Investing Alongside the U.S. Consumer
This past September, the Federal Reserve Board released their 2Q2021 Flow of Funds data, which confirms and helps quantify what you might already suspect: aggregate measures of consumer health are in as good a shape as we’ve seen in modern history.
The Flow of Funds data are the Federal Reserve’s (Fed) estimation for various account values of the United States, a comprehensive set of accounts that includes detail on the assets and liabilities of households, businesses, governments, and financial institutions. As of the most recent measurement, the asset side of the U.S. consumer balance sheet included $159.3 trillion of assets, while consumer liabilities totaled $17.7 trillion, for a net worth of almost $142 trillion. Let’s put that into perspective: prior to the 2008 market crash, household assets peaked at $85.1 trillion, while liabilities were $14.4 trillion, for a net worth of $71 trillion. That’s right: assets have appreciated 87% since the prior cycle high, while liabilities are up only 23%, resulting in a net worth that is exactly double the level from Q3 2007.
Figure 1: U.S. Household Balance Sheet
Now, some of this is to be expected: as the economy grows, so too should consumer net worth. But even normalizing relative to disposable personal income, we see in Figure 2 that the ratio of net worth to disposable personal income (DPI) has reached a new record at close to 800%.
Figure 2: Net Worth as Percent of Disposable Personal Income
What’s behind this run-up in consumer net worth? Household assets can be broken down into financial (e.g., deposit accounts, investment accounts, pension entitlements, etc.) and non-financial (largely real estate and consumer durable goods). Benchmarking the latest data to pre-pandemic (Dec 2019) levels, the value of non-financial assets have increased by over $5 trillion, thanks in large part to strong home price appreciation across the country. Among financial assets, all major categories are up, led by the increase in equities held by households, almost $10 trillion. Let’s not forget deposit and money market accounts as well as currency in circulation, though, where (as our Chase data has helped spotlight), balances are up by almost $4 trillion.
In short, consumers are currently sitting on more cash and cash equivalents, have higher investment account balances, and are enjoying much greater home equity value.
What may be even more notable this time around is what consumers are NOT doing! Unlike the prelude to the Great Financial Crisis (GFC), this run-up in asset prices is not being fueled by risky borrowing (or in many cases, borrowing whatsoever). From 2000 until the GFC in 2008, consumers increased notional borrowing level from 97% to 137% of disposable personal income; i.e., layering on more debt without a clear path to be able to repay that debt. In comparison, household debt was about 101% of disposable personal income at the end of 2019 and has fallen to 98% as seen in the most recent analysis. We know much of this was due to the substantial paydown of high cost credit card debt from the proceeds of the 2020 stimulus checks. We also know that much of the debt accumulation that occurred between 2004 to 2007 was offered to lower credit quality borrowers and often took the form of riskier loans (anyone remember pay-option ARMs??).
As if all this wasn’t enough, let’s not overlook one other key aspect of the recent consumer debt cycle. Not only have notional balances grown at a slower rate than disposable income, but the cost to service the outstanding debt has come down even further, thanks to low borrowing rates and (even more so) the ability to refinance mortgage debt at record low rates. The result is that the cost of servicing debt relative to income is now sitting near record lows, both for mortgage debt and non-mortgage debt.
Figure 3: Percent of Disposable Income
As investors in various segments of consumer-related channels (mortgage, auto, unsecured, etc.), we should expect consumers to fall behind on debt payments at fairly low rates, based on the analysis, which is exactly what we’re seeing (Figure 4).
Figure 4: Consumer Loan Delinquency Rate
As bond investors, we always put this through the risk lens, asking questions like “what are we missing?”, “where’s the downside?” and “how does this evolve from here?” There are a few things that we need to keep in mind. First, be careful in interpreting aggregate or average data, when often it is the tail risks that we’re most sensitive to. Even though the average consumer is doing well, we know that not everyone is benefitting equally (and some aren’t benefitting at all). We also know the important role that fiscal policy (stimulus checks, enhanced unemployment, etc.) have played, and the largest of those programs are likely behind us. Monetary policy and low interest rates have certainly helped support asset prices and borrowing costs as well, and we’re now measuring the tightening of monetary policy in weeks rather than quarters or years (though policy will likely remain accommodative for some time to come).
While we believe that the best of the improvement in consumer credit may be behind us, there are still many reasons to remain optimistic around the outlook for the consumer going forward. A successful handoff from a strong government backstop to a functioning global economy and improving employment outlook will only help secure that view. As long as that remains the case, we continue to believe that the consumer sector, accessed through asset-backed securities and mortgage-backed securities markets, remains an important anchor in well-balanced portfolios.