If you've been to the gas station as of late, which we know you have, you're clearly aware that gasoline prices are up noticeably. In fact for those of us in Northern California in quite close physical proximity to actual refineries; ironically prices are meaningfully ahead of the national average! Is it déjà vu all over again, thinking back to how this same set of circumstances occurred in early 2011? What's going on here? Is oil demand up dramatically across the globe?
In the last few months we've been writing about what we believe to be the two key drivers of the current financial market and economic cycle - central bank monetary expansion (think money printing) and the short term rate of change in business input costs (inflation). Francois Trahan has been spot on in his theme that the economy short term is being directionally driven by near term changes in inflation that have in effect become the new Fed Funds rate. From our viewpoint, we'd suggest it's also very important to acknowledge and factor into decision making the fact that the Fed and their global central banking brethren are impacting these short term business input costs with their money printing experiments, so there is a bit of circularity to the interplay between these key economic and financial market drivers of the current cycle.
Back to gasoline prices. Although central bankers will deny they "see" any inflationary impacts resulting from their monetary escapades of the moment, we do not need a 26 year old PHD high frequency trading algorithmic programmer to show us the light, if you will. All we need to do is look at the history of the Commodity Research Bureau Index and actual gasoline prices themselves since 2009, overlaying the periods in which the Fed and other global central bankers have been printing money. Simple enough? We think so.
Doesn't this historical rhythm really speak for itself? Point blank, when global central bankers create new money, that money needs to find a home. Without labored explanation and documentation, it's a fact that at least some of that new money finds a home in commodity investment, necessarily driving prices higher for a time. But in terms of ironic circularity, higher commodity prices ultimately sow the seeds of the next macro economic slowdown. So far, we've been repeating exactly this circular rhythm since 2009. Have we found ourselves living in the Bill Murray movie, "Groundhog Day"?
Wall Street discussion over energy prices has received a ton of airplay in recent weeks and we do not want to regurgitate the obvious. What we hope is much more meaningful is to look at the actual historical data point interplay between gasoline prices and both small business and consumer confidence over the current cycle. Is there anything we can learn and apply to the current year and new round of central bank sponsored monetary largesse? We want to focus first on small business optimism as importantly small businesses are the jobs creators in the US . Secondly, the consumer confidence numbers correlate very highly with actual personal consumption expenditures in the US . What has happened to small business and consumer confidence when gasoline prices have risen in the past? Is there a "tipping point" at which gasoline prices impact small business and consumer decision making? Important questions now that general perceptions are that the economy is improving.
The top clip of the next chart is the NFIB small business optimism index, the bottom clip retail gasoline prices. Small business optimism in the current economic cycle peaked in early 2011. As retail gasoline prices hit and ultimately exceeded $3.50 in early 2011, NFIB optimism dropped in each and every subsequent month for half a year. And when did small business optimism bottom? As retail gasoline prices first dropped back below $3.50. Is this some type of tipping point for retail gas prices in terms of how they actually or perceptually influence business decision-making? As we now cross back up through $3.50 per gallon, it will be very important to watch how small businesses respond in the months ahead. IF this is truly the beginning of some type of economic cycle acceleration, small business optimism will not even flinch and continue to move higher. But as is seen in the recent month, optimism was basically flat after rising for four months. And the flatness comes with gas prices at $3.50.
Just some type of coincidence? Maybe not.
Let's shift from business perceptions to the consumer viewpoint. The Conference Board Consumer Confidence headline composite is derived from two subcomponents that are the present conditions and future expectations data points. The future expectations component of the consumer confidence numbers has been very highly correlated with real personal consumption expenditures (PCE) over time. Important in that real PCE accounts for over 70% of US GDP. The top portion of the chart below displays this very important directional correlation.
Very quickly, the bottom clip of the chart shows us that the periods of a trend rise in future confidence expectations numbers throughout this current cycle have come only when the Fed's quantitative easing (money printing) actions have been occurring. Interestingly, we may be now making a lower high in the expectations numbers, suggesting the public is becoming perceptually numb to central bank money printing as the prior two rounds of QE watched higher highs form in the confidence data. But again, what is most important right now is the relationship of the trend in personal consumption (consumer sending) to the confidence expectations numbers. To the heart of the matter, gasoline is one component of a broader package of consumption. Academically in an income growth deprived world, higher gasoline prices will displace another form of consumption. So what about the history of the consumer confidence expectations numbers relative to actual gasoline prices? What are the lessons of the current cycle so far?
Once more the $3.50 level for gasoline sure appears at least perceptually important to consumers. In the very month we crossed $3.50 in retail gas prices to the upside in early 2011, confidence expectations numbers started an eight-month decline. In like manner, once gas prices dropped back below $3.50 in October of last year, consumer confidence bottomed and went straight up. It appears fair to say that in 2011 $3.50 gasoline was a very important perceptual demarcation line for both small business and consumer confidence. Again, what this may portend for personal consumption and small business hiring and capital spending ahead is the important issue. So rather than "speculating" about the impact of oil prices on the economy, this gets a bit more quantitatively granular and specific to what we hope are key data points to monitor directly ahead.
We're not suggesting that a $3.50 national gasoline price is some type of magic number that will immediately impact economic outcomes beginning tomorrow. But what Iwedo believe is important is acknowledging that a $3.50 and above retail gas price has importantly already acted to change small business and consumer perceptions and actual confidence readings only one short year ago, ultimately leading to a slowdown in the entire economy. Will it be so again? That's the question of the moment. It's how changing perceptions impact actual forward consumer and small business decision making that will be the key to real world 2012 outcomes.
Although a number of economic stats have been coming in "better than expected" over the last three to four months, we need to remember that on a year over year rate of change basis, average hourly earnings rest at a multi-decade low. Consumers are not enjoying wage growth in helping to offset higher costs at the pump. Additionally, looking at the recent GDP numbers, stripping out inventory accumulation and the drop in the deflator for 4Q we see that real final sales ( US domestic aggregate demand) grew less than 1%. A year ago that number was 4%. We've already headed into 2012 with slowing domestic consumer demand. And what happens now that gasoline prices have risen? As a final point of perspective, regardless of how near term central bank money printing follies impact commodity prices, oil is heading directly into its strongest seasonal calendar period for price strength.
We need to keep a very sharp eye on small business and consumer confidence directly ahead. Relative to our experience with energy prices and the economy in 2011, is it déjà vu all over again? Is it groundhog day?