Oct 28th
Those like me who are suckers for good graphics are the reason graphic artists and web designers can find jobs in the most unlikely places. Courtesy of Mint.com online personal finance software is a infographic showing Americans’ responses to a series of questions about the recession.
HAT TIP: Ritholtz.com
The data released since the August edition of the Harmonic Notes e-newsletter suggests that, like a patient recovering from an illness who suffers an alarming relapse, the global economy seems to have regained its path towards gradual recovery — at least for the moment. Unlike last month, when the data was across-the-board sour, some data series have recently stabilized or risen.
- Home sales were abysmal after the expiration of the homebuyers’ tax credit, consumer credit continued to decline (although this is a necessary evil and a therefore a mixed blessing) and of course unemployment remains sickeningly high.
+ Retail sales, however, came in stronger than expected, as did other measures of consumer spending. Also, the Consumer Price Index rebounded to show marginally positive month-over-month growth (not that we’re rooting for inflation, but it’s better than outright deflation.) Finally, although private payrolls were uninspiring (the US economy needs about +120K new jobs each month to keep up with population growth, so +67K isn’t up to snuff) the figure improved from July and was better than expected, and the Average Hourly Earnings rose a solid +0.3%.
- Business productivity turned negative as costs rose during 2Q10, and the ISM Service Index fell again (although it remains marginally in expansionary territory).
+ Industrial Production and Capacity Utilization were reported better than expected, though CapU remains at a very low level. Business inventories also grew. Importantly, the ISM Manufacturing Index unexpectedly rose well into expansionary territory.
+ Exports rose and imports fell as the July trade gap narrowed significantly, reversing June’s drop.
- Second quarter GDP growth was revised further down, to 1.6%.
+ The Chicago Fed National Economic Activity Index rebounded to neutral. One of our favorite leading indicators, the ECRI Weekly Leading Indicator, has trended sideways for the last 2 months; after a precipitous decline it hasn’t deteriorated further, so we’ll consider that a positive.
FISCAL POLICY
Tax policy is an issue that has the potential to push the economy one way or the other. We’re not hard-core anti-tax advocates, but it seems obvious that an economy experiencing such a fragile recovery will have a difficult time bearing the weight of higher taxes. We’re pleased, therefore, to see some dialogue about extending the lower capital gains and dividend tax rates passed during the previous administration. Doing so isn’t a panacea to the US economic problems but a 1-2 year extension might keep a little more cash in consumers’ and businesses’ pockets that they could use toward helping the economy recover.
We’re in wait-and-see mode on the recently proposed additional stimulus measures, like road and rail infrastructure spending, extension of research tax credits and a 100% write-off of business investments. Our constant refrain may sound like a broken record, but job creation is the key to driving the economy forward: To the extent these measures create jobs we’re in favor. However, it should be noted that the proposed infrastructure bill is only $50 billion, a drop in the bucket compared to the size of the US economy, and any legislation faces (1) an extremely contentious election season until early November, when political points are worth more than solutions, and (2) a lame duck Congress from November through early January.
NO DOUBLE-DIPPING
The more positive tone of the recently released data buttresses our assertion that a double-dip recession seems unlikely. Very importantly, the consumer has for the moment risen to the occasion by heading back to retail stores after an early summer pause, and the small (12% of GDP) but crucial manufacturing sector continues to expand. Though significant headwinds remain – surveys of truckers, retailers and homebuilders have recently weakened, and a recent CFO survey showed a sharp decline in optimism, so second half economic growth won’t be stellar – our view on the currently available data is that growth won’t be negative.
Risk remains clearly skewed to the downside, however. It may be that, like an aircraft taking off, a certain amount of velocity is required for an economy to “get lift” without stalling. That supposed level is about 2% according to ISI Group, so we need to see more growth than the revised 1.6% 2Q10 figure.
Quarter-over-quarter GDP growth, 3Q05 – 2Q10
BLESSED ARE THE WEAK…
Recent further weakening in the US Dollar helps, since it makes US exports more attractive abroad. As the alarms predicting an imminent collapse of Eurozone have faded, the Euro has strengthened against the US$. The German economy has been an unexpected bright spot. The Yen has also strengthened against the US$, recently hitting a 15-year high.
CASH IS KING
It’s well known that corporations are holding a substantial amount of cash on their balance sheets. Interpretation of this fact is in the eye of the beholder: For those with a negative outlook, the roughly $2 trillion in liquid assets held by nonfinancial firms is seen as companies creating their own “insurance policy”, rational behavior in a highly uncertain (or deflationary) economic environment. According to ISI Group companies also about $1 trillion in unrepatriated foreign earnings of US firms. For those with a more sanguine outlook, those balances are potential fuel for a market rally.
