire large pools of new workers until they have more confidence in their long-term growth prospects.

Do Longer-Term Metrics Make European Stocks More Attractive?

This week’s Chart of the Week shows CAPEs for market stock indices of 47 countries including the United States. The U.S. comes in at the middle of the pack, with a CAPE of 19.6.

Most investors are familiar with the PE ratio as a metric of valuation. This metric divides the current stock price by trailing twelve month earnings. In effect, it measures how much an investor pays compared to the amount of earnings a company or index provides. As a measure of valuation, PE can be heavily influenced by the cyclical nature of earnings. To smooth out fluctuations due to cyclicality, one approach, popularized by Robert Shiller, is to divide equity index prices by ten-year average earnings. The measure, known as the Cyclically Adjusted PE (CAPE), can provide an indication of when markets are exceptionally over or undervalued.

This week’s Chart of the Week shows CAPEs for market stock indices of 47 countries including the United States. The U.S. comes in at the middle of the pack, with a CAPE of 19.6. This is much higher than the trailing 12-month PE of 13-14, due to the large declines in earnings suffered over the last ten years. Perhaps unsurprisingly, the countries with the lowest CAPEs reside in peripheral Europe. Greece, with a CAPE of 3.0, looks extremely undervalued by this measure. Spain and Italy, which are both home to large multinational corporations, have CAPEs just below 10. The Netherlands, which is a net lender in the Eurozone, has a CAPE below 10.

Of course, while low valuations have tended to precede strong long-term performance, this is by no means guaranteed. Additionally, given the ongoing nature of the Eurozone crisis, short-term performance of European equity markets is likely to be choppy at best. The Athens Stock Index, for example, is down 49% over the last year alone. Still, on a relative valuation basis, European equity markets look attractive compared to other countries for long-term investors.

Are U.S. Stocks Fairly Valued?

There are a variety of methods to measure market valuation but one of the simplest is to compare market capitalization to GDP. Investors can think of this as a price-to-sales multiple for the macro economy.

There are a variety of methods to measure market valuation but one of the simplest is to compare market capitalization to GDP. Investors can think of this as a price-to-sales multiple for the macro economy. For U.S. stocks over the last 50 years this ratio has averaged 0.76x (U.S. Market Cap/U.S. GDP). The gold line on the chart shows this ratio over the last 50 years and the dotted gold line shows the average. This simple valuation metric clearly shows the market was overvalued in 2000, and given that the market is currently valued at 1.07x U.S. GDP, stocks also look pricey today.

However, this valuation tool ignores the increasing importance of global sales and profits to U.S. firms. As many investors are aware, almost 40% of S&P 500 company profits come from overseas. The blue line shows the U.S. share of global GDP. Over the last 50 years, and particularly over the last decade, the U.S. share of global GDP has fallen to record lows, currently at just 21.5%. As the U.S. accounts for less of global GDP, U.S. GDP becomes a less relevant metric to value firms with a global reach.

As a result, global GDP may be the more relevant metric to follow. The dark gray line looks at the ratio of U.S. Market Cap to global GDP. The dotted dark gray line shows the long term average. Based on this metric, stocks were clearly cheap in the late 1970’s and early 1980’s, and expensive during the dot-com years around the turn of the century. Currently, based on global GDP, stocks do not look nearly as expensive today. In fact, stocks look fairly valued compared to their long term average.

While these metrics can act as a useful guide to broad over and under valuation in markets, they tell investors very little about where markets are headed in the short-term. However, as U.S. company sales and profits become more global, investors will increasingly want to focus on global benchmarks when looking at valuation.

Italian Debt Conundrum

This week’s chart depicts the amount of Italian government bonds held by Italian banks. As seen in the chart, this amount hovered between $200 and $250 billion until December of 2011, which is when the first round of the Long-Term Refinancing Operation (LTRO) began.

The chart above depicts the amount of Italian government bonds held by Italian banks. As seen in the chart, this amount hovered between $200 and $250 billion until December of 2011, which is when the first round of the Long-Term Refinancing Operation (LTRO) began. A notable aspect of the LTRO was that it allowed Italian banks to borrow funds from the ECB for 3 years at a 1% interest rate with appropriate collateral. Given these favorable terms, Italian banks used portions of the funds obtained from the ECB to invest in higher yielding bonds issued by their government. As a result, the number of Italian bonds owned by Italian banks has since swelled to nearly $350 billion. Ultimately, this trend has been helpful to lower the interest rate on Italian bonds, but is troublesome since a large portion of the debt that Italy issued has been purchased by Italian banks because foreigners have been skittish to invest. Foreign investors have cut their holdings of Italian governments bonds to their lowest level since 2005. As Italian banks purchase more Italian government bonds, the public and private sectors become more intertwined.

Italy has a substantial portion of debt maturing in the next few months (table below). It remains to be seen if there will be sufficient demand (foreign and domestic) to refinance these obligations at a reasonable interest rate.

