Personal income statistics for the United States were released today surprising economists with an actual increase of 0.5% (annualized). The expectations had been for an April decline of 0.2% as a weak economy has certainly cut back on employment levels and hurt the earnings power of many individual Americans. At ZachStocks, we have often discussed how consumer spending is an important part of the economy and one that has experienced the most weakness. Today’s Free Newsletter also discusses how inflation could be a significant hurdle for consumers.
The economic stimulus packages have been successful in putting cash into the pockets of many through three primary categories:
- Personal Current Transfer Receipts – This is technical jargon for “benefits received by persons for which no current services are performed.” So essentially one of the issues propping up personal income is an increase in government handouts.
- Extra Payments for Unemployed – We have certainly seen more activity in programs designed to provide assistance for the unemployed – although these payments do very little to create actual economic growth.
- Decrease in Taxes Paid – There have been several stimulus tax credits implemented which essentially props up the net income for individuals.
So despite the positive headlines of income actually increasing in April, it becomes very clear when digging a bit deeper that this “income” is largely a function of government intervention and much less an economic recovery issue.
The bullish argument has been made that regardless of where the capital actually comes from (be it government stimulus or actual earnings from services performed), the bottom line is that these dollars will be circulated in the economy driving economic growth. As cash is spent on necessities and discretionary items, businesses will be able to realize more revenues, profits will tick up, and economic activity will surge. After all, the consumer accounts for roughly 70% of GDP.
But what happens when the consumer decides not to spend this new found income? Will the consumer-led economy be able to recover given the fact that this new income is being stored away instead of put into circulation? And how much additional income needs to be generated in order to affect spending levels.
Old Models Don’t Work Anymore
Economists and government policy makers have typically built models based on some assumption of personal spending. For instance, if income is up X%, then we should see spending increase Y%. Obvioulsy there are many other factors to consider but as a general rule it is accepted that income and spending are closely linked.
But large social trends are currently in place which distort these models and will likely render them useless for several years (if not decades) to come. For the majority of the period since WWII, the United States has been a nation of spenders. This has been reinforced in the last two decades as loose monetary policy and rising asset levels have encouraged individuals as well as corporations (and governments too) to use leverage as a tool for generating wealth.
It makes sense to borrow 100% of the value of a home purchase with a payment that only barely fits into a budget, when rates are low and expected to stay low, and when the value of the property will continually increase. We’re all well aware of the “housing piggy bank” phenomenon where individuals would add a line of credit to their house in order to finance a summer vacation, or better yet a vacation home.
But as these arguably irresponsible consumer trends took decades to build, it could also take decades to unwind the speculative mindset. Consumers are currently fighting an uphill battle when it comes to financial stability and this struggle includes:
- Employment concerns including layoffs and income reductions
- A weak economy with less opportunity for career enhancement
- High consumer debt levels which become harder to keep current
- Low availability of credit for when unexpected expenses occur
- Stock market losses which have decimated many retirement accounts
- Declining home sales which have left many owing more than property values
These issues will take quite a bit of time to be resolved on a nationwide (and truly global) scale and will have a noticeable effect on social attitudes toward spending and saving. After the great depression there was a general distrust of the ensuing recovery and to this day many who lived through that era have embraced and maintained a thrifty, conservative approach to their finances. It may be that in 2020, the US will be considered a nation of “savers” once again.
As investors, it is important to not rely on just a “gut feeling”; or historical principal, but instead ot see what the statistics and economic reports are showing us. The report out this morning showed that personal saving came in at 5.7% of disposable personal income. That compares to a 4.5% level in March, and a 4.1% level in February. So it is clear that the numbers are backing up this concept of “saving more and spending less”; The question is not if this trend will occur, but rather how long and how severe will the savings trend be before we move toward spending again.
Distrust For Investments Could Result in Market Weakness
I have explained this concept to a few who have responded with excitement over how this will cause more money to flow into the equities markets. But I have doubts as to whether this capital will actually make its way into the stock market. From an academic standpoint, there is a significant difference between saving and spending. Saving capital is largely parked in actual savings accounts, CDs, money market funds and the like. This capital will do very little to help promote economic growth as it will likely sit idly by.
The recent weakness in the markets have led to a distrust for traditional equity investments. While we haven’t written off stocks and mutual funds as a cultural washout yet, there is a growing desire for stability and investors are likely to allocate larger portions of their capital to low risk, low return vehicles. While investments in equities actually brings capital into the economy that can be used to build businesses, promote employment, and generate profits; savings capital has much less of an effect on economic activity.
The best case scenario is that the troubled banking industry will likely be able to raise the level of deposits as long as the government does a good job of promoting confidence in the banking system. It will be interesting to see how interest rates behave over the coming quarters and we could quite possibly see rates rise to where bank savings accounts are once again profitable places to hoard reserves.
Consumer Spending Stocks Especially Vulnerable
In my opinion, consumer retail stocks are the most dangerous places to park investment capital in todays market. ZachStocks has published quite a few articles on vulnerable retail names including Tiffany & Co. (TIF), Steven Madden, Ltd. (SHOO), Chipotle Mexican Grill (CMG) and Netflix, Inc. (NFLX). While timing has been difficult to nail down as investors have confidently re-entered the market, the long-term danger for these stocks is significant.
In the current market environment it is important to have an objective view of the fundamental backdrop and then pick investments on a case by case basis. Long positions in hard assets, precious metals, and inflation hedges will likely serve well while stocks dependant on consumer spending, economic growth, and full employment will likely be good short candidates. Above all, use discipline and employ risk control in order to protect your capital and avoid the catastrophic losses many have endured over the past 12 months.Personal Spending hits Perfect Storm