“FEELING” BETTER (SORT OF)
Obvious to even the unseasoned observer (although not to the economists that have been blinded to reality by theory) is that sentiment plays an enormous role in the workings of economies and markets. While consumers and businesses apparently “feel” a little better than they did when we wrote last month’s newsletter, they remain very uncertain about the long-term prognosis.
Aug 13th
The economic world seems to have spun a bit off its axis since the last Harmonic Notes e-newsletter was distributed two months ago. Virtually all of the measures we consider when evaluating the outlook for the US and global economy have seen their growth slowed, or outright fallen, over the past few months.
It seems to us that the rebound seen in the US economy earlier this year and in late 2009 was unfortunately based, as we feared, on little more than restocking of too-low inventories and a brief surge in consumer spending. As we’ve consistently argued, the path to improving the debt-deflation driven is through private sector job creation that has yet to meaningfully appear. Whether the US’s political and economic leadership is capable of understanding and executing on this (to us, rather obvious) point is a fair subject for vigorous debate; however, it’s clear that end demand will remain weak so long as employment is uncertain and both of those things will probably last longer than most expect.
US Unemployment Rate
For those “keeping score at home” here’s a brief rundown, courtesy of ISI Group, of the reasons the world economy has slowed:
An interesting albeit frustrating feature of this downturn, and one that fools casual observers into believing the economy’s closer to “all’s well” than “batten down the hatches”, is that the economy is now more than ever one of “haves” versus “have-nots.” Large companies, which are predominantly those represented in the government economic data, are faring much better than their smaller brethren; lending statistics suggest that bank lending is substantially freer to large firms than small. Similarly, large banks seem to be doing much better than their community bank competitors. Another dichotomy is between businesses, which have as a group solidified their balance sheets by hoarding cash and reducing debt (and of course paring human capital) and consumers, a far larger segment of the economy that that has only just begun the balance sheet mending process.
National Federal of Independent Business Confidence Index
For all of our scoffing at the idea of a “V-shaped” recovery, in the ongoing debate over whether US economic growth is simply slowing marginally or will experience a “double-dip” recession we come down on the side of the former. It’s clear growth has slowed dramatically but our research suggests that the nation’s economy won’t relapse into negative growth.
We continue to repeat our steady refrain of the past 21 months, however: The developed economies’ malaise is a debt-reduction, balance sheet driven downturn that’s likely to linger for years, not the run-of-the-mill inventory / employment based correction typical of the post WW2 period.
Jul 19th
The Economist recently published an outstanding series of articles on the financial tool that “got us in this fine mess” — too much debt. The articles discuss the Western attraction to debt financing, especially over the past 25 years; and the Economist’s editors’ view on the changes (policy and otherwise) that are required to extract ourselves from the quagmire. The Leader article is here; other articles in the series are here, here, here, here, and here.
The online version provides an interactive chart showing debt burden by country.
Our thesis is that strong, sustainable economic growth is very unlikely so long as the US consumer is unwinding the debt load racked up since the 80s. The consumer spending that would fuel this growth is, in turn, unlikely with stubbornly high unemployment. The recent and expected sharp growth in governmental debt is a special case, of course, because with it could come the specter of inflation and much higher interest rates. As consumer debt is paid down or defaulted on, and sovereign debt rises, from our point of view there’s a very narrow path between the deflation frying pan and the inflation fire.
Jun 01th
Who’d have thought that, until recently, anyone other than economists at the European Union, International Monetary Fund, European Central Bank would care a whit about the fiscal status of Greece, Italy, Ireland, Portugal, Spain and other small European countries? US investors have learned more about those nations than they perhaps ever cared to, especially the ability of small nations to unwittingly create dramatic turmoil in the financial markets. Since we at Harmonic have been focused, like most others, on the explosion onto the world stage of sovereign risk among Euro-zone countries, the never-ending flow of US economic data has been pushed to the back burner. It appears upon examining recently released data, however, that the US economy may have slipped into what research firm International Strategy & Investment (ISI) refers to as a “soft patch.”
The strength of the economic rebound from the painful 2008-2009 recession was surprising to many observers (yours truly included) ; whether that rebound is sustainable remains a legitimate subject for debate. The manufacturing-led and stimulus-fueled rebound appears to have stalled recently:
The downturn of the growth rate and level of the WLI are of particular concern to me; I’ve noted in earlier posts that the WLI has historically been a solid predictor of US economic activity.
Those concerns noted, the balance of economic data released in the past couple of weeks has been positive. Of particular interest were:
The so-called “soft patch” is a reminder that the US and world economies are far from out of the woods; while such pauses in economic recovery are probably to be expected, the exceptionally high unemployment rate, skyrocketing fiscal deficits, number and magnitude of economic problems confronting the US and other world economies continues to suggest a longer and rockier road to stability than in other post-war recoveries.
