AFTER TWO PAINFUL YEARS of retrenchment, American consumers are flexing their wallets again. They have paid down debt, boosted their savings and otherwise strengthened their personal balance sheets since the recession hit with terrifying force in the second half of 2008.
As a result of their improving circumstances, the nation's merchants are likely to enjoy a jolly holiday season, with retail sales up 3.5% to 4%, exceeding both last year's meager 0.4% gain and expectations of 2.3% growth forecast by the National Retail Federation. More important, the consumer-dependent U.S. economy could grow by as much as 4% in 2011, well ahead of the current consensus estimate of a 2.4% increase in next year's gross domestic product. Consumer spending accounts for more than 70% of GDP, although that figure includes government spending on health care.
Look almost anywhere these days, and the data paint a picture of household finances on the mend. After three years of deleveraging, total U.S. consumer debt has falln by roughly $1 trillion, to $11.58 trillion, from a peak of $12.5 trillion in the third quarter of 2008, according to data from the Federal Reserve Bank of New York. In particular, credit-card debt has shrunk by 16%, to around $730 billion, and auto loans have fallen about 12%, to $710 billion.
Moreover, household financial obligations defined as debt and lease payments, rent, home insurance and property taxes have fallen to 17% of disposable income, down from an all-time high of 18.9% in the third quarter of 2007 and below the 30-year average of 17.2%, notes James Paulsen, chief investment strategist at Wells Capital Management.
In a further sign of consumer retrenchment, U.S. discretionary spending has fallen to 50-year lows as a percentage of total consumer spending, notes Steven Wieting, U.S. economist at Citi Global Markets. The decline began when the dot-com bubble burst in 2000, but accelerated with the onset of the financial crisis in 2008.
Collectively, sharp cutbacks in debt and discretionary spending, along with lower interest rates and potentially good news on taxes, suggest the U.S. consumer isn't quite as tapped out as some economists fear. Rather, consumers have more spending power today than they have had in a while, which, together with improvements in the equity market, could boost retail sales, and help shoppers satisfy long pent-up demand.
The stock market, at least, has been anticipating an end to the deleveraging process. Propelled by news of rising sales and earnings, retailers' shares have rallied in recent months, and the Standard & Poor's 500 Retailing Index is outperforming the broader S&P 500 by nine percentage points year to date. "I have a lot of faith in the consumer's demand for goods and services," says Wells' Paulsen. "I don't think we've killed that off."
Paulsen expects household debt to "bottom out and start turning up next year," as the recovery blossoms. Noting that fears of a double-dip recession have faded and leading indicators have risen, he expects the economy to grow by 3.5% to 4% next year.
MANY ECONOMISTS, on and off Wall Street, project substandard GDP growth of 2% or less in coming years what Pimco's Bill Gross calls the "new normal" and some expect the consumer to remain an endangered species. For openers, they note that total household debt, though down from its peak, is up by more than $6 trillion in the past decade. Equities and real-estate investments, on the other hand, have lost 23% of their value since peaking at a combined $37 trillion in 2006. An aging population also could be a drag on future spending.
Nor has deleveraging been a speedy process in the past, as economists Carmen and Vincent Reinhart reminded readers in "After the Fall," a paper they published in August. According to data the Reinharts assembled, in the decades following past financial crises since the Great Depression, GDP rates have risen only 1% and unemployment in developed economies has been about five percentage points higher. The process of deleveraging has taken an average of seven years.
"The decade that preceded the onset of the 2007 crisis fits the historic pattern," they wrote. "If the deleveraging of private debt follows the tracks of previous crises as well, credit restraint will damp employment and growth for some time to come."
There are several reasons, however, to think the current deleveraging cycle might be foreshortened, chief among them massive stimulus spending worldwide to get the global economy back on its feet. As Diane Swonk, chief economist at Mesirow Financial, notes, "the whole world joined together" in pumping $5 trillion into the financial system.
Such intervention has led to historically low U.S. interest rates, an unqualified boon to borrowers, though sadly not to savers. Rates on 30-year mortgages, to cite the most sizable component of consumer debt, have dropped to 4.39% from 4.83% a year ago, while 15-year mortgage rates have fallen even more sharply, to 3.76% from 4.32% a year ago, according to Freddie Mac.
In addition, falling stock prices, ultra-low bond yields and unemployment, real or threatened, have forced consumers to focus more on saving. Household deposits, which include savings at banks and in money-market shares, are up a staggering 32% in the past six years, to $7.5 trillion, according to data from the Federal Reserve.
Reflected in those numbers is a sharp increase in the personal savings rate, which rose to a peak of 8.2% in May 2009 from as little as 0.8% in April 2005. The savings rate the percentage of personal income that isn't consumed since has fallen back to 5.3%.
