After seeing this week's announcement that February consumer spending increased 0.3% the pundits were elated and used the number as proof that the consumer was back and that this virtually assured a typical post-war recovery. What the "experts" failed to do however, was examine the underlying data to determine where all this new-found spending power was coming from. True, consumer spending has risen in eight of the last nine months and has climbed 3.7% in that span. Although those results are far from robust it is, at least, an increase. The question is how this happened in the face of lackluster employment, weakness in housing, flat income and tight credit.
The answer is surprisingly simple once you look at the savings rate. As we mentioned, consumer spending has climbed 3.7% since May; that amounts to $373 billion of increased spending in the period. During the same span consumer savings declined by almost the same amount---$374 billion-while disposable income was basically flat, dropping by 0.1%. It is therefore easy to see that the entire increase in consumer spending for the nine months was due to reduced savings.
For some context let's look briefly at the household savings rate as a percentage of disposable income in the past. From 1955 through 1992 the savings rate stayed mostly within a range of 7%-to-11%, and then began a steady decline. The decline was slow at first, dropping to about 5% in 1998. After that the rate of decline accelerated, first with the bursting of the dot-com boom, and then with the boom in housing later in the decade. By 2007 the rate had dropped all the way to an average of 1.8%. The period of decline coincided with below average growth in wages and employment compared to prior decades. To maintain their standard of living, consumers went heavily into debt, aided and abetted by extremely easy monetary policy, soaring home prices, rising net worth and lax borrowing terms that enabled millions to borrow more than they could afford.
As we know, during the recession consumers were hit by high unemployment, lower incomes, tight credit and rapidly declining net worth. By May of last year they had raised their savings rate back to 6.4% Since then, however, the savings rate has dropped back to 3.1% in February, thereby accounting for all of the increase in consumer spending in that period.
In our view, therefore, the prospect for further substantial rises in consumer spending rests on an extremely shaky foundation. Households cannot continue to decrease savings rates without great harm to both their balance sheets and their retirement. In fact, it is far more likely that consumers will continue to deleverage and start raising their savings rates back to historical levels. At the same time the labor market will remain below par no matter what Friday's payroll employment number shows, while credit is still restrictive and the housing picture still quite weak. We think that the market, as it did in early 2000 and late 2007, is once again discounting a "goldilocks" outlook that is unlikely to occur.