The final week of April gave us an uninspiring (and dated) reading on housing prices, the latest snapshot of consumer sentiment, and two readings on the overall state of the US economy – one reviewing 1Q10 and the other looking at March conditions. There were few surprises in the week’s data, which showed a slowly improving economy and initial signs that while they are clearly skeptical, the American consumer may prove more resilient than expected.
|
RELEASE (leading, coincident or lagging indicator) |
PERIOD |
ACTUAL |
EXPECTED (consensus) | LAST |
HIA COMMENT |
|
Case-Shiller 20-city Home Price Index (lagging) |
February |
144.03 |
144.80 |
145.32 |
On a seasonally adjusted basis home prices fell -0.1% month-over-month but rose +0.6% year-over-year. On an unadjusted basis, prices fell -0.9% MoM. |
|
Chicago Fed National Activity Index (coincident) |
March |
-0.18 |
N/A |
-0.31 |
March’s level rose slightly from February and remained above the important -0.70 level. |
|
GDP (lagging) |
1Q10 advance |
+3.2% |
+3.3% |
+5.6% |
The initial look at first quarter economic growth moderated from 4Q09 anticipated, but consumer spending was stronger than expected. |
|
Univ of Michigan Consumer Sentiment (leading) |
April |
72.2 |
71.0 |
73.6 |
American consumers’ opinion of their circumstances fell from its March reading. |
S&P / CASE-SHILLER HOME PRICE INDEX
While the overall level of home prices appears to be slowly improving, this report suggests that the housing rebound that appeared last fall has faded. Only one of the 20 cities saw a month-over-month price increase, and 6 cities reported new lows in prices. However, 9 cities saw year-over-year price improvement. Prices stand at their autumn 2003 levels and are down -30.3% from their summer 2006 peak.
As with other lagging indicators, this data is a bit stale and projections made from it may be suspect.
CHICAGO FED NATIONAL ACTIVITY INDEX
The CFNAI is a weighted average of 85 indicators of national economic activity. The indicators that comprise the Index are drawn from four broad categories:
As a reminder regarding this useful but little-known Index, when the 3-month moving average value moves below -0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the 3-month moving average value moves above -0.70 following a recession, there is an increasing likelihood the economic contraction has ended. When the 3-month average moves above +0.70 more than 2 years into an economic expansion there is an increasing likelihood that a period of sustained inflation has begun.
March’s 3-month moving average rose slightly from February and remained above the important -0.70 level, suggesting that economic activity is muted but continues to improve. According to the CFNAI inflation should not be a significant problem over the coming year.
We note, however, that the “consumption and housing” component of the index remains negative.
GRAPH: Chicago Fed
“ADVANCE” GDP
This release is a first look into the first quarter of 2010, which fell slightly short of consensus expectations. The “advance” report will be revised over the next two months as additional data becomes available. The positive surprise in the report was the better-than-expected showing from the consumer; business investment, exports and “nonresidential fixed investment” also made positive contributions. The slowing from 4Q09 was driven by decelerations in inventory replenishment, exports and housing investment, all which have been signaled by data released earlier.
It appears as though the inventory restocking that drove GDP growth in 4Q09 has subsided and the strengthening US Dollar has taken the wind out of the sails of exporters. The question that has plagued economic observers since the beginning of this recession remains: Can the US consumer – with an unemployment rate near 10%, wage growth nonexistent and housing flat at best – drive the economy forward without creating another debt bubble?
The contributions to growth looked like this:
| SEGMENT | CONTRIBUTION |
| Consumer spending | +2.55% |
| Gross private domestic investment | +1.67% |
| Net exports | -0.61% |
| Government spending and investment | -0.37% |
| TOTAL PERCENT CHANGE AT ANNUAL RATE | +3.24% |
GRAPH: Bureau of Economic Analysis
CONSUMER SENTIMENT
Consumers may be losing faith in the signals of economic improvement; the U of M Consumer Sentiment Index continued its recent slide, dipping from 73.6 in March to 72.2. The measure of current conditions, which reflects Americans’ perceptions of their own finances and whether it is a good time to buy big ticket items such as cars and homes, declined further from its cycle high in February to 81.0. The index of expectations six months from now, which more closely projects the direction of consumer spending, also worsened again, from 67.9 to 66.5.
As we’ve noted elsewhere, economic improvement is clearly centered in manufacturing, not in housing and employment, two areas much closer to consumers.
Apr 02th
As even a casual observer would recognize, there are hundreds of pieces of economic data available from various departments within the Federal government and private research firms. There’s also lots of anecdotal information, too. Unfortunately, as a relatively young (17 month anniversary is tomorrow, 3 April!) investment and research firm we don’t have time or the patience to try to analyze and write about what we find interesting, much less every thing that’s available. It’s clear, though, that some data are more important than others, because:
With the able assistance of intern Vu Ngo, a senior majoring in finance at Boise State University, we’ve “separated the economic wheat from the chaff” by creating a list of about 15 indicators on which our research will focus.
