Watching the Economy by Clint Burdett CMC® FIMC

February 2010

A Strategic Planner's Responsibility is to Anticipate Consumer Demand

By Clint Burdett CMC

A consensus emerging is in 2010 we will see a slow recovery, with a chance of a double dip. Company strategists, consultants and planning teams will be challenged to manage the pace of growth as they assess consumer spending patterns. Those who take the risk, advise clients on risk or facilitate planning team's discussions about risk must carefully calibrate the timing to turn it on. In 2010 the US consumer spending and politics will increase the uncertainty. How do your sales compare to the US consumers spending patterns?

The recovery will be slow because consumer spending has not taken off; it's up but just so. The best national measure of consumer spending is personal consumption expenditures (PCE), measured monthly by the Bureau of Economic Analysis and others. Simplistically, our combine cash in - our earnings from salaries and investments - plus cash from borrowing LESS what we saved equals US personal consumption expenditures.

First, embedded in PCE are businesses and consumers reaction to inflation or deflation. If inflation growth is greater than improvements in PCE from raises, you are losing purchasing power. When inflation slows, everything else being equal, PCE increases.

Second, hourly earnings growth from raises drives PCE improvements. With more earnings in the economy, consumers can either spend more or set funds aside "just in case." So far in this recovery, the national saving rate is near 4% and consumers are holding back - cash is being held in reserve. (See St Louis Fed FRED chart for latest data - note the anomally that consumers are spending but earnings are not growing coming out of the Great Recession.)

Third, increased employment improves hourly earnings, but unfortunately, new hiring lags in a recovery. Bosses wait to hire until they are sure.

In the last few months, most of the improvement in PCE has been from lower inflation (called the PCE deflator in BEA speak) rather than from very modest earnings improvements. It helps if you can factor out inflation using the PCE deflator, which is called Real PCE.

Most analyst report the change in Real PCE compared to the same month last year (noted as year on year or YoY) or to the previous month (month on month or MoM). The next analytical step is to determine the rate of change from the previous data point. For example, Real PCE grew 1.80% YoY month two and was up the previous month one's YoY growth of 1.71%, its rate of growth is 0.5%.

A fundamental strategic planner's responsibility is to anticipate the pace of the recovery. The YoY rate of change lets you analyze the pace and PCE lets you examine the cash in the economy ready to spend. GDP growth lets us examine manufacturing, the inventory ready to sell.

I think that 2010 Q1 and Q2 GDP numbers will look good but may be deceiving. American businesses let inventories fall last summer and fall to save replenishment costs and use that cash for other purposes. Many wholesalers pushed their inventory through retail channels offering substantial savings, which were passed on to consumers. Since fall and holiday sales revenues were okay with significant sales discounts, in Q4 2009 into Q2 2010, wholesalers and retailers will rebuild stocks, hence GDP will rise as those items are manufactured. But into January 2010, commercial credit applications fell, except to roll over old maturing debt. The restocking is being paid for mostly out of cash on hand. A tick up in commercial credit applications would indicate increased consumer demand and that is not happening yet. The question is will this new inventory sit idle? A fundamental cause of the double dip is when inventory stocks are replenished too soon and other factors dampen consumer spending. I think political uncertainty will dampen demand.

A volatile macro factor will be politics. 2010 is a mid-term election year with local, states and the US Government desperate to increase revenue. There is significant uncertainty about the outcome of political initiatives at all levels. Though inflation has been benign, with folks out of a job, governments are seeing their tax and fee revenues drop and from my perspective, being very, very creative how they create new revenue - my effective tax rate is going up about 6%. Similarly, insurance companies are raising rates (mine up 22%) and banks increasing consumer interest charges, anticipating new Federal financial regulations. The uncertainty is we don't know and have no experience with the new rules.

So, my disposable income is actually shrinking and I expect my family health costs to continue to go up too, even if the health care overhaul proceeds. There is considerable pressure on consumers' disposable income and folks are still being very careful. My new kitchen counters will have to wait.

I am always impressed at the data analysis of sales my clients compile. Those numbers need to be compared to changes in Real PCE to put sales in perspective. I recommend business compare their sales figures YoY rates of change (demand proxy) with national YoY rates of change to Real PCE (cash available to spend proxy) to see if your sales are leading, coincident or lagging the national PCE trends. Pay attention to GDP numbers but don't equate GDP as demand; it is inventory.

Strategists, strategy consultants and facilitators should insist on sober analysis of consumer spending patterns before presenting their plans to the C level. These analyses should explain their customers' attitude about discretionary income. Ask them about their concerns, their need to save, are they seeing tax increases, do they expect a raise in 2010, are their health costs going up, can they borrow? Get a sense of how the Great Recession is changing their spending habits!

To broaden your perspective, read Joseph H. Ellis' Ahead of the Curve, A Common Sense Guide to Forecasting Business and Market Cycles. In his January 5th update on his website, he observed that this recovery is following the 1974 pattern and suggests we need to see at least 2.0% YoY rate of increase in Real PCE to spur industrial spending and then create jobs.