Odds stacked against the consumer

Yesterday I briefly mentioned the relief consumers got last year from falling energy prices and how that “stimulus” at the pump is fading as gasoline nudges up against $3 a gallon. Today, I am noticing that breakfast in America is getting pricier as well with tea, cocoa, sugar, and coffee prices all hitting multi-year highs. In addition, bad weather in the U.S. Midwest may put some upward pressure on corn and soybean prices. All of these rising costs leave less cash for discretionary spending.

This trend couldn’t occur at a worst time with holiday shopping season just around the corner. Many businesses rely on holiday sales to hit their quarterly and/or annual targets, so the prospects of dismal holiday spending is concerning. It is possible consumers will unleash some pent-up demand after spending two years forgoing purchases to bolster savings, but recent surveys aren’t giving much hope.

The NPD Group shows in its survey that 30% of adults are going to be cutting holiday spending this year from last year’s very low levels. Meanwhile, Deloitte Consulting concluded from their broad survey that “U.S. shoppers will buy fewer gifts and spend more on items such as clothes, entertaining and home furnishings during the holiday season.” Surveys like these make it impossible to get excited about the strength of consumer spending.

Earlier in the week the Conference Board’s measure of consumer confidence came in at 47.7, which is not only abysmal but also doesn’t match up well to past recoveries. According to Gluskin-Sheff:

• The average level of consumer confidence at the end of a recession is 71.5 (data back to 1967, cover 7 cycles).
• The average level during recession is 72.0 and even excluding the latest downturn, the average was 65.9.
• The average level during an expansion is at 102.0.
• The average consumer confidence is 90.5 during periods when the S&P 500 has gained 60% or more.
  

All of the above makes it difficult to believe that the nascent recovery is sustainable if consumer spending, which makes up 70% of GDP, remains low.

On the other hand, evaluating a recovery’s sustainability with consumer spending is tricky because consumer spending doesn’t always snapback quickly. Consider these facts (complements of J.P. Morgan):

• Over 60% of the time, consumer spending in the first quarter of an expansion is less than 5% growth; and 30% of the time, consumer spending is down 1% to flat.
• 75% of recoveries see consumer spending growth lower than overall GDP growth during the first nine months of the expansion (typically investment spending leads).
• In 25% of recoveries, consumer spending averages 2.3% growth in the first nine months, yet GDP during that time grows 3.1%.
  

I would argue that the consumer is in a worse position today than in past cycles, but at least these statistics provide a glimmer of hope.

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Peter J. Lazaroff, Investment Analyst