We segmented our list by the component of the economy about which it informs us. The list looks like this:
CONSUMER
BUSINESS
FOREIGN TRADE
OVERALL MACROECONOMIC ACTIVITY
Of course we’ll keep our finger on the pulse of other data, and this list may change if items lose their efficacy. We think, however, it strikes a good balance between data overload and having too narrow a focus.
The week ending 26 March saw indicators that provided incremental information on housing, the manufacturing sector, the American consumer’s mindset and the overall economy. The data confirms our thesis that economic growth will continue to be lead by the industrial sector rather than households. We note also that the 4Q09 inventory- and stimulus-driven growth spurt appears to be waning, suggesting a significantly lower 1Q10 GDP print.
|
RELEASE (leading, coincident or lagging indicator) |
PERIOD | ACTUAL | EXPECTED (consensus) | LAST |
HIA COMMENT |
|
Chicago Fed National Activity Index 3-month moving average (coincident) |
February | -0.39 | NA | -0.13 |
Three of the four broad categories of indicators that make up the index deteriorated, with only the sales, orders and inventories making a positive contribution. |
|
Durable Goods Orders (leading) |
February | +0.5% | +1.0% | +3.0% |
Orders excluding transportation rose +0.9% month-over-month. |
|
New Home Sales (leading) |
February | 308K | 315K | 309K |
New home sales plummeted for a fourth month, down -2.2% MoM. |
|
Existing Home Sales (leading) |
February | 5.02M | 5.00M | 5.05M |
Sales slipped again, dropping -0.6%. |
|
GDP (lagging) |
4Q09 final | +5.6% | +5.9% | +5.9% |
The final look at 4Q09 economic growth shaved the rate from earlier reports. Still, the pace of economic growth was the fastest in more than 6 years. |
|
Univ of Michigan Consumer Sentiment (leading) |
March | 73.6 | 73.0 | 73.6 |
American consumers’ opinion held steady in March. |
CHICAGO FED NATIONAL ACTIVITY INDEX
As discussed in last week’s Economic Insight, the CFNAI will replace the Conference Board’s Index of Leading Economic Indicators in our analyses.
The indicators that comprise the Index are drawn from four broad categories:
A zero value for the index indicates the national economy is expanding at its historical trend rate of growth; negative values and positive values indicate below- and above-average growth, respectively.
Month-to-month movements can be volatile, so the Index’s 3-month moving average is used to show a more consistent picture of national economic growth.
When the 3-month moving average value moves below -0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the 3-month moving average value moves above -0.70 following a recession, there is an increasing likelihood the economic contraction has ended. When the 3-month average moves above +0.70 more than 2 years into an economic expansion there is an increasing likelihood that a period of sustained inflation has begun.
February’s 3-month moving average decreased slightly from January but was higher than at any point since December 2007. The negative reading suggests US economic growth is below its historical trend and that there is low inflationary pressure.
DURABLE GOODS ORDERS
While the overall orders figures fell short of consensus expectations, the important manufacturing sector once again showed solid growth. Month-over-month growth in new orders was seen in 4 of 8 major industry groups surveyed, including machinery (+4.7% and fabricated metal products (+1.9%). Weakness was centered in electronic equipment (-3.3%) and transportation equipment (-0.7%).
January’s durable goods inventory figure was revised upward to show +0.1% month-over-month growth, making February’s +0.3% figure the second consecutive month of inventory growth. Perhaps US manufacturers have finally seen the bottom of the inventory cycle that’s been long expected.
Durable goods orders (red) and consensus expectation (green), Jan 2000 – Feb 2010
EXISTING AND NEW HOME SALES
According to the National Association of Realtors, sales of existing homes dropped once again in February, following the combined 23% decline in December and January. As noted in earlier commentary the initial wave of first-time homebuyers crested in November but the second (assuming there is one) has not yet fully taken hold. Without sharply higher interest rates or other negative factor intervening, we’ll likely see another surge of first-time buyers in March and April.
The housing market continues to be supported through the Federal Reserve’s purchase of mortgage-backed securities, a key mechanism for providing liquidity to lenders and keeping mortgage interest rates down. Those purchases, however, expand the Fed’s balance sheet and exacerbate longer-term inflationary concerns. This program, like many of the other extraordinary liquidity programs in which the government has engaged, is slated to end on March 31, 2010; it’s an easy bet that rates will likely rise if purchases are ceased.
