The Consumer Sees Reasons to Spend
Thursday, 1 November 2012
As the holiday season draws near, confidence rises because of falling unemployment, an improving housing market, lower debt, and buoyant stock prices.
As goes the consumer, so goes the economy—at least in the U.S. Consumer spending has accounted for more than 70 percent of GDP since early in this recovery. As a result, any outlook must pay close attention to this massive force.
Right now, the consumer is out spending. This is particularly important in late October and early November as we go into the annual holiday buying season.
Consumers are feeling more confident for good reason. They have higher income and lower debt payments. They are less in debt, and their home values are appreciating rapidly. This should add up to a stable, if not growing, pattern of expenditure.
Even the employment numbers are bolstering consumer confidence. According to the October Bureau of Labor Statistics (BLS) report, the overall unemployment rate fell to 7.8 percent. While the size of the decline may be something of a statistical fluke—a number of factors came together unexpectedly—the direction is clear. Moreover, at 18.5 weeks, the median duration of unemployment is the lowest it has been in three years.
Although unemployment and the duration of unemployment are falling, some argue that under-employment may be skewing the data. But pointing to under-employment as a sign of poor business conditions may be misleading. It is hard to hear, but in many cases workers are unlikely to find the same kind of employment they had in the past even as business conditions improve. Their training is a mismatch for the emerging new economy. That is, a lot of the under-employment is structural, not cyclical.
It is also easy to forget that the labor market is marked by broad variations across states and regions, and many areas are enjoying better-than-average job markets. The jobless rate in North Dakota is only 3 percent. Unemployment rates in 12 other states are under 6 percent, well below the national average that has hovered around the 8 percent mark for months. There is also a lot of variation according to worker age and degree attainment. While unemployment is highest among young and lower-skilled workers, the national average rate for those over 25 years of age is 6.6 percent. For those over 25 who have a college degree, the rate is 4.1 percent.
The improvements in the labor market have created growing optimism among those who do not have jobs and a sense of greater security among those who do. It is not a surprise that the Conference Board’s Consumer Confidence Index recovered to over 70 percent in the latest month for which data is available.
Incomes, while rising, constitute a comparatively weak spot in the improving economy because of the slow growth in wages. There is too much slack remaining in most areas of the labor market. Enough people are still looking for jobs that employers don’t face much pressure to raise wages. After-tax incomes rose only 0.1 percent in the latest month, an increase more than offset by inflation.
On the positive side, after adjusting for inflation, incomes were still 1.8 percent above a year ago. At the same time, households are holding less debt and facing much lower payments on the amounts they owe. Household debt service payments have fallen to 10.7 percent of disposable income, the lowest level since 1993. This means consumers have increased buying power and are more willing to borrow to buy goods.
Fueled by this and by expanding consumer credit, real consumer spending rose by 2 percent over the same month last year, reaching an all-time high.
Rapid improvements in the housing and stock markets have further encouraged consumers by raising household wealth and buoying confidence. Housing starts continue to rise, and new-home sales were up 27.1 percent compared with the same month a year ago. The prices of existing homes rose the most since 2005, with the median price rising 11.3 percent year-to-year. Besides increasing household wealth, the rise in house prices suggests more labor mobility, allowing workers to move wherever jobs may be.
In addition, many homeowners have refinanced their mortgages at lower rates, while some have shortened the terms of their mortgages. Both make consumers feel richer and more likely to increase spending.
Securities markets continue to soar, bringing increased wealth to fuel consumer spending. The S&P 500 Index ended September more than 25 percent above August. The Dow Jones Industrial Average has more than doubled since its low point during the recession and is less than 5 percent off its all-time high.
Rising wealth and buying power translate into growing consumer demand. At 73 for the third consecutive month, AIER’s leading indicators reflect this growing strength with four of the indicators reaching new highs. Interpreting the remainder of the indicators requires a deeper look and an understanding of the role of each indicator in capturing information about the business cycle.
The negatives reflect the peculiar nature of this recovery, which follows from the peculiar nature of the recession that preceded it. This was a recession born of a real estate collapse that led to a financial crisis. The construction industry screeched to a halt. Policy initiatives designed to address these problems involved pouring money into financial institutions, which brought interest rates to abnormally low levels. All of this has an impact on business and capital formation.
We typically expect to see wholesale prices rise and deliveries slow as the expanding demand of a growing economy causes firms to approach production capacity. Firms also expand inventories in anticipation of higher future sales. We normally take all of these as positives.
That’s not what’s happening this time. More than three years into the recovery, the capacity utilization rate remains under 80 percent. Companies are taking advantage of low capital costs resulting from low interest rates, high cash holdings, and the collapse in the construction and real estate industries to build new facilities. But fearful of economic uncertainty, they have been slow to hire, expand machinery (new orders for core capital goods), and build up inventories. Extra capacity means fewer slowdowns in deliveries, fewer wholesale price increases, and less need for inventory buildups. Hence the negatives among the corresponding measures in our indicators.
As we said in our last Business-Cycle Conditions, businesses remain out of sync with growing consumer sector demand. They are responding in a rational way to real risks in the economy. This means their actions are measured. Firms will adjust as these risks are resolved. When businesses get back in sync with the increasingly confident consumer, the remaining leading indicators should turn positive.
The remaining coincident and lagging indicators only confirm our view. Employment, industrial production, output, and sales measures all continue to improve.