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Consumers Not Spent Out Yet

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar.

Our director of economic analysis Bob Johnson keeps a very close eye on the consumer, and he says their spending has been pretty consistent, but will it be sustainable? He is here to offer his take today.

Bob, thanks for joining me.

Bob Johnson: Nice to be here.

Stipp: So the consumer spending, you said, although you some wiggles in the line month-to-month, when you look at it over a broader time period, has been a pretty consistent. What has the consumer spending trend been over a longer period of time here?

Johnson: Generally, on a year-over-year basis, the broadest measure, the government numbers, have been running around 2%. Now we actually had in the first quarter, with autos in particular, we had some acceleration on a year-over-year basis--the consumption number was up as high as 2.9%. Clearly, not a sustainable number, probably, but the 2% has been more consistent, and I think that's the broadest measure that we have.

Because once in a while, the autos ... get a little funky in the numbers, I do like to step back and look at the retail sales number, and there I like to look at the same-store sales report from the International Council of Shopping Centers, and we've been stuck very much in that 2.5% to 4% range on a same-store sales basis, and then you've got to add a little bit to that because they open more stores every year as well. But we've been stuck in that very narrow range, and that's not really what I'd call a boom, but it's certainly not a bust, and it has been remarkably consistent.

Stipp: Several factors feed into the ability for these trends to sustain themselves, and I think perhaps one of the most important, or at least the one that comes to mind first, are consumers' incomes. So they have to make money in order to be able to spend money. What trends are you seeing there that would suggest that this consumer spending trend can persist?

Johnson: Well certainly, on a year-over-year basis, employment continues to grow. We may have a report one month that we don't like, and then like the next one a lot, but overall you take all the bumps out of it, and we're growing employment about 2%, and that's a pretty good number, because the population is growing well less than 1%. So we really are outstripping population growth with growth in employment.

It takes awhile ... people get a job, it takes them a while to get established, get the first check, so [consumer spending] doesn't come instantaneously [with employment growth]. But we are seeing continued employment growth, and I think we all got a little scared that initial unemployment claims went up for a few weeks in a row, and then last week we had the big fall-off. So that seems to have stabilized a little bit.

The job openings report, which we got earlier this week, showed that new job openings were at kind of a recovery high, not that much better than the previous month, but nicely over year-ago level. So we're starting to turn the corner on employment, and I think that's probably, as you point out, the biggest driver.

Stipp: So going from no paycheck to having a paycheck is obviously going to give you the ability to spend more.

What about people who already have jobs, who have been able to maintain a job throughout the recovery--they haven't been making a whole lot more, necessarily, in their wages. So there is not a whole lot of extra gunpowder there for them to spend, right?

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Johnson: Well, the good news is, they have made more and maybe quite a bit more than they made the year before. But the bad news is, when you adjust it and take out inflation, they've been behind the eight ball. It has been a negative number, and then last fall, we had a couple of months where, if you adjusted for inflation, you might have been as much as a percent or two behind the eight ball.

We've now got that number pretty close to zero. We've continued with about the same wage growth number and now the inflation rate has come back in a little bit. So we're looking a little bit better on that front, and I bet in the next month or two, we'll be above the zero mark on that point.

Stipp: Inflation is going to be a big swing factor in how much consumers have, the ability to spend. And so on that point, let's talk about expenses and what they are spending money on, and how much they have to spend. Gas has obviously been in the news a lot recently, but some trends are looking more positive there, right?

Johnson: I tell you, the gasoline prices this spring is what got me scared more than anything else. Now that those have backed off a little bit, I'm feeling a little more flush right now.

I think that we've had five weeks in a row now where gasoline prices have been down. Gasoline prices peaked considerably earlier than they did last year, in 2011, and as a matter of fact, we've got had or three weeks now where gasoline prices are actually down from the year-ago period, so consumers should feel a little better than they did last May with these falling gasoline prices.

Stipp: What about other commodities? We saw gas prices were pretty high last year, and they weren't the only things that were high, right?

Johnson: Right, and I think that's where people get confused ... last year they remember high gasoline prices, but they forget clothing was up because of weather, food--especially vegetables and fruits--were way, way, way up at the beginning of the year, and all that stuff really worked against the consumer. And food is more like 10% of consumption, gasoline is only 5%. So you had those two together, and you are throw in some other commodities, and inflation was up a lot, and that really scared consumers.

Now this time around, gasoline was up, but a lot of the other things were not. Now we've actually even got gasoline moving in the right direction, and that's why I feel better about the consumer.

Stipp: So commodities overall are a little bit less pressure on consumers' wallet right now.

Obviously, though, gas and food aren't the only things that consumers spend money on. What about some of their other obligations--some loans and things like that? How much has that changed, and does that give them a little bit of extra discretionary money that they could go out and spend?

Johnson: Yes, and this is one thing that the government's official statistics don't really capture very well, because they don't actually take ... your mortgage check and calculate that into what consumer spending is. Instead, they make the assumption that if you own a house, what could you rent it for? And that's what goes in the consumption number, and that goes in the income calculation.