The NAR report also showed that the reported estimate of existing homes for sale rose for the third consecutive month, by +9.5% to 8.6 months of inventory. Also, the median home prices were essentially flat at $165,100 while the average price fell to $210,500. Lower prices are a logical outcome of lower demand and increased supply. It must also be kept in mind that the reported figures ignore the massive overhang of foreclosed and delinquent properties that have yet to be officially put on the market. According to one researcher, the actual supply is around 2 years’ worth, a far stronger headwind for the economy to lean against.
The decline was not adversely affected by the weather, as the Northeast and Midwest rose but South and West decreased.
As with existing home sales, the drop in new home sales can in part be attributed to a lull in purchases via the first-time homebuyer tax credit. Also like the existing home sales release, supply was reported to have risen, in this case from 8.9 to 9.2 months. Unlike the report on existing homes, though, the median and average homes sales prices rose 6% to $220,500 and 5% to $282,600 respectively.
New (white) and existing (red) home sales, February 2005 – February 2010
“FINAL” GDP
This release is the third and final look into the final quarter of 2009, which once again beat the consensus expectations. The “final” report is based on more complete data than was available at the time of the “preliminary” estimate last month or January’s “advance” estimate. The report confirmed that fourth quarter growth was dominated by an enormous inventory adjustment. The downward revision from the “preliminary” report a month ago was cause by adjustments to spending on inventories, consumer spending and “nonresidential fixed investment.”
For 2009, this report puts full-year economic growth at -2.4%.
Accounting for the additional data released in the “final” report the contributions to growth looked like this:
|
SEGMENT |
CONTRIBUTION |
|
Consumer spending |
+1.16% |
|
Gross private domestic investment |
+4.39% |
|
Net exports |
+0.27% |
|
Government spending and investment |
-0.26% |
|
TOTAL PERCENT CHANGE AT ANNUAL RATE |
+5.56% |
The problem with inventory restocking-driven growth, of course, is that it’s temporary – once the proverbial shelves are full manufacturers will return to lower production levels. In order to create a self-sustained economic growth we need to see demand from domestic consumers and businesses and/or foreign ones. As regular readers know, the downward pressure on demand is why we continue to focus so much of our work on understanding the unemployment trends.
CONSUMER SENTIMENT
The U of M Consumer Sentiment Index held steady at 73.6 for March. The measure of current conditions, which reflects Americans’ perceptions of their own finances and whether it is a good time to buy big ticket items such as cars and homes, rose to 82.4 in March, the highest reading of this cycle. Ominously, however, the index of expectations six months from now, which more closely projects the direction of consumer spending, again worsened, declining to 67.9 from 68.4 a month earlier.
As we’ve noted elsewhere, economic improvement appears to be centered in manufacturing, not in housing and employment, two areas much closer to consumers.
Mar 26th
Courtesy of The Economist
Pepsi gets a makeover
Mar 25th 2010 | NEW YORK | From The Economist print edition
COCA-COLA once famously defined its market as “throat share”, meaning its stake in the entire liquid intake of all humanity. Not to be outdone, Indra Nooyi, the boss of Coke’s arch-rival, PepsiCo, wants her firm to be “seen as one of the defining companies of the first half of the 21st century”, a “model of how to conduct business in the modern world.” More specifically, she argues that Pepsi, which makes crisps (potato chips) and other fatty, salty snacks as well as sugary drinks, should be part of the solution, not the cause, of “one of the world’s biggest public-health challenges, a challenge fundamentally linked to our industry: obesity.”
To that end, on March 22nd she unveiled a series of targets to improve the healthiness of Pepsi’s wares. By 2015 the firm aims to reduce the salt in some of its biggest brands by 25%; by 2020, it hopes to reduce the amount of added sugar in its drinks by 25% and the amount of saturated fat in certain snacks by 15%. Pepsi also recently announced that it would be removing all its sugary drinks from schools around the world by 2012.
Although Ms Nooyi talks about the need to “cherish” employees, and once wrote to the parents of her senior managers thanking them for bringing up such wonderful offspring, she rejects the notion that these goals are soft-headed or decorative. She argues that they are necessary to prevent food companies from going the way of tobacco firms, which are perennially held responsible by governments for the health problems associated with their products, and penalised accordingly. As it is, several countries in Europe and various localities in America have banned trans fats, a particularly unhealthy ingredient in much junk food. A bill introduced earlier this month in New York’s state assembly proposes banning salt in restaurants. Michelle Obama, America’s first lady, has launched a campaign against obesity among children.
In the 1990s virtually all of Pepsi’s products were bad for you—or “fun for you”, as the firm likes to put it. Under Ms Nooyi, who became boss in 2006, it has stepped up its diversification into products it calls “better for you” and “good for you”, including fruit juices, nuts and porridge (oatmeal, to Americans). Ms Nooyi does not see this as a case of trading profits for virtue. Instead, she insists both are possible—an idea expressed in the firm’s syrupy motto: “Performance with purpose.”
