by Calculated Risk on 8/05/2009 12:16:00 PM

Yesterday I posted some comments from Multi-Color Corp. (makes labels mostly for consumer product companies): "While you would expect inventories to be replenished as the economy stabilizes, we have not seen a trend of increasing orders to date.”

Today, from the WSJ: P&G Sales, Profit Fall as Shoppers Opt for Cheaper Brands

P&G projected ... sales excluding acquisitions and divestitures would be flat to down 3% in the [Q3 2009]. On a conference call, company executives said results would improve sequentially after [Q3 2009].

... Sales of the higher-end, more discretionary line of Braun shavers fell sharply. But some of P&G's everyday brands also continued to see declines as consumers traded down to cheaper brands and private-label goods in grocery stores. ...

In recent years, Procter & Gamble has put more focus on higher-priced products, seeking to drive growth by getting consumers to trade up. That strategy has hurt the company during the recession as consumers cut discretionary spending in areas like beauty and traded down to cheaper pantry staples.

Some of this is classic consumer theory concerning inferior goods; as incomes fall, demand increases for generic products at the expense of more expensive brands.

However it helps to remember that there is a usual temporal order¹ for emerging from a recession.

When Recovery Typically Starts

During Recession	Lags End of Recession	Significantly Lags End of Recession
Residential Investment	Investment, Equipment & Software	Investment, non-residential Structures
PCE	Unemployment2

Housing usually leads the economy both into and out of recessions (this was true for the Great Depression too). And even though new home sales and single family housing starts may have bottomed, it seems unlikely with the the huge overhang of excess inventory and high levels of distressed sales, that residential investment will pick up significantly any time soon. Note: Residential investment is mostly new home construction and home improvements.

And that leaves Personal Consumption Expenditures (PCE), and that is why the ISM non-manufacturing numbers this morning and the P&G numbers matter. Away from auto sales, it is hard to find much evidence of a pick up in consumer demand.

I've seen some argue for a business led recovery. That is the wrong order. Sure, there will probably be some inventory replenishment since some companies probably cut back too far, but most companies already have too much capacity, so after the inventory adjustement what will happen? They will not need to expand until their sales pick up significantly.

So I still think the keys are Residential Investment (RI) and PCE, and therefore I think the recovery will be sluggish. Note that CRE and non-residential investment in structures is a lagging indicator for the economy.

¹ From a post in March, (see Business Cycle: Temporal Order for the order in and out of a recession).

² In recent recessions, unemployment significantly lagged the end of the recession. That is very likely this time too.