Market Directions

The Consumer in Question

One aspect of the United States economy merits concern even as the world seems ready to give up its reservations about the strength and durability of the recovery. Will consumer spending recover sufficiently to drive down unemployment and initiate a self-sustaining economic cycle? More than half of the 5.6% growth in the fourth quarter was driven by business expenditures. American business investment and inventory restocking along with government payments and stimulus spending have carried the economy past the danger point of a year ago when all categories of consumption had collapsed. Businesses spend to promote and satisfy future sales. Business consumption is a calculated risk; it is dependent on the consumer in future quarters. To put it another way, the hope of future sales is what drives investment and inventory build. If sales do not materialize, if for some reason the consumer does not participate, or participates at a lower than expected level, business investment cannot continue and the accumulated inventory has to be sold off rather than replaced. Beyond a finite point, no executive will build that new plant, hire workers or stockpile materials unless there are sales to justify the expenditures. In the United States particularly, the economic future is conditioned on the attitudes and spending of the consumers. Retail sales posted a strong gain in March rising 1.6% from February, almost one-third higher than the 1.2% median prediction. January and February results also improved, each was revised to 0.5% from 0.1% and 0.3%. This was the third positive month in a row and the ninth out of the last twelve. The yearly return advanced 7.6%, the fifth consecutive up month after fourteen straight negative issues beginning in September 2008. The monthly historical average for this series, which began in 1992, is 4.4%. Even when corrected for 2.3% inflation in March, sales still grew 5.3% over March 2009. Two factors are important. The first is the base effect. Last March yearly sales were down 10%. From September 2008 until October 2009, annual sales dropped every month. The March percentage increase is thus on a much diminished base. In absolute terms, sales must grow strongly for a year or more just to return to the economy before the collapse. Large numbers of jobs will not begin to return until well into that cycle. The second consideration concerns the content of the sales growth. In this I will offer a bit of conjecture. The severity of the recession combined with the financial panic induced consumers to stop all but necessary purchases. The magnitude of the sales decline implies that not only were discretionary purchases delayed, but many replacement but not mandatory items were neglected as well. Even if a family could have afforded a new car, many households must have elected to forego the purchase. The same was probably true for whole categories of goods, which are not quite discretionary but not necessities either. Are these once delayed purchases the consumption that has fueled the recent sales growth? Beyond these postponed items, has the consumer regained sufficient optimism to make those discretionary purchases that provide the growth factor in GDP? From the relative modest size and pace of the retail sales improvement over the past six months the answer would appear to be no. This does not mean that consumers will not gradually resume spending a larger part of their discretionary income. However, those expenditures will likely depend on jobs and unemployment. Consumer attitudes and confidence give a gloomy picture of the immediate future. In the University of Michigan survey, overall consumer sentiment fell to 69.5 in April from 73.6 a month earlier. The forecast had been for a rise to 75.0. It was the lowest score since last November. The current conditions component, which assesses consumers’ estimates of their financial situation and their willingness to purchase large ticket items, sank to 80.7 from 82.4. Moreover, expectations, the measure of what individuals expect their own and their family’s’ situation to be six-months from now dropped by 5.6 points to 62.3. The health care legislation appears to be the reason behind the large and unexpected drop in sentiment. Thirty-eight percent of responders said they expected the bill to worsen their personal finances and only 8% said they expected improvement; 51% said they expected the bill to have an unfavorable impact on the country and only 20% thought it would be beneficial. Pessimism also stems from the tax environment, with large pluralities expecting their taxes to rise in the near future. Historically, this level of consumer expectations supports only very modest 0.5%-1.0% annual growth in consumer spending. In the eyes of the consumer, the economic future has many questions. People are inclined to caution. Logic, common sense and experience dictate restraint. Much will have to improve in the unemployment picture before consumers are ready to fund a real recovery in spending.