Half-time report on the U.S. consumer

Marie M. Schofield, CFA, Chief Economist and Senior Portfolio Manager | July 28, 2014

  • U.S. consumers have taken a more cautious attitude toward debt and been more selective about using it for discretionary purchases.
  • With consumers using credit cards less and using debit cards much more, the supports for higher discretionary spending are keyed off income and wages and also employment.
  • With low debt use and income growth holding back consumption and demand, households will require stronger job growth and real wage gains to accelerate their spending.

Households have made enormous progress in the past few years with the ongoing repair of balance sheets, grudging yet steady job gains and confidence levels that have just tipped more optimistic about both present situation and outlook. One metric that has yet to lift is consumption, which has frustrated expectations for an acceleration in consumer spending. Indeed, personal consumption expenditures have been rising at a steady but numbing (inflation adjusted) rate of about 2% annually during the entire recovery. Past recoveries have witnessed real spending gains of about 4%, excepting the recovery earlier this decade where real consumption gains slowed to 3%. A big swing factor over the last few decades was the expansion of leverage and credit, as avenues and incentives to borrow increased over the last 30 years via credit cards, home equity loans and cash-out mortgage refinancing. Lending standards also fell and credit access reached to lower income households, particularly earlier last decade. The dynamic reached an apex when debt-to-income levels reached 128% in 2008 and could not be sustained, ushering in the great deleveraging. Six years later, lending standards have loosened somewhat, but are generally tighter than before the crisis. Even so, increasing the availability of credit does not necessarily translate into a greater inclination to use credit.

Bruised by this experience, U.S. consumers have taken a more cautious attitude toward debt and been more selective about using it for discretionary purchases. However, consumers are receptive to take on debt for larger purchases of durable goods, such as cars, where credit is more available and demand solid due to the aging fleet of cars on the road. Credit availability has been easing here too with auto lending up about 5%. One caution is that a small but growing share is sub-prime. However, auto sales have been a key driver of overall consumption, with overall durable goods spending rising 7% annually for much of the recovery, well above the growth rate of overall consumption. The discouraging note is that it accounts for only 13% of personal consumption.

Non-durable goods spending, which includes discretionary purchases like food and apparel, has lagged in this recovery with advances of about 1.7% annually where real annual gains of 3%-5% were more typical in the past. This sector accounts for a larger 22% of total spending and includes retail spending which has seen only tepid gains, particularly as e-commerce has cut into sales. Finally, spending on services carries the largest share at 65%, but has actually seen even weaker annual gains of only 1.5% versus 3% gains in past recoveries. The non-durable and service sectors are also subject to swings in inflation due to volatility in food and energy costs, and recently falling inflation has helped consumer pocketbooks. An exception to the slower growth trends within these latter two spending categories is health care (pharma and physician services), where real purchases are increasing about 2.5%, and also housing-related categories (furniture, building materials) which have climbed about 8% annually on the housing recovery. Consumption trends (real personal consumption expenditure) tend to be driven by the 87% share of non-durable goods and services purchases (Exhibit 1).

Exhibit 1

Chart: Real PCE and Components, Annual Change %

Source: Bureau of Economic Analysis, May 2014

These discretionary purchases, if financed by borrowing, would be seen in the revolving component of credit (credit cards). But growth in revolving credit has been sub-par, rising less than 1% annually during the recovery, although it has ticked slightly higher in recent months and should be watched. Household preferences have shifted, with consumers using credit cards less and using debit cards much more. Absent the debt lever, the supports for higher discretionary spending are keyed off income and wages and also employment. But so far in this cycle income gains have lagged with real disposable personal income rising only 1.5% (the portion of income left over after taxes and inflation). Real disposable personal income (RDPI) gains averaged about 3% in the last recovery and about 5% in prior recoveries. The more miserly gains in income leave the consumer little scope to advance their discretionary spend, absent the debt channel. A continued fall in inflation is unlikely, savings rates are already meager and the Fed’s wealth effect to boost spending is impaired without some support from rising income.

More encouraging is a recent pickup in job gains which, if sustained, should help broaden aggregate income growth and move the employment-to-population ratio higher. The quality of these gains (part-time, low-wage) remains a restraining factor, and only a handful of industries are seeing wage pressures. But continued improvement in labor markets and wages may help nudge consumers’ use of plastic on the margin (Exhibit 2).

Exhibit 2

Chart: Employment vs. Credit/Wage Trends

Source: Columbia Management Investment Advisers, LLC, May 2014

For many decades, wider access to debt and looser lending standards was a fundamental support to spending that supplemented mediocre income gains and depleted savings. But preferences and attitudes toward spending and debt have changed with consumers becoming more chaste, discriminating and conservative. Debt use for discretionary purposes remains light and income growth has been soft, both factors holding back consumption and demand. Households will require stronger job growth and real wage gains to accelerate their spending, particularly if inflation and interest rates begin to rise as we pass the mid-point of the business cycle.

 

Marie M. Schofield

CFA, Chief Economist and Senior Portfolio Manager
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