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Johnson: Consumers Feeling a Little Better

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. Two big drivers behind consumer spending are consumers' current incomes and consumers' assets. We got some data on the former of those. Morningstar's Bob Johnson is here to give his take on consumers' net worth and what that might mean for consumer spending in the future.

Thanks for joining me, Bob.

Bob Johnson: Nice to be here.

Stipp: We got a report on consumer net worth last week, and it hit an important milestone that we've been waiting for since the 2008 downturn.

Johnson: Yeah. The net worth number, the raw single-point number at $70 trillion, that's trillion with a T, and that compared to $68 trillion in 2007 when we last hit a peak of consumer assets. So, that was a big landmark. We like to talk about landmark. We talked about it when we crossed the gross domestic product landmark, which we did a year or so ago in terms of exceeding past highs. Employment, we're not near there yet. We're getting very close on industrial production. So, this is another important economic milestone that we've crossed over to recover what we've lost in the recession.

Stipp: Break down the components of the net worth calculation. What's behind it, and what is it measuring exactly?

Johnson: Yeah. Net worth is a real fancy term. All it means is assets. It's everything you own, and you take away what you owe against it, such as your mortgages and so forth. And that's all the number is, so there is nothing really complicated about it. The asset side of the house is made up of real estate at about 25% and other hard assets are at about 6%. You've got bonds and bank assets at maybe of 20% of your assets and the same 20% for mutual funds and equities. Then the other 30% is a big amalgam of long-term stuff; it's really kind of hard to tap. It's your pension assets, your life insurance assets, and your small businesses that you might own.

Stipp: It's important to point out that we've come back a long way, as well. So, you mentioned that $68 trillion in 2007, and then we saw a big dip in net worth during the financial downturn. It was kind of a double whammy with the economy and the stock market losses.

Johnson: It went down 32%. It went into the mid-50s in terms of trillions of dollars. So, the consumer really took quite a hit in terms of their balance sheets. Again, if you think housing is 25% of the number, that's a big deal. And mutual funds and equities are another 20%; those are really pretty volatile things. And that's what kind of moves this number around.

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Stipp: One of the components of the net worth you mentioned is the debt side. So, that's subtracted from what the assets are.

Johnson: Correct.

Stipp: Consumer deleveraging, or paying down that debt, is one of the contributors that we've seen help net worth.

Johnson: Yeah. In this particular report, the one thing that really kind of shocked people was that the overall consumer debt went down again, yet this quarter, and it's been trending down for some time. This time a lot of it was driven by mortgage debt as it had been for some time, but that mortgage debt continues to fall and bring the number down into line. So that's been a really good thing. Debt now is about 16% of consumer assets. It was 18% in 2007, so we've really pulled that back. After years of seeing that number expand, now we've actually managed to move that number in reverse, offsetting some of the debt we're seeing on the federal side.

Stipp: So let's talk about what this might mean for consumer spending. So consumer incomes, if that's the other big driver of consumer spending, have been relatively stagnant in recent times. How stagnant have they been? How bad is the consumer income part of that component right now?

Johnson: We usually grow incomes peak-to-peak in a recovery about 3%. We're certainly not at the end of this recovery yet, but a typical recovery might be about 3% or so for incomes. And incomes kind of move consumption, and that usually ends up being about in the same 3% number. They usually track very closely. In this recovery so far both metrics are up less than 1%, 0.7% and 0.9%, respectively. So we've really been in a very slow-growth mode.

Stipp: If growth is stagnant on that side of the consumer-spending driver, if the incomes aren't really going up, how much can we depend then on this better net worth picture to really drive consumer spending? What would it mean for higher net worths? What's the transmission mechanism for greater consumer spending?

Johnson: A lot of things you can't get at right away. Your stocks, your pensions, there are a lot of things that you can. So it's not an immediate transmission. In fact, I generally think about if your net worth goes up, you'll probably spend about 5% of it during the next couple of years. So certainly it's a nice number to have. It's a nice little add-on, and we've been moving right along on that number, but it is hard to get at. The transmission mechanism is that people can go take out loans again, which maybe the credit cards, car loans, and student loans are up a little bit, student loans. But mortgage debt, as I mentioned which is the biggest piece of consumer debt is actually still headed down and acting like it wants to head a lot further down. So, that's certainly one transmission level: buying a car or buying a house. Another is taking a home equity loan against a home that you already own, that's certainly a transmission mechanism, as well. Or selling your stocks and bonds, or if you are retiring and taking money out of your Roth 401(k), that's another add-on.

Stipp: So as we see baby boomers retiring, one of the mechanisms they use to fund their retirement is selling those assets that are in their portfolios. Do you think that could be a contributor to consumer spending on a secular basis over the next five or 10 years?

Johnson: Well, I think it'll be a little bit of a help. I don't know that it will be a big kicker, because they generally consume less once you retire, too. So that will be a holdback to economy. The biggest years of spending are in your early 50s.

Stipp: So, all in, given this net worth picture and given the stagnant income picture that we see, what are your expectations for consumer spending?

Johnson: For the last couple of years they've run about 2% or so, which is a little better than if you mark it off the last peak. But it's been running about 2% for a couple of years now. I think we've had a couple of quarters where it was actually over 3% recently. And so it appears that the consumer is feeling a little better and spending a little bit more.

Stipp: We'll hope that that trend continues, Bob. Thanks for giving these insights on those very interesting net worth data that we got.

Johnson: Thank you.

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