The 5 Hour Energy Economy

If you watch TV or shop at a convenience store, you have certainly seen 5 Hour Energy drinks. This two ounce shot promises to give you a quick, and temporary, energy boost with no side effects. It’s like a sugar high, without the sugar. This energy shot has become so popular the founder, Manoj Bhargava, was recently added to the Forbes World’s Billionaire List. It appears that we like our sugar highs. Unfortunately, our economy might need another one soon.

At the end of September the Economic Cycle Research Institute (ECRI) made a very lonely call. They predicted the US economy was tipping into a new recession. We highlighted this lonely call at the end of last year and the beginning of this year.

After last week where 18 of the 21 economic indicators released were weaker than expected, their call looks more right than wrong. What’s especially concerning about their call is that they have accurately called the last three recessions without any false alarms in between.

The most troubling things about last week’s economic data were the downward revisions to the GDP and employment numbers. The Bureau of Economic Analysis revised the first quarter GDP from 2.2% to a paltry 1.9%. Followed by the employment report from the Bureau of Labor where we only grew jobs by 69,000 in May and April was revised down from 155,000 to just 77,000.

With that said, it’s important to remember that 70% of our GDP is based on consumption. This consumption is driven by income, and we saw Gross Domestic Income (GDI) grow by 2.7% last quarter, up from 2.6% in the prior quarter. For those who don’t remember what GDI is, it’s just another way to measure economic activity. In theory, GDP and GDI should be equal. Money spent (GDP) by one person (or company), is income (GDI) for another person (or company). However, in practice they differ wildly because they are calculated with different inputs.¹

Last week we highlighted the consumer’s ability and willingness to consume, despite weak income growth. We can spend our income, our savings and our credit (specifically, revolving credit primarily used for short term financing).

Recently, Real Personal Income growth has slowed.

However, in the absence of income growth the US consumer has been willing to spend down their savings over the last several months, possibly due to growing confidence in the stability of their income.

It appears the consumer is also done deleveraging for the time being, and feels confident enough to spend borrowed money.

A couple of other mitigating factors before we all pull our money out of the market and stuff it into our mattresses:

• Based on data from Bloomberg markets are already down approximately 10% from their April highs. Once again, the efficiency of large numbers suggests our markets were forecasting a slowdown and not simply a 3-5% routine correction after a strong rally.
• Further, we believe that Ben Bernanke will do everything he can to prevent a deflationary scenario. So far the Federal Reserve’s liquidity programs (QE1, QE2, and Operation Twist) have led to significant market rallies.