There is no shortage of sceptics, both about the sincerity of Pepsi’s social mission and, more recently, its performance, which was decidedly flat in 2009. Indeed, this week, at the firm’s first meeting with investment analysts since 2006, in New York’s Yankee Stadium, Ms Nooyi admitted to a series of disappointments, before promising that lessons had been learned and that “we won’t make the same mistakes.” As well as being hurt by the economic downturn, Pepsi suffered from a flawed financial hedging strategy that left it paying too much for commodities. And it has suffered from some recent marketing disasters, including a campaign for Tropicana fruit juice that is widely regarded as one of the worst brand makeovers since Coca-Cola launched New Coke.
Yet investors seem to be taking seriously Ms Nooyi’s claim that Pepsi’s future is bright. It helps that the firm has raised its dividend and announced a big share buyback. Investors also seem to be reappraising Pepsi’s decision last year to acquire the two independent firms that bottle its drinks. The deal had received a tepid reception, not least because Coca-Cola had insisted that keeping syrup-making and bottling separate made sense. Now, however, Coca-Cola has decided to follow Pepsi’s lead by acquiring its main bottler—a move Ms Nooyi describes as “vindication”.
The hope is that integrating the bottling company into Pepsi will bring greater control over an increasingly diverse drinks portfolio, and promote cross-marketing between the food and drink divisions (not something that Coca-Cola’s acquisition will help with much, as it does not own a large snack operation). Pepsi, which jointly markets several different brands, dubs the clout this gives it with retailers and customers “Power of One”. The bottling acquisition should boost this tactic by ending the need to negotiate a division of the spoils on every big deal. When Wal-Mart calls asking for a joint promotion of, say, Pepsi and Doritos, as it did for the Super Bowl in February, Pepsi can “respond in 24 hours, instead of six weeks.”
Ms Nooyi wants to take this idea further, with a strategy she snappily dubs “Power of Power of One”. By that she means partnerships with other firms to cut the cost of procurement, or research and development. Pepsi has already signed a supplies and ad-purchasing deal with Anheuser-Busch, a big brewer.
In the long run, much will depend on the success of Pepsi’s strategy to convince the public and regulators that it is on the side of reducing obesity, not creating it. This strategy will have several prongs, including reducing the amount of obviously unhealthy ingredients in its existing products, adding new healthier products to its portfolio, promoting healthier lifestyles and trying to point the finger of blame away from how many calories people consume to how few calories they burn. “Why aren’t we going after computer and cable-TV companies for creating a sedentary lifestyle?” asks Ms Nooyi.
Pepsi’s growing portfolio of “good for you” products now accounts for around $10 billion in revenues (nearly a fifth of the total). Ms Nooyi expects that figure to grow to $30 billion within ten years. The firm has been hiring an army of experts on health to work in its research and development business, to give credibility to its claim that it is applying science to creating products that are better for its customers. Mahmood Khan, a British-born doctor recruited to run Pepsi’s R&D at the start of 2008, says he has been “pleasantly surprised by how rapidly this new health agenda has been embraced.”
Pepsi already claims to be making significant progress in making its “fun-for-you products better for you” by voluntarily removing trans fats long before it was required to do so, and reducing the amount of sugar, fat and salt. There is now less salt in a packet of crisps, claims Dr Khan, than in a slice of white bread.
Quaker, which makes porridge, cereal, cereal bars and rice crackers, is Pepsi’s leading healthy brand. Pepsi hopes to use its expertise in product design and packaging to make these goods more enticing, especially to children at breakfast time. It is already testing oatmeal drinks and biscuits, as well as new flavours of porridge. Quaker Oats packaging will also get a more contemporary look, although the black-hatted Quaker mascot will survive. “Our goal”, says Ms Nooyi, in typically forthright style, “is to rewrite the rules of breakfast.”
There is no doubting the seriousness of Ms Nooyi’s drive to increase Pepsi’s sales of healthy products. But it will not be easy to push them without undermining sales of its other, less wholesome wares or appearing to nanny its customers. Moreover, politicians and public-health campaigners may not regard selling more healthy products, while continuing to profit handsomely from unhealthy ones, as the best way to tackle obesity.
Mar 18th
Economic Insight: Harmonic Notes e-Newsletter, March 2011
Author: Kenn Lamson
Comments: 0
On balance it could be said that we’ve seen a continuation of improving but uneven growth in the US economy since our last Harmonic Notes e-newsletter in mid-January, with one rather large wrinkle: Inflation concerns are back in the headlines.
