Personal consumption is holding steady and helping to bolster economic growth
A version of this story first appeared on TKer.co
Stocks closed higher last week with the S&P 500 rising 1.6%. The index is now up 9.2% year to date, up 17.2% from its October 12 closing low of 3,577.03, and down 12.6% from its January 3, 2022 record closing high of 4,796.56.
As worries about recession risks linger, the focus last week shifted to the consumer. Remember: Personal consumption accounts for about 71% of GDP.
Good news: Personal consumption is holding up!
According to Census Bureau data, retail sales in April climbed 0.4% to $686.1 billion.
While the pace of sales is off its record high, it continues to trend well above pre-pandemic levels.
“Not to take issue with a popular coffee ad, but America runs on consumer spending,” JP Morgan economist Michael Feroli wrote Friday. “And consumer spending continues to run in the right direction, as this week’s strong April retail sales report confirmed.”
None of this should be very surprising to TKer readers. As we’ve discussed repeatedly, consumer finances have been in remarkably good shape despite what weak sentiment may suggest. And robust demand for labor continues to fuel job creation. All of this represents massive tailwinds powering spending, which has been bolstering economic growth for months.
Just last week, San Francisco Fed researchers estimated consumers were still collectively sitting on $500 billion in excess savings — the extra cash consumers piled up since February 2020, thanks to a combination of government financial support and limited spending options during the pandemic.
“The consensus expects a recession starting next quarter, but the upside risk to this negative forecast is that consumers still have plenty of savings left,” Torsten Slok, chief economist at Apollo Global Management, wrote on Tuesday.
Resilient, but cooling 👀
This is not to say that economic growth hasn’t been cooling. Indeed, the Federal Reserve’s campaign to fight inflation by tightening financial conditions and slowing growth has been effective.
And while aggregate retail sales grew, some categories — including electronics, furniture, and general merchandise — saw declines.
Retailer earnings, meanwhile, have been a bit mixed. Last week, Walmart reported strong sales growth whereas Target sales growth was lackluster and Home Depot sales fell.
Berkshire Hathaway CEO Warren Buffett warned earlier this month that most of his many companies expected to report lower earnings this year. In addition to weaker demand, Buffett said many of his companies would be selling goods at unfavorable prices as they clear out excess inventory.
“It is a different climate than it was six months ago, and a number of our managers were surprised,“ Buffett said. “We'll start having sales at places where we didn't need to have sales before.”
Consumer finances are normalizing 📉
While consumer finances have been strong, they have been normalizing.
The San Francisco Fed suggested that the $500 billion in estimated excess savings could dwindle by Q4 of this year, depending on how quickly consumers draw them down.
And credit card balances have been on the rise. While they remain low relative to disposable income, these metrics have been trending higher.
Meanwhile, the New York Fed’s Q1 Household Debt & Credit report shows debt delinquency rates are up from their lows. From the report (emphasis added):
Aggregate delinquency rates were roughly flat in the first quarter of 2023 and remained low, after declining sharply through the beginning of the pandemic. As of March, 2.6% of outstanding debt was in some stage of delinquency, 2.1 percentage points lower than last quarter of 2019, just before the COVID-19 pandemic hit the United States.The share of debt newly transitioning into delinquency increased for most debt types. Transition rates into early delinquency for credit cards and auto loans increased by 0.6 and 0.2 percentage points, following similarly sized increases for the past year. Delinquency transition rates for mortgages upticked by 0.2 percentage points. Those for student loans have remained flat, as the federal repayment pause remains in place.
The number of consumers with a bankruptcy notation ticked up in Q1, but the level remains below the pre-pandemic trend.
Again, all of this is a discussion about normalization. The evaporation of excess savings only means savings levels would have returned to the pre-pandemic trend level. Same with rising delinquencies: they’re rising, but they’re mostly gravitating back to the pre-pandemic trend.
The big picture 🤔
Economic recession remains at bay thanks to an increasingly employed American consumer with a strong balance sheet.
Yes, recession risks are up as the Fed actively tries to slow the economy.
But the macro tailwinds bolstering the economy seem likely to keep growth going.
And even if the economy does slip into recession, keep in mind that many metrics are at historically strong levels. In other words, a recession could mean the economy goes from being very strong to just slightly less very strong, with limited risk of the bottom falling out thanks to what continues to be a lot of excess demand in the economy.
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
👆 Consumer check. Last week came with April retail sales, Q1 household debt stats, and a bunch of earnings announcements from major retailers. We discussed all that above.
💵 Household debt is up. According to the New York Fed’s Household Debt & Credit report, total household debt stood at $17.05 trillion in Q1, up 0.9% from the prior quarter. From the report: “Mortgage balances shown on consumer credit reports increased by $121 billion during the first quarter of 2023 and stood at $12.04 trillion at the end of March, a modest increase.
Balances on home equity lines of credit (HELOC) increased by $3 billion, the fourth consecutive quarterly increase following a nearly 13 year declining trend; the outstanding HELOC balance stands at $339 billion. Credit card balances were flat in the first quarter, at $986 billion, bucking the typical trend of balance declines in first quarters.
