U.S. economy losing

(October 1, 2004) Despite a positive spin by the U.S. administration and the Federal Reserve, America’s economic prospects leave little to cheer about, according to one economist. The engine of the economy, the U.S. consumer, is about to run out of gas.

“Up to about three or four months ago everyone was pretty sure that things were going to go hunky-dory for 2005-2006,” said Andrew Pyle, vice-president and head of capital market research at Scotia Economics. “Over the past four or five months, things have begun to show signs of wear.”

Pyle, keynote speaker at the IFIC’s annual conference, says blame for economic softness is too often assigned to the easiest target — in this case, the short-term effects of expensive oil.

“When Greenspan was talking about what happened going into the summer … the comments made were that we had a substantial run up in the price of crude oil going into the summer months,” Pyle said. He points out that crude rose by an average of 9.75 cents per day in the first five months of the year. But the rate of increase in July hit 39.5 cents per day and 43.7 cents per day in September.

“If we thought that from January to May was substantial, one has to ask what do we think about September and what happened in the early summer?” he said. “If this is traction, I’d hate to see Greenspan’s idea of hydroplaning.”

But the biggest problem with the U.S. economy could well be the consumer. Pyle says the consumer has been the driving force of the economy, with positive spending growth for 50 consecutive quarters.

“The consensus view after 9-11 was that the U.S. economy was going to look a lot different,” says Pyle. “You could not expect the consumer to be your leading contributor to growth in the States. Confidence would deteriorate, there would be way too much uncertainty and Americans would go into hibernation.

“What has happened since has been completely counter to what economists said. Consumer spending growth has been explosive, interest rates fell to levels that drove consumption, the housing market has boomed and the result has generated growth rates in the consumer sector of 5%.”

But a crisis in consumer credit is now in the offing.

As interest rates fell, consumers flocked to refinance their houses — a smart move which allowed them to not only decrease their mortgage costs, but gave them the cash to pay off higher interest lines of credit. Pyle says the problem is that they did not rein in their spending and almost immediately hit their credit limits again. With their homes already in hock, consumers are facing rising interest rates on their floating-rate lines of credit.

“It appears that what happened this summer is that we reached the threshold in terms of how much more refinancing can alleviate the non-secured lines of credit.”

To make matters worse, there is little room left for economic stimulus, as interest rates have already reached record lows and there are no more tax cuts in sight. The only remaining source of stimulus is job creation, but this depends on stable corporate profits, which have yet to materialize.

In fact, real wage growth has been trending lower since 2002 and has been negative for several quarters.

The employment outlook for September is gloomy, thanks in large part to the unusually active hurricane season which wreaked widespread destruction in the American south-east. This is a one-time occurrence that will lead to a boom in reconstruction activity, but consumer confidence is already shaky. One more month of poor job creation could erode confidence even further.

“We’re going to spend a lot of time as economists that morning [when the data is released] telling the press that this is all just hurricane-affected, but from the consumer point of view, reading the headlines in the morning, all the consumer is going to see is that employment news is still discouraging,” he said.

Florida’s reconstruction efforts will be a boon to one sector of the economy that has been outperforming the rest of the market already this year. Commodity prices have soared in the past 12 months, with the closely watched price of oil actually lagging minerals and materials.

Aside from the much talked-about Chinese expansion, Pyle says American policy makers still want to rebuild the electrical grid in response to the 2003 blackout in the north-east. This project alone will require massive amounts of aluminum, driving the commodity higher.

Pyle says the Canadian economy is currently outperforming that of the U.S. and expects this to continue for a few more quarters. The stronger Canadian economy, with its exposure to the commodity markets, should drive the dollar higher, reaching 82 or 83 cents by summer 2005. At this point he expects the economy will slow.

Pyle sees this strength continuing and suggests that U.S. equity fund managers should be overweight in commodities. He says oil stocks are underpriced, with traders essentially assigning crude a price in the mid-$40 range. Oil has replaced gold as an inflation hedge, leaving gold relatively undervalued and therefore highly attractive as an investment. Because consumer spending is expected to contract, he says exposure to housing and retail stocks should be limited.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(10/01/04)

Steven Lamb