The savings rate typically rises during recessions and falls amid recoveries, as the public grows more confident about the future. Economists such as Paulsen expect that the savings rate will plateau around current levels.
ONE LEADING INDICATOR of the consumer's health is the default rate on loans; it peaked in the past year in several key loan categories, and has been declining since. The S&P/Experian Consumer Credit Default Indices, a measure of changes in U.S. consumer-credit defaults, fell 3.6% in October from September's level, according to data released recently, and is down more than 36% from a year ago. Index calculations are based on the assumption that auto loans and first- and second-lien mortgages are in default if payments are 90 days late, and that bank-card loans are in default after 180 days.
Default rates have dropped, in part, because banks tightened their lending standards after the credit crisis in 2008, and no longer lend to people and businesses that defaulted. Consequently, the number of delinquent accounts also has declined, says Erkan Erturk, a credit analyst with Standard & Poor's. "We are expecting [continued] improvement but we are cautious" because the unemployment rate remains high, he says.
A Better Balance Sheet
TransUnion reports that credit-card delinquencies, reflecting payments late by 90 or more days, fell to 0.92% of credit-card holders in this year's second quarter, down 17.1% from the previous quarter and 21% from the prior year. The credit-information provider expects the delinquency rate to continue dropping next year.
Even in the troubled mortgage market, delinquencies look to have peaked. TransUnion reports that the percentage of borrowers 60 days past due or more, has fallen slightly in the past two quarters, to 6.67%, which still is higher than a year ago but moving in the right direction.
Credit-card performance historically has tracked weekly unemployment-insurance claims, which peaked at 651,000 in the spring of last year. Last week 439,000 people filed claims, up slightly from the prior week but not by enough to halt a decline in the four-week average.
Monthly jobs data also are looking somewhat better. Total nonfarm payrolls increased by a larger-than-expected 151,000 in October, while private-sector payrolls surged by 159,000. The private sector has added a net of more than a million jobs this year, which might not sound like a lot, but it "gives stability to those who are already employed and increases their willingness to spend," says Carl Steidtmann, chief economist at Deloitte Research.
Steidtmann is forecasting a 2% increase in holiday sales, excluding gas and autos.
EVEN AS THEY WORK to fix their own finances, consumers are getting help from other quarters. Banks and finance companies might be bidding some customers adieu, but they are lending again to those who have proved credit-worthy. Credit-card issuers, for instance, mailed 1.2 billion solicitations in this year's third quarter, a threefold rise from a year earlier, according to Mintel Comperemedia.
In addition, many more prospective borrowers want loans. The number of credit-related, consumer-initiated loan inquiries rose by 1.56 million in the second quarter and 11 million in the third, to 160.8 million, according to the Federal Reserve Bank of New York. While that is well below a peak of 244.6 million inquiries in 2006's third quarter, it is up from a first-quarter low of 148.1 million.
HELP FOR STILL-STRAPPED CONSUMERS and the economy likewise could come from Washington, where President Barack Obama indicated after the midterm elections that he would be willing to compromise on extending the Bush administration's tax cuts beyond their scheduled Dec. 31 expiration. Previously the president had stated his intent to seek a tax increase next year for wealthier Americans, but in the view of Daniel Clifton, head of policy research at Strategas Research Partners, "all the tax cuts will be extended for one year."
If the Bush tax cuts aren't extended for those making at least $250,000 a year, some $65 billion will start coming out of their paychecks and pockets starting Jan. 1. The potential hit to consumer spending could be significant, because although this group represents only 18% of U.S. taxpayers, they account for 35% of spending, notes ConsumerEdge Research.
Despite widespread skepticism about a consumer rebound, not to mention a surge in economic growth, sales trends suggest shoppers are heading back to their favorite haunts, from car lots to coffee shops to the mall, in greater numbers this year than last.
Spurred by special promotions, U.S. sales of cars and light trucks rose more than 13% in October from a year ago, to an annual rate of nearly 12 million, the highest pace since September 2008. Traffic at Starbucks was up 5% in the quarter ended Oct. 3, fueling an 8% increase in sales at stores open at least a year and an 85% surge in earnings.
Same-store sales surged 11.5% in October at Neiman Marcus and 8.1% at Saks, attesting to pent-up demand among the well-heeled. Then again, the urge to splurge was also apparent at Target, which impressed Wall Street last week with a strong third-quarter earnings report, and forecast that fourth-quarter comp-store sales will be the best of any quarter in the past three years.
MANY AMERICAN CONSUMERS still have too much debt, and potential threats such as renewed inflation, rising interest rates and higher taxes could prove formidable obstacles to a recovery in spending. But John Q. Wal-Mart and Jane Q. Saks have worked hard in the past two years certainly harder than their Uncle Sam to mend their financial health. They could be in much better shape than you think.