Auto loan balances increased by $10 billion in the first quarter, continuing the upward trajectory that has been in place since 2011. Other balances, which include retail cards and other consumer loans, increased by $5 billion. Student loan balances now stand at $1.60 trillion, up by $9 billion from the previous quarter. In total, non-housing balances grew by $24 billion.“
🚗 Watch auto loan delinquencies. The NY Fed’s report showed auto loan delinquencies in aggregate were normalizing. However, delinquencies for young people have jumped well above pre-pandemic levels.
On a call with reporters, New York Fed researchers said: “One area of particular concerns are younger borrowers and their auto loan accounts. … For borrowers under age 30, we've seen increases in their auto loan delinquency rates, which now surpass where they were pre-pandemic, and that's something to keep an eye on in particular because car prices had increased so much that these borrowers were taking out more for their loans than they would have been previously.“
🏦 Bank lending conditions tighten. The Dallas Fed’s May Banking Conditions Survey — which covers banks in Texas, New Mexico, and Louisiana — suggests things continue tighten on the banking side. From the report (emphasis added): “Loan demand declined for the sixth period in a row amid further loan pricing increases and worsening general business activity. Overall loan volumes continued to decline as well, though at a decelerated pace.
Residential real estate loan volumes stabilized after falling for several months, and consumer loan volume declines slowed notably. Significant volume declines continue to be seen in commercial and industrial and commercial real estate lending. Credit conditions tightened further; 48 percent of bankers said they tightened credit standards and terms over the past six weeks, the highest share since the survey began in 2017. Loan nonperformance continued to increase slightly.
The banking outlook continues to deteriorate, with contacts expecting a further contraction in business activity and loan demand and an increase in nonperforming loans over the next six months.“
🏚 Home sales cooled. Sales of previously owned homes fell 3.4% in April to an annualized rate of 4.28 million units. From NAR chief economist Lawrence Yun: “The combination of job gains, limited inventory and fluctuating mortgage rates over the last several months have created an environment of push-pull housing demand.“
💸 Home prices ticked up. Prices for previously owned homes rose month over month, but were down from year ago levels. From the NAR: “The median existing-home price for all housing types in April was $388,800, a decline of 1.7% from April 2022 ($395,500). Prices rose in the Northeast and Midwest but retreated in the South and West.“
🏠 Home builder sentiment jumps. From NAHB Chairman Alicia Huey: “New home construction is taking on an increased role in the marketplace because many home owners with loans well below current mortgage rates are electing to stay put, and this is keeping the supply of existing homes at a very low level… While this is fueling cautious optimism among builders, they continue to face ongoing challenges to meet a growing demand for new construction. These include shortages of transformers and other building materials and tightening credit conditions for residential real estate development and construction brought on by the actions of the Federal Reserve to raise interest rates.”
🔨 New home construction rises. Housing starts climbed 2.2% in April to an annualized rate of 1.4 million units, according to Census Bureau data released Thursday. Building permits declined by 1.5% to an annualized rate of 1.42 million units.
🏭 Industrial activity picks up. Industrial production activity in April was up 0.5% from March levels, with manufacturing output climbing 1.0%. Though activity in prior months was revised lower.
💼 Unemployment claims remain questionable. Initial claims for unemployment benefits fell to 242,000 during the week ending May 13, down from 264,000 the week prior. As we previously noted, last week’s claims figure was reportedly inflated by fraudulent claims filed in Massachusetts.
If there’s a silver lining, it’s that fraudulent claims inflate these figures – meaning that the number of people actually seeking out unemployment benefits is likely lower.
That said, no one’s really refuting the claim that the labor market has been cooling.
🏢 Offices are very empty. From Kastle Systems: “Office occupancy remains around 50%, falling two-thirds of a point last week to 49.3%, according to Kastle’s 10-city Back to Work Barometer. Nearly all tracked cities—except New York City—saw declines of less than a point. Only Houston and Austin, Texas experienced larger declines, falling 1.8 points to 60% and 2.5 points to 60.6%, respectively. New York City rose 0.6 points to 48.9%. The daily high was Tuesday at 57.7%, and the low was Friday at 33.1%.”
✈️ People are flying. From Renaissance Macro Research: “More passengers being screened at airports. TSA traveler throughput ran 2.63 million as of May 18, the highest level since the pandemic. Over the last 7 days, traveler throughput has averaged 101% of 2019 levels.”
🏛️ Debt ceiling drama continues. There’s still no deal to resolve the debt ceiling issue. But there’s still some time before it becomes a very serious problem for the financial markets. That said, raising the debt ceiling is nothing new.
😬 The pros are worried about stuff. According to BofA’s April Global Fund Manager Survey (via Notes), fund managers identified “Credit crunch & global recession” as the “biggest tail risk.”
The truth is we’re always worried about something. That’s just the nature of investing.
Putting it all together 🤔
Despite recent banking tumult, we continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on May 3, the Fed signaled that the end of interest rate hikes may be here.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations) to linger.
All of this means the market beatings may continue for the time being, and the risk the economy sinks into a recession will be relatively elevated.
At the same time, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
