US Perspectives: Consumers' Crisis of Confidence

New higher savings rates mean the consumer has the wherewithal, if not the confidence, to spend more.

Robert Johnson, CFA 17.08.2010
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For the past several months I have noted that improved consumer spending has been driven largely by spending on consumer electronics--computers, televisions, and audio equipment. While I was glad to see that consumers had enough confidence to spend on anything, spending on electronics often causes a significant boost in imports.


Last week, import data came home to roost as the trade deficit jumped to $49.9 billion in June, far above last month's reading of a $42.0 billion and far above consensus forecasts. The market reacted negatively to the news on Wednesday, when the Dow Jones Industrial Average fell 265 points.


The news was significant in that a rising trade deficit means that the GDP growth for the second quarter will have to be revised down to the range of 1%-2% from an already meager 2.4% announced at the end of July. Imports can also serve to break the virtuous cycle of ever increasing spending leading to more production leading to more employment leading to more spending. If the increased employment comes from overseas, and those workers don't spend an equal amount on U.S. goods, the positive loop is at least partially broken. Of course, exports, which were a little soft in June, can offset some of that leak.


In other news last week, retail sales overall increased 0.4% according to the Census Bureau, following two months of decline. Stronger auto sales and higher gasoline prices were the key drivers of the improvement. Despite all the complaining about the consumer, retail spending at stores and restaurants is pretty typical of the last 10 recoveries. Unfortunately, poor spending increases in the larger consumer services sector mean that the total consumer spending improvement is still near the bottom of the list when compared to past recoveries.


The headline increase in the consumer price index for June was 0.3% (3.6% annualized and seasonally adjusted). As in the retail sales report, energy was a key driver and accounted for almost two thirds of the increase in prices. Less the volatile food and energy components, prices increased just 0.1% for the month or 1.2% annualized. When compared to a year ago, overall prices are up just 1.2% and excluding food and energy, up 0.9%. While overall prices remain under good control, used cars and apparel, in addition to energy, jumped more than 3% at an annualized rate in July. The list of 3%-plus gainers has fallen from March when transportation services, medical products, and medical care services all exceeded 3%.


Sky-high used car prices, which are now up 17% year over year, might drive consumers on to the new car lot. New cars sales to consumers still need a huge lift to approach anything like a normal recovery. Total auto and auto parts sales have added only a measly $14 billion of sales this recovery, versus more than $50 billion in the recovery from the 2001 recession, which was also characterized as anemic.


Last week's data combined with the week before last week's employment data and the prior week's personal income and expenditures reports continue to confirm that the economy is not as strong as I had forecast or even as strong as I thought it was. The revised personal income data was pretty stunning and now paints a very different picture of the recovery than just a month ago. Prior to the revision, it looked like consumers were back to spending most of what they made and that they would be hard-pressed to step up spending without more income. The new data shows that consumers had been consistently more frugal than previously thought. One very recent data point, the first quarter of 2010, saw the savings rate revised from 3.5% all the way up to 5.5%. The June quarter saw the savings rate increase even further to 6.2%, making it the highest savings rate of the decade.


A Crisis of Confidence

These new higher savings rates mean the consumer has the wherewithal, if not the confidence, to spend more. The old data showed exactly the opposite--that the consumer was back to spending as much as during the previous spending peak and running out of steam as the savings rate fell back to a fairly low level. Now the question is exactly what will pull consumers out of their funk, and I don't have any easy answers.


Improvement could come out of nowhere as it did with the huge consumer spending increases in March. Sales then drifted back to much more staid numbers in the second quarter. My personal guess is that maybe autos will pull us out of the slump again. In hindsight, it was monumental auto purchases by the business sector that really dragged us out of the manufacturing recession in mid-2009. Now with new models due soon, cars wearing out, and used car prices going through the roof, it may well be the consumer that finally begins to lift auto sales.


Not-so-Hot Medical Sector Holds Back Recovery

Exactly why the consumer recovery has been so slow this time around has been a matter of some concern. However, the source of the surprise is quite unique. Nondurable goods (think necessities like food and clothing) are experiencing a fairly normal recovery. Durable goods like cars and furniture are experiencing a below-average recovery but are still doing better than some of the worst recoveries.


Meanwhile the service sector, which makes up almost two thirds of consumer spending, remains in the doldrums, experiencing its worst recovery when compared to the previous nine. Surprisingly, one of the slowest growers is health care, which did exceptionally well in the down leg of this recession. Coming out of the 2001 recovery, health care contributed about $70 billion to a total consumer recovery of $240 billion. In this expansion, health care contributed just $7 billion of our $140 billion recovery. Spending on financial services and recreational services are other laggards, actually showing declines from June of 2009 through June of 2010. However, shortfalls in these other categories are small compared to the health care figure. The "why" of slowing health-care spending is fodder for future columns.


The consumer durable goods sector is being held back by poor auto sales, which at are still within 10% of their recession lows. Strong shipments of computers and other electronics goods have largely offset disappointing auto sales in the aggregate durable goods shipments category. Unfortunately, strong electronics sales, which also require imports, don't help the U.S. economy as much as improved auto sales and service sector performance, which tend to have higher U.S. content. That partially explains last week's poor trade deficit number.


On Tap: Housing Data and Industrial Production

Industrial production and housing starts are both due this week along with the first set of regional purchasing manager reports. I suspect the news here will continue to be rather lackluster but not particularly alarming. The consensus for industrial production is an increase of 0.5% down from the rather torrid near-1% levels that have characterized many months this year. I suspect the increase might beat expectations because of higher utility output in the Northeast due to abnormally hot weather. Also, the lack of a major model change over shutdown at GM this summer probably diminished June production and increased the July figures. Weighing on the other side is more moderate growth in the ISM purchasing numbers that have grown at a slower pace over the past several months. Reports out of the Philadelphia and New York Federal Reserve on the manufacturing sector should give us some indication whether things have changed at all early this month.


The expiring homebuyers' credit has weighed on the housing starts number for a number of months. Unfortunately, I don't expect the number to be much better this time around, with starts mired in the mid-500,000 range for yet another month. I suppose we could see a little surprise here, but with new home sales still soft it would be hard to see much improvement in the category just yet.



This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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