DATA OVERVIEW
- The major negative factor facing consumers remains, of course, stubbornly high un- and underemployment levels. True, the headline unemployment rate fell to 8.9% in February but recent declines have come in part because the “participation rate” fell. Also, while home sales have recently been mixed, with sales of new homes flat but sales of existing homes rebounding, home prices as measured by the Case-Shiller Home Price Index resumed their decline. A recent reading of consumer sentiment came in sharply lower than expected, presumably a reaction to the recent surge in fuel prices.
+ The broadest measure of un- and underemployment fell to 15.9% in February, its third consecutive monthly decline. Despite the still-elevated monthly unemployment rate, weekly unemployment claims have recently fallen below the critical 400K level, suggesting a downward bias to the rate in coming months. Probably influenced by this gradual improvement, retail sales and other measures of consumer spending rose (although the latest readings were taken prior to the recent spike in oil product price spikes). Also, February’s Consumer Price Index showed a moderate +1.4% YoY increase; concerning, however, was the index’s +0.4% month-over-month spike. More on the CPI and other inflation measures below.
- Participation in the recovery by small businesses continues to be a sore spot; while the NFIB Small Business Optimism Index ticked up in February to a 3-year high, the index remains at very low levels. Also, January’s Industrial Production report came in lower than expected but the weakness may be short-lived because warmer than expected weather temporarily cut demand from utilities.
+ The ISM Manufacturing and Service Indices, surveys of mostly large businesses, both continued to surge higher and both remain solidly in expansionary territory.
- Imports rose more than exports in January, widening the trade gap. Import growth was driven dominantly by energy prices.
+ The +2.8% revised reading on fourth quarter GDP growth was an improvement from +2.6% in 3Q10 but a drop from the initial estimate of +3.2%. The report showed the strongest consumer spending since 4Q06 and received a huge boost from exports. Meanwhile, our favorite coincident macroeconomic indicator, the Chicago Fed National Economic Activity Index, continues to wobble around the neutral mark. And our favorite leading indicator, the ECRI Weekly Leading Indicator, has continued its gradual improvement; after a precipitous decline for about nine months beginning late 2009, it’s risen back into expansionary territory.
EMBERS OF ENCOURAGEMENT
Several anecdotal and quantitative pieces of data suggest the economic expansion is becoming self-sustaining1:
Unemployment rate (white, right scale); Average hourly earnings (orange, left scale); Average workweek (yellow, right scale) {GRAPH: BLOOMBERG}
ISM Manufacturing Index (orange) and ISM Service Index (white), 13 years ending February 2011 {GRAPH: BLOOMBERG}
Total Consumer Credit, 3/31/05 to 1/31/11 {GRAPH: BLOOMBERG}
DISTURBING DATA DEEP DIVE
Despite the overall improving data trend there remains plenty of things about which to worry; a partial list2:
Case-Shiller 20 City Home Price Index (not seasonally adjusted), January 2005 – December 2010 {GRAPH: BLOOMBERG}
{GRAPH: Bloomberg}
INFLATION
Maybe it’s biased by our information sources, but it seems like there’s been an increase in the chatter about inflation lately. We noticed an uptick last summer when Bernanke signaled the Fed’s intention to launch QE2 and it’s really caught the public’s attention since gasoline prices spiked higher. We thought it worthwhile to dedicate a portion of this newsletter to discussing what inflation is, what we’ve experienced in the past, the most recent readings and where we think we may head.
An online search for definitions of inflation will likely confuse a careful reader. Each school of economic thought offers its definition, the most well-known of which is probably Milton Friedman’s assertion that “inflation is always and everywhere a monetary phenomenon”. The difficulty of defining inflation naturally leads to disagreement over how to measure it, and thus whether the US is currently suffering from it. Rather than choosing a side, we’ll simply observe that inflation’s a widespread rise in the general price level in an economy; it’s NOT:
We’ll focus this discussion on inflation on consumer price inflation so we’ll leave aside a discussion of measures like the Producer Price Index.
The most widely known indicator of inflation is the CPI – the Consumer Price Index. The Bureau of Labor Statistics, which calculates and publishes the Index, reports the CPI with and without the impact of food and energy prices (aka the “core” CPI). It’s been said that the Fed prefers to look at the core rate since it’s a more stable reading of prices affecting consumers; that may be so, but I don’t know many people who don’t use energy or eat, so I tend to consider both.
Year-over-year change in CPI (orange), “core” CPI (yellow) and PCE deflator (white),
August 1980 to January 2011 {GRAPH: Bloomberg}
The CPI is well-known and broadly used by investors, economists and the media as a proxy for the overall level of inflation in the US economy. In fact, the US government uses the measure to adjust the value of Social Security and other transfer payments. Also, there’s a type of US Treasury bond (which will be discussed in some detail later) that has its principal value adjusted to reflect changes in CPI. However, problems with the calculation of the Index are widely known and include:
Another government-produced measure of consumer price inflation is the Personal Consumption Expenditure (PCE) deflator. It’s a broader measure than the CPI, capturing expenditures made by others on behalf of households. The PCE deflator’s composition changes from quarter to quarter, so it’s more up-to-date than the CPI. The CPI actually represents about 74% of the PCE deflator, with the balance consisting of other price indices. Because of these advantages it’s understood that the Fed prefers to watch the PCE deflator.