Italy – Principal Maturity

Month

Aug-12

Sep-12

Oct-12

Nov-12

Dec-12
Amt (Mil)

$30,663

$27,462

$36,751

$26,975

$53,718

 

ECB president Mario Draghi has indicated a willingness on behalf of the ECB to step in and purchase Italian bonds that fall on the short end of the yield curve to ensure liquidity. This implied guarantee means that Italy will most likely issue short term debt to attract investors. By issuing short-term debt, Italy essentially buys itself a little more time to demonstrate economic improvement to attract foreign investment. However, a lack of progress will likely translate into larger near-term debt and rising interest rates.

The Ongoing Debt Challenge in Europe

This week’s Chart of the Week shows that through the first quarter of 2012, euro area governments’ debt-to-GDP ratio stood at 88.2%, up from 87.3% at the end of the fourth quarter of 2011. This was the eighth debt-to-GDP increase in the last nine quarters.

This week’s Chart of the Week highlights the euro area’s ongoing debt problem. As the chart above shows, through the first quarter of 2012, euro area governments’ debt-to-GDP ratio stood at 88.2%, up from 87.3% at the end of the fourth quarter of 2011. This was the eighth debt-to-GDP increase in the last nine quarters. Since the fourth quarter of 2009, only four countries (Estonia, Hungary, Sweden, and Norway) have reduced their debt-to-GDP levels. The countries with the highest government debt-to-GDP ratios at the end of the first quarter of 2012 were Greece (132% despite the most recent debt write-down), Italy (123%), and Portugal (112%). The lowest ratios were Estonia (6.6%), Bulgaria (16.9%), and Luxembourg (20.9%).

Even though many of the most indebted countries have instituted rigorous austerity cuts, debt-to-GDP levels have continued to rise, mostly due to a lack of growth. Severe austerity cuts have resulted in larger than expected decreases in GDP, which has led to continued increases in debt-to-GDP levels. For example, Italy has contracted more than expected for each of its prior two GDP releases (-.7% and -.8%). Furthermore, on July 27, the IMF lowered Spain’s 2012 GDP forecast from -1.5% to -1.7%.

It is no secret that the euro area has established very stringent debt and deficit ratios for the weakest members. However, with euro area unemployment at 11.2% (much higher in certain countries such as Spain, whose rate is 24.6%) and a systematic lack of growth, euro area leaders must find a way to establish policies that will allow for economic expansion alongside spending reductions. Until this happens, economic growth and capital market performance from these countries will likely remain choppy.

Emerging Olympic Champions?

The growth and development of Olympic champions is due to a myriad of factors, many of which are impossible to account for by data analysis. However, are there any parallels between countries’ economic growth and Olympic success?

The growth and development of Olympic champions is due to a myriad of factors, many of which are impossible to account for by data analysis. However, are there any parallels between countries’ economic growth and Olympic success? In particular, as countries mature into developed economies, does their increased prosperity translate into more Olympic success, as a result of greater resources to develop athletes?

To answer this question, we analyzed medal distribution (via number of medals won) by splitting countries into one of three groups:

  • G-7 nations: Canada, France, Germany, Great Britain, Italy, Japan, and the United States
  • BRIC nations: Brazil, Russia, India, China
  • ROW: all other countries

If our hypothesis proves true, we would expect emerging market countries – which have experienced significant growth over the last fifteen years – to constitute a larger percentage of the medals won with each subsequent staging of the summer Olympics.

A look at the data reveals this to indeed be the case. Though our analysis strictly focuses on the major emerging market countries, we see the BRIC nations taking home more medals each Olympic summer. On average, BRICS have increased their medal count approximately 15% each time the summer Olympics have taken place (in relation to the G-7 nations), using 1996 as the starting point. Going forward, we would expect greater convergence between these two groups of countries, as the BRICs continue to mature into large developed economies. To this point, China’s early success in this year’s games illustrates the growing Olympic success of emerging market countries, a trend which will likely continue.

State and Local Government Budget Cuts a Drag on GDP

This week’s Chart of the Week shows the contribution to GDP growth in the United States from spending at the state and local government level since 1990. As the chart shows, state and local government spending, which has contributed an average of 0.23% to GDP growth annually over the past 30 years, has declined to a level well below its 30 year average.

This week’s Chart of the Week shows the contribution to GDP growth in the United States from spending at the state and local government level since 1990. As the chart shows, state and local government spending, which has contributed an average of 0.23% to GDP growth annually over the past 30 years, has declined to a level well below its 30 year average.

The sharp reduction is mainly due to a significant plunge in tax revenues for state and local governments, which is a direct result of the recession that began in December 2007. Since almost all state and local governments are subject to balanced budget requirements, they have had to slash spending in order balance their budgets. As a result of these budget cuts, government spending at the state and local level has detracted an average of 0.20% from GDP growth annually since the first quarter of 2008. Given the drag that state and local government spending has been on overall GDP growth in the United States for the past several years, it is not surprising that growth has been well below trend since the recovery began in the third quarter of 2009.