Well the reality is, that you send a check, and that check can change with the interest rates, and as time has gone on here, people have been able to refinance their mortgages down at a lower rate, and even the current new buyers buy their homes, and they are buying them at a lower rate than what the previous owner did.

So this financial obligations ratio, the amount of consumer income that's being spent on mortgages, on cars, car leases, and credit cards--that number has fallen from ... close to 19% to under 16%, and I think it's on its way to 15%, a new record low, by the end of this year.

Stipp: So low interest rates certainly have crimped a lot of retirees, but on the flipside, the positive side of that, it means less debt payments that you have to make for some of those things like mortgages and car loans.

Johnson: That's one of the big things that's put cash in consumers' pockets that really the government statistics don't capture very well.

Stipp: Utilities are another one that we spend money on every month. Has there been any moderation in the trend there?

Johnson: Absolutely. Certainly, last year with natural gas, we saw that help in 2011. It helped again, maybe even more, in 2012. This year we kicked in the utilities that generate electricity--they had to cut their rates in some markets because they switched over to natural gas, which was cheaper than the fuels that they were using before. So that chimed in as well.

Then on top of it, we had warm weather. So there was less usage--which, by the way, makes GDP look worse--but I'm glad that we spent less money on oil, I really am. So ... the less money we are spending on utilities and gasoline have both helped in the most recent weeks and months.

Stipp: Warm weather probably also means less wear and tear on your car, potentially on your house, and other things as well. We also saw natural disasters not be as acute this year, so some of the expenses that would be associated with weather-related factors were more moderate this year than we saw in years past?

Johnson: Absolutely, and I think even last year, we had a lot of flooding in this timeframe, which maybe affected agriculture more than anything else, but certainly it hurt the central part of the country, where we had a lot of flooding going on, and that's just not there this year.

Stipp: So, we talked a little bit about what customers are making, and we talked about what their expenses have been. Let's talk about their propensity to spend--more of that mental calculation. We don't necessarily look at those consumer confidence reports, but you do look at some other things that can give you a gauge on how confident consumers are based on what they're actually doing, what they are actually spending. What are those signals saying to you?

Johnson: They are really all quite positive. The auto numbers are particularly strong. We've been over 14 million units [annualized] for most of the year in terms of auto sales, and we were down at 9 million [annualized] one month in the recession, and we had a full year that was just over 10 million, and now we have moved up very nicely, and we are not quite back to the normal, which is 16 million to 18 million. But [consumers] clearly have shown a willingness to spend.

Stipp: They are borrowing more, obviously, if they're buying bigger-ticket items?

Johnson: Absolutely, and there can be mixed interpretations of this--let me just put that on the table--but consumer borrowing has gone up. For four or five months in a row, it's been a relatively big number, and every month that comes out, it kind of surprises people, but a lot of it is auto loans, and that's a good thing.

I think we went through a period where people were buying cars with cash, or they had to have a perfect credit rating, and I don't think we can function in an economy where we've got an asset that lasts five to 10 years at least, and say that you have to pay cash upfront. It just really doesn't make a lot of sense. You don't want to be borrowing crazy, but at least a little borrowing on autos ... the freeing up of that market ... has been a big positive for the auto market.

Stipp: You also keep a close eye on small businesses and what they are doing, because that has a pretty strong relationship to consumers as well, right?

Johnson: This week we got the report out of [small businesses], and clearly the business confidence from small businesses was a little better again. Not a huge, great number, but they even had some intentions to hire more people, and since that's the biggest group of hirers, I was very pleased to see that. So I consider that to be a relatively optimistic report, and again, when people run small businesses, it's a little hard to separate what's personal spending and what's business spending, and I think the fact that they are doing well bodes well for the consumer in general.

Stipp: So it looks some potential tailwinds to keep this consumer spending trend going. I am concerned, however, about the headwind of the "wealth effect." So we know that the higher-income folks have done a lot of that spending that we've seen throughout the recovery, and we know that a lot of their spending may be connected to how they feel like their investments are doing.

This year, so far year-to-date, we're still up about 10%. In the last month or so, Europe has crept back into the headlines, and we've seen about a 2% drop; so the market has definitely been more volatile, has been down recently.

Is this a headwind and a concern for consumer spending in general looking forward?

Johnson: It's always a hard number to tease that out, but just a couple of things: I think that a month's worth of [losses] really doesn't make a difference, unless [the market] just totally collapses and you lose everything or you have one of those months where you are down 10%-20%, and then people immediately react and shut down.

But, in general, if assets go down, 3% to 5% of that will show up in the spending numbers, and that doesn't happen instantaneously. That happens over a one- to five-year period. People seem to say, let's take this in stride. Let's look at it. And it tends to spread over a pretty long period of time. And now we are actually coming off of 2010, 2011, [which] were good years. We started off this year on a good note. So I think the wealth effect is still positively contributing to consumer spending, although if we keep going the way we have over the last few weeks, then maybe that turns around.

Stipp: Bob you've said again and again that the consumer is the person to keep your eye on right now in the economy. Thanks for helping us to do that again this week.

Johnson: Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.