Economic indicators: Consumer Spending v.

Kansas City Fed Financial Stress Index.

By Ron McWilliams January 22, 2012

We see, now days, remarkably good result in U.S economic performance. From various PMI indictors through SMI indicators and Fed regional indicators. Some of these include a rising Empire index, Philly fed index, Chicago PMI. We’ve also seen some encouraging jobs data and expectations for a Q4, 2011 GDP in the area of 3%.

But then we see other suggestions. Some analysts attribute the rise in Q4 GDP to firms expanding inventory in expectation of growing demand. However, if December’s flat retail sales (.1% growth) are an indicator, consumer fatigue might be something to watch.

Interestingly, the meat price spread of beef values provided by the USDA, Economic Research Services, http://www.ers.usda.gov/Data/Meat/PriceSpreads/, show a record for retail prices. Retail can earn an average of $5.016/lb., wholesale is at an average of $2.903/lb, leaving the farmer at $2.576/lb. According to the USDA, these differences are producing record prices.

When records in pricing are made, either the trend can be sustained, or reversals occur. The consumer has been under some stress for some time. On January 19, the Bureau of Labor Statistics released its Consumer Price Index ending December 2011. According to the report, the energy CPI ended 2011 with an increase of 6.6% versus 13.8% in 2010. The gasoline component of the CPI registered an advance of 9.9 % in 2011.

All of this indicates that in both in 2010 and 2011, the consumer endured healthy trends of increasing energy and transportation costs. In 2011, the stress hit the dinner table with the food CPI increasing at a rate of 4.7% in 2011 compared with 1.5% in 2010, and the “food at home” price category advancing 6% against the 2010 rate of 1.7%.

Where the consumer experienced ever increasing energy prices in 2010, in 2011, the consumer saw price increases in both energy and food. Retail sales data provided by the government shows that while the year over year gain in 2011 stayed strong, it displays a decline that started in the late summer to early fall. It was in nearly the 8% range in late summer and posted at 6.5% in December (with the m/m number being a gain of .1%). Will the decline continue.

Looking at the ICSC-Goldman same store sales for the  12/31/11 week, things seemed to start strong enough, posting a third straight week of gains with an increase in sales of 1.2% week over week. But, it was the next week where you ask, “how”?. For the week of 1/7/12, the indicator showed a 5.4% contraction in sales versus the previous week (that is, sales were minus 5.4%). Then, the week of 1/14 showed a soft .1% increase. Year over year sales of the index are currently at the 3% level. This compares with December’s closing y/y number of 5.3%. Is January looking at another soft result as with December?

Recessions are correlated with consumer spending, which is a reflection of demand. What’s more, recessions are also correlated with rising commodity prices, which tend to dampen demand. So much of where these indicators go hinge on the price of commodities, and the consumer’s response.

The Kansas City Fed Financial Stress Index, www.kc.frb.org/publicat/research/indicatorsdata/, provides an additional piece to the puzzle. Essentially the index considers the effects of yield spreads and behavior of asset prices on financial stress.

On the index, anything below zero is positive for economic growth. Likewise, above zero, shows indicators of weakness and increasing stress. The index was released January 9 and is at .21, versus for example a reading of 5.61 in October, 2008, or a reading of 1.18 in 1998. In fact the index, while having trended up in the 2H of 2011, is now trending down. In July, 2011, the index was at .21 and progressed up hitting .50 in October. In November, it hit .26 and now shows .21 for December  

There are nonetheless some items on the index that could dramatically change to generate upward pressure. The index tracks 11 variables, with 7 variables being yield spread comparisons and 4 showing asset price behavior. In December, four of the eleven variables decreased from November to December. This means 5 of the variable increased.

December found the yield spread side of the index producing upward pressure, in nearly all variables. This was mitigated by the behavior of asset prices netting results to a lower reading of -.05 versus November. The yield side could have had more upward pressure to show added financial stress due to the downgrades of European sovereigns.

However, such down grades were forewarned well in advance and appear to have been priced in, thereby producing a much muted market response. Still, the index suggests deterioration among spreads, but nothing significant. Unless, of course, the deterioration slowly accretes and builds. Further deterioration could be read from disappointing company earnings, slowing economic indicators, and obviously the European debt issue.

What is of real concern in the index is on the asset price behavior side. Here, improvement in the implied volatility of overall stocks (the VIX) is the suspect. This indicator has improved from highs in the 40’s this last fall, to now ranging in the low 20’s. VIX improvement accounts for a decrease (reduction of financial stress) in the index of .11. Which is the largest item showing relief of stress.

But, current convention has it that the stock market is overbought and has struggled to reach its current level, all the while being boosted on low volumes. On charts, stocks have been resting at resistance, not declining to support, only to hardly break resistance. Once resistance has been broken, conviction has not erected itself to sustain a rally.

The other variable on the asset side supplying indication of declining financial stress is the correlation between asset prices and treasury returns. This variable contributed .03 to show, like the VIX, improved conditions. Yet, as long as stocks hold high, they drive down the VIX, and compare favorably against other assets. Still, nothing can go up forever.

Basically, so many drivers of improving conditions for the KCFSI are stock driven, amid an overbought market. The one asset based variable that showed the opposite is the performance of bank stocks. The volatility of bank stocks showed a .04 increase. Banks are very sensitive to yield spreads, and the yield spread of the KCFSI shows overall decline.

Where the answer can be hidden in a thousand indicators, we see but a few here. Demand ultimately drives supply. Whether it is consumer demand, credit demand, or demand for various asset classes. From U.S. consumer demand, we see signs of weakness and causation. We then can see the influence of credit that demonstrates a weakness across grades of credit, given spreads. But stocks are strong.