As one can easily observe from the graph above, the PCE, CPI and core CPI all currently are near their lows of the past 30 years. The year-over-year change in these measures was in the low single digits as of the most recent reading; at 1.1%, the core rate remains below the 1.75%-2.0% range indicated by the Fed as their target.
An interesting third, but by no means final, alternative inflation measure is one calculated by professors in MIT’s Applied Economics Group called the Billion Prices Project (BPP). The BPP conducts a daily online survey of about 5 million individual items across 70 countries that provide a nearly real-time measure of goods price inflation. Obvious weaknesses of the BPP are that it doesn’t include services and the surveys are conducted online only. However, given the breadth and depth of the survey, the BPP provides an interesting and potentially useful counterpoint to the government-collected statistics.
Each of the aforementioned price indices is retrospective and so is of limited value in estimating prospective inflation. As we build our outlook on the economy and financial markets, Harmonic reviews short-term estimates from several sources, including the Federal Reserve Bank of Philadelphia, CXO Advisory Group, and BMO Nesbitt Burns Capital Markets.
GRAPH: CXO Advisory Group LLC
The long-term inflation forecast we find most useful is one that’s derived from the financial markets themselves. We’re of the frank opinion that an investor who’s putting money behind their opinion is a more credible source than an economist who doesn’t. Treasury Inflation-protected Securities (TIPS) are a widely traded type of bond that offers a direct view into the market’s inflation forecast; subtracting the yield of a TIPS bond from a nominal (not inflation-adjusted) bond of same maturity provides an estimate of the average CPI for that upcoming period. For instance, the top panel of the graph below shows the 10-year nominal US Treasury note (orange) and corresponding TIPS yield (white); the lower panel shows the spread, equivalent to the market consensus forecast of the average CPI inflation for the next 10 years, at 2.33%.
{GRAPH: Bloomberg}
Understanding inflation is critical to gauging value in the financial markets and it has an obvious and immediate impact on the quality of life of those it touches. Wages that don’t rise enough to offset higher costs put consumers under greater pressure and may result in undesirable purchasing patterns. In its worst form, hyperinflation, consumers may be relegated to bringing large amounts of rapidly depreciating cash for their purchases.
Inflation also has a measurable impact on the level of interest rates. Since the coupon rate and principal of most bonds is fixed, the price an investor is willing to pay should change in direct negative proportion to anticipated changes in inflation; if inflation is expected to rise, the price of a fixed rate investment should decline to compensate investors for the loss of purchasing power of their securities. Since interest rates move in an opposite direction from bond prices, those price declines create rising market interest rates.
Inflation expectations affect stock prices in two ways: First, since the fair value of an investment is simply the present value of its expected cashflows, higher (lower) interest rates translate into higher (lower) discount rate and therefore lower (higher) estimated fair value. Second, from a fundamental perspective an increase in prices that can’t be passed on to consumers will be seen as pressuring companies’ margins. All other things equal, lower margins mean lower company earnings and lower stock prices.
As can be observed in the bottom panel of the graph above, next-10-year inflation expectations are within a rough “normal” zone of 1.30% to 2.65% despite recent spikes in energy and food prices and widespread concerns regarding the inflation-creating potential of monetary policies like QE2.
We believe that inflation pressures may be building. While velocity of the money supply remains quite low, suggesting that the flow-through of liquidity being pushed to the financial system by the Federal Reserve is being restrained from entering the real economy, velocity may be set to rise because, in part, consumers are no longer deleveraging.
{GRAPH: St. Louis Fed}
Current inflation levels and those short-term forecasts by market participants have risen from 2009 but on balance they appear moderate. We worry, though, that the Fed’s focus on the core rate of inflation, ignoring the affect of energy and food prices, causes the central bank to fail to see the larger picture and to maintain an easy-money policy longer than is necessary. The pressure on consumers caused by rising food and energy prices is a concern, as are rising rents. It’s worth remembering too that forecasting models don’t handle structural changes well, such as an increase in the Non-accelerating Inflation Rate of Unemployment (NAIRU) or changes driven by foreign economies, like we’ve seen with commodity demand from emerging markets.
1 SOURCES: Bureau of Labor Statistics, Cantor Fitzgerald, ISI Group, CIA World FactBook
2 SOURCES: Gluskin Sheff, Bureau of Labor Statistics, ISI Group, Global Macro Monitor, CXO Advisory Group, BMO Capital Markets, Federal Reserve, MIT Billion Prices Project,