The US Consumer

“The sense of security more frequently springs from habit than from conviction, and for this reason it often subsists after such a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened, is, in this logic of habit, constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.”  - George Eliot, Silas Marner, 1861

“Never underestimate the US consumer” is what we are always told. So far this has been a winning assumption. For some reason it appears that the whole world economy has come to depend on this insatiable creature. Policy makers and politicians tremble at the thought that one day the shoppers will not show up. How then will they be able to portray their economy a success?

Living carefully and respectfully within one’s means used to be considered virtuous. Saving for a rainy day and a pension and exercising thrift at all times was supposed to increase one’s wealth and personal financial security over time. Now this type of behaviour is considered too dangerous by politicians. Recessions and, heaven forbid, deflation are far too risky to even contemplate.

So how can this never-ending spending machine be kept alive? Very simple, with Debt. Any shortfall or downturn can always be offset by new credit, and the chart below shows the incredible, relentless and accelerating rise in debt relative to income.

 

 

What this tells us is that there is some conditionality to our assumption of the never-ending growth in spending by the US consumer. The US consumer can only continue its habit with ever increasing debt at an accelerating rate. The relentless rise in consumer spending may have continued for decades, but surely, while no-one can predict the precise ending of this remarkable trend, this behaviour is clearly not sustainable. 

New Threats

In the last 5 years the American way of life has been under threat as never before. For the great majority wages have barely been rising in real terms, but as the chart below shows basic living expenses have.

In order to maintain standards of living it has been necessary to borrow as never before, and this is why interest rates needed to fall to record levels of 1%. This lead to massive asset inflation particularly in the housing market, which became a great new source of collateral for further staggering levels of borrowing. 

Fed Chairman Alan Greenspan himself co-authored a report last month which concluded that the combination of home equity loans, capital gains from home sales and mortgage equity cash outs added about $700 billion to economic activity last year. This amazing boost means that the entire increase in nominal GDP last year, can be traced back to the housing market. So the housing market has enormous implications for consumer spending and the economy in general.

Now, however, this source of credit is reaching its limit, as the housing market has almost certainly reached a peak. For the first time since July 2000, housing starts, new home sales, mortgage applications and building permits are all negative year-on-year. Meanwhile, inventories of unsold homes are now rising to almost 5 months supply, a nine year high, and affordability for the first time buyer sank to a 20 year low.

The impact of a slowing housing market on consumer spending is still being ignored by Wall Street where 20% earnings growth is still expected next year in the consumer discretionary group as a whole.

Summary

Although it is a trend that has lasted for decades, it is very dangerous to assume that the relentless strength of the US consumer will last for ever. This consumption has depended on ever rising debt levels relative to income. Indeed the ratio of debt to income has been accelerating. This cannot last.

The latest borrowing binge has been driven almost exclusively by rapidly rising house prices. Indeed Alan Greenspan’s co-authored research piece last month showed that the entire growth of nominal GDP last year could be attributed to the housing market.

Now, however, it is clear that the housing market has reached a peak. Several indicators have now turned negative, with multiyear highs in inventory levels and a 20 year low in first time buyer affordability.

So far the link between what is now happening in the housing market and its effect on the economy is being ignored by Wall Street which is still forecasting 20% growth in earnings of consumer discretionary stocks next year. Do you think that there is scope for a sudden change in expectations?

 

 

Notice

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