Cognitive dissonance is holding opposing views in your head and trying to make sense of it while maintaining your sanity. The equity market appears to be having its moment of cognitive dissonance. The market seems to be rallying because, after Yellen’s lunchtime speech, most seem convinced the Fed keeps pumping. Yet the market is not going to get the more rapidly growing economy that can fulfill its earnings expectations and get sustained central bank largesse. Pay your money and take your chances, as the expression goes, but be forewarned: value stocks against future earnings or for inflows of central bank capital -- Yellen is telling it no longer can be for both. Whether the economy achieves accelerating growth with higher rates is a tale for another day, but it suffices to say we have our doubts.
Our high frequency data continue to show the economy expanding, although the revival of consumer spending has yet to take hold. Don’t, however, let the spring retail bounce fool you into believing a new trend pace. Our contention has long been that resurgent economic expansion will need to be rooted in the commercial/industrial rather than consumer side of the economy. In the past few months, the loan data suggest that might be occurring.
As far as GDP growth is concerned, the economy still looks to be tracking back to its 2.5% real growth path. This means below average growth in the first quarter should be offset by above average growth in the second (no news here) followed by a 2.5% average for the second half of the year. Although this less growth than what the Fed and the consensus are anticipating, it will still be enough growth for the economy to continues its march towards Glocca Morra. With that, the Fed continues to taper and begin raising short-term interest rates in about a year’s time.
Within the FOMC one major debating point is whether there is rising inflation risk. Looking at the recently released CPI and retail sales numbers we see that in an economy with still low wage growth, higher inflation and higher prices are not the same thing even though price indexes such as CPI can make no such distinction.
Inflation other than rent continues to trend lower. The impact of higher prices for basics, among them the very things the Fed and others tend to exclude as transitory (food & energy), has reduced discretionary spending on a trend basis. The March jump in retail spending looks more like catch-up from the winter with rent inflation more likely to curtail spending growth going forward than not. That is unless the new found contention short-term unemployment rates drive wage gains turns out to be correct.
While higher rents look like a limit to growth in discretionary spending, this price signal is generating a higher pace of multifamily construction relative to pre-recession levels. We also see this reflected by loan demand growth at commercial banks (see chart). Multi-family is included in commercial real estate. Unfortunately the Federal Reserve doesn’t separate loans to build apartment houses from loans to build shopping malls, chemical plants, office buildings, manufacturing facilities and the like. Nevertheless, it is worth noting the commercial real estate and C&I loans are growing at a more rapid Y/Y pace.
We know from Census construction data that spending on manufacturing and chemical facilities has been growing since the recession and this is, from our perspective, a critical key to getting real growth on track and cutting into longer-term unemployment. On a rolling three-month growth basis, manufacturing production has picked up but this still looks more like catch-up than resurgence. Perhaps when the real 10-year Treasury yield starts rising towards 2.5% because of the bid for credit can we join with Yellen’s seeming optimism on the economy based, in part, on manufacturing production being back to pre-recession levels.
Steve Blitz is Chief Economist of ITG Investment Research, Inc. For disclosures applicable to his published research and additional information about ITG, please see: http://www.itg.com/compliance/ITGIRDisclosures/.
