The play, entitled “Steadily She Slows”, has, from a dramatic perspective, turned out to be a dud.
It started with such a promising prologue of pandemic, recession, recovery, political upheaval, war and inflation. However, it has since settled into a drawn-out, repetitious script, wherein the lead actor, consumption, hogs the center stage and the supporting cast, in the form of investment spending, government spending and trade, has very little impact on the plot. The promoters, on cable news shows and social media feeds, do their very best to gin up public interest by prophesying catastrophic collapse into recession or reignited and blazing inflation. But still the play drones on, unloved by all, except, of course, the investors, who are profiting handsomely from its extended run.
That being said, consumption, is showing signs of faltering, warranting a health checkup on behalf of those investors who worry that the show could be brought to a rather abrupt halt.
Signs of Consumer Fatigue
The week ahead should provide some further evidence on the issue of consumer momentum with the release of May numbers for personal income and spending. We estimate that nominal consumer spending rose by 0.3% in May and, because we expect the consumption deflator to be essentially flat, this should also translate into a real spending increase of 0.3%. However, the latest retail sales report suggests that spending will be revised down for both March and April. Because of this, we now expect 2nd quarter real consumer spending to rise at a modest 1.3% annualized rate, following 2.0% growth in the first quarter and 3.3% growth in the fourth.
Looking at the details, there are three clear areas of softening – vehicle sales, housing services and non-durable goods spending, while consumer spending on services outside of housing continues to grow at a robust pace.
Vehicle sales and homebuilding both look relatively stagnant. With May data in the door, we now estimate that light vehicle sales will be 15.8 million units annualized in the second quarter, essentially unchanged from a year ago. Housing starts are tracking 1.32 million units annualized for the second quarter, down from 1.46 million a year earlier.
In both cases, soaring prices in recent years, followed by surges in interest rates and insurance costs have reduced the pool of potential buyers. Meanwhile, very slow growth in the native-born working-age population is limiting demand and many new immigrants are in no position to impact the demand for new vehicles or new homes.
For non-durable goods, the problem is likely just a squeeze on discretionary income. Pandemic aid has long been spent and, over the past two years, consumer spending on the basics, such as food, clothing, energy and household supplies has been supplemented, to an extent, by a runup in consumer credit. However, consumer credit, which rose by 9.9% in the year that ended in April 2022, climbed just 1.9% in the year that ended in April 2024. This likely reflects greater caution on the part of lenders, as delinquency rates on consumer loans have now risen above pre-pandemic levels, (although they remain far lower that in the years surrounding the Global Financial Crisis)
Meanwhile, for the one-third of U.S. households that rent their accommodation, rents continue to absorb a greater share of disposable income than before the pandemic, forcing families to economize in other areas. Because of this, it isn’t surprising to see some softening in consumer spending on the basics.
Offsetting Forces
However, it is important to recognize that there are significant offsetting forces.
- First, strong growth in both employment and real wages have led to solid year-over-year gains in real disposable income since the start of last year.
- Second, assuming there is no significant change in the stock market over the next week, we estimate that the net worth of U.S. households will have increased by a huge 13.7% or $18.6 trillion over the last 18 months, a number that coincidentally, is more than the total spending of U.S. consumers in 2023, which was $18.5 trillion.
- Finally, it should be noted that while interest rates are higher on new mortgages, new vehicle loans and revolving credit, those with existing fixed-rate mortgages continue to be insulated from the impact of higher borrowing costs while benefiting from higher interest income.
All of this is bolstering the finances of richer and older households, supporting spending on high-end consumer goods, leisure and entertainment. This is being further enabled by a remarkable surge in labor supply. As an example, health care employment has risen by 782,000 workers or 4.6% over the past year, which is allowing for more patient care to be delivered in an area where staffing shortages remain a severe problem.
Finally, some point to falling consumer confidence as a warning sign of lower spending ahead. However, this theme may not be as important as it seems. First, it should be noted that the University of Michigan Index, which has fallen from 79.4 in March to 65.6 in early June, has a bias, due to a transition to new survey methods, which may account for more than a third of this decline. Moreover, the Conference Board Survey, due out on Tuesday, has so far shown no such weakening.
More generally, though, neither consumers nor investors are behaving as if they are scared – investors have pushed the S&P500 to an all-time record high 33 times already this year while consumers have maintained a personal saving rate of 3.6% - far below the 6.2% average in the five years before the pandemic.
Investment Implications
In short, it appears that worries about consumer spending probably amount to a false alarm – at least in terms of triggering an imminent recession. Consumer spending will likely keep growing, although more slowly, in the months and quarters ahead, suggesting that it would take a significant shock elsewhere to tip the U.S. economy into recession.
For investors, this is a generally positive outlook. Milder but continued economic growth should allow for a continued gentle decline in inflation and, particularly when the Fed finally begins to ease, some fall in long-term interest rates.
However, it should be noted that a continuation of this benign economic scenario is encouraging more and more lofty valuations, particularly for large-cap growth stocks. For this reason, while the show is likely to continue, investors should be aware of the location of the exits and more deliberately diversify their investments to counter markets that continue to grow more concentrated.