Encouraging Signs of Life from the U.S. Consumer

Early data from the start of the 2010 holiday shopping season indicate this could shape up to be the best year for consumer spending (and retailers) since 2005. Some have attributed this simply to consumer psychology based on pent-up demand and frustration after nearly three years of relative austerity. However, there are other indicators suggesting that consumer finances are at least on the mend. As U.S. households struggle with the longest stretch of unemployment over 9% since World War II (19 months and counting as of November), substantial declines in home values (resulting in 15 million homes with mortgage balances in excess of market price) and stagnant wages, this is welcome news.

 

An Encouraging Start to the Holiday Shopping Season

Retailers were generally very pleased with both the number of shoppers that kicked off this holiday season and their spending levels. As a result, several organizations have increased their growth forecast for holiday season spending upward from an initial range of 2 to 3% to a revised range of 4 to 4.5%. As the chart below illustrates, if these estimates prove correct, it will convincingly reverse the steep declines that occurred between 2006 and 2009.

 

 

Notes:    (1) The 2010 estimate shown is for 4.5% growth.

(2)  The National Retail Federation defines holiday sales as retail industry sales in the months of November and December. Retail industry sales include most traditional retail categories including discounters, department stores, grocery stores, and specialty stores, and exclude sales at automotive dealers, gas stations, and restaurants.

               (3) In 2009, the dollar value of retail holiday sales equaled $437.1 billion.

 

In addition to consumer psychology, the recent performance of the major stock markets may also be playing an important role in both improving consumer confidence and erasing bad memories of investment wealth that declined severely during the Great Recession. Year-to-date and on a one-year basis, most markets are up on a total return basis, as illustrated by the Standard & Poor’s 500 Index in the table below. In fact, with the S&P 500 up over 13% in just the last three months, this may be the best Christmas present investors have received in quite a long time.

 

S&P 500 Index’s Total Return Through November 30
3-Month	YTD	1-Year	3-Year	5-Year	10-Year
13.08%	7.86%	9.94%	-5.15%	0.98%	0.81%

Source: Standard & Poor’s

Notes:    (1) The 1-, 3-, 5- and 10-year returns are annualized figures.

(2) The S&P 500 Index is a market value-weighted index of the stocks of 500 publicly traded U.S. companies chosen for market size, liquidity, and industry group representation that are considered to be leading firms in dominant industries. Each stock’s weight in the index is proportionate to its market value. Created by Standard & Poor’s, it is considered to be a broad measure of U.S. stock market performance.

 

Other Positive Signs for Households

Since excessive debt and leverage was one of the key causes of the financial crisis behind the Great Recession, it’s important to understand where households are in the deleveraging process. The U.S. Federal Reserve calculates two statistics that are useful in this regard: the household Debt Service Ratio (DSR) and Financial Obligations Ratio (FOR). The DSR is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. The FOR incorporates these same payments and adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance and property tax payments to the DSR. It is also a ratio calculated relative to disposable personal income. The chart below plots the trends in both ratios from the first quarter 1980 to the third quarter of this year, with the dashed lines showing their long-term averages.

 

 

Both the DSR and FOR are on substantial downward trends since peaking in the third quarter of 2007 (one quarter prior to the start of the Great Recession), and both have recently dropped below their 30-year averages (in the second quarter of this year for the FOR and the third quarter for the DSR). These statistics and trends suggest that households are reducing the impact on current disposable income caused by various forms of debt, leases and other fixed obligations, whether that’s through deleveraging, lower interest rates (e.g., mortgage refinancing), or even defaults. However it is occurring, it means consumers should have more disposable income for discretionary spending with the trend toward even greater amounts in the future.

 

Another angle on this topic can be gained by analysis of the National Income Product Accounts (NIPA) tables that the U.S. Bureau of Economic Analysis calculates on a quarterly basis. The chart below plots two statistics from these tables: total consumer debt to disposable personal income ratio and the personal savings rate (personal savings as a percent of disposable personal income) from the first quarter of 1947 to the third quarter of this year.

 

 

Note: The personal savings rate is a rolling four-quarter average to smooth out quarter to quarter variations.

 

As the dashed oval highlights, there have been encouraging shifts in the trends of both total consumer debt and personal savings rates over the past three years. Consumer debt has begun to come down (slowly at first, but more convincingly since late 2009) while personal savings rates have increased to over 5% of personal income. The gap or spread between these two statistics had been widening over a 16-year period from 1991 to 2007 as the personal savings rate plummeted while the consumer debt ratio increased substantially. The reversal in this spread based on rising savings and declining debt is another positive sign for the future outlook of households and spending.

 

There’s Still a Way to Go

Despite the encouraging trends identified here, consumers and households still have a long road ahead in the deleveraging and recovery process. Continued high unemployment and a weak housing market will complicate and extend the recovery time for many households. And even after the process is well along, it’s unlikely—given the very painful experiences of most during the Great Recession and its aftermath—that households will return to their borrow and spend ways that seemed to propel much of the economy through the last decade. However, the most important thing is the trends do point to recovery in the balance sheets of many U.S. households, which is an important and long-awaited development.

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