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5 Tailwinds to Consumer Spending

Jeremy Glaser
Robert Johnson, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Will consumer spending start to pick up again? I'm here with Bob Johnson--he is our director of economic analysis--for his take on the state of the consumer. Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: As we are approaching the holiday season and we're wondering what consumer spending is going to look like in the fourth quarter, what are some of the factors that you're looking at to determine the strength of the consumer right now?

Johnson: Well, there are four or five factors that I believe are really important that are going to help the consumer in the fourth quarter and make for a very good holiday season. I think the National Association of Retailers is thinking sales over the holidays may get up to 4.1%--that would be the best number since 2011.

So, let's go over some of those reasons why the economy might do better. First, let's start with gasoline prices. Gasoline prices are down from about $3.70 a gallon earlier in the year all the way to $3.08 on average today across the U.S. And looking at crude-oil prices, it looks like there may be even more room for that gasoline price to fall, potentially under $3, in just the next couple of weeks ahead.

Glaser: Defying expectation, interest rates keep coming down. Do you think that will support spending?

Johnson: I think it absolutely will and the primary mechanism there is probably in the housing market. I think housing had stalled out a little bit because of affordability issues, and now we've seen home price stop accelerating so quickly. And now, we've got interest rates actually coming into a point where they are going to be lower. I think that's a big help for the housing market and, of course, the housing market has a big knock-on effect of furniture, mortgages, moving--all sorts of different things that are very positive for the economy. So, lower interest rates are certainly a big help.

Glaser: One of the big worries, though, has been stagnant wage growth and the jobs market. Do you think the [economic] recovery and the jobs recovery we have right now is enough to support more spending?

Johnson: I think the jobs market is actually something I'm looking forward to helping the fourth-quarter and 2015 numbers. We've now got the unemployment initial claims down to its lowest level since 2001, and that's usually a pretty good harbinger of what's coming in employment. And we've certainly seen the employment numbers look relatively good lately, a slightly accelerating trend. That should put more money in the consumers' pockets. And I've got this ongoing thesis that has yet to fully identify itself, which is that we're going to have a labor-market scarcity in higher wages. And I think we've certainly seen some of the scarcity show up, but the higher wages have not just yet, and I expect to see those over the next six to nine months.

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Glaser: What kind of progress are households making in paying down debt and cleaning up their personal balance sheets? Does that kind of support spending or is all this extra money really just going to go to paying down more debt?

Johnson: I think the consumer has been remarkably conservative in 2014. We've gone for an unusually long period of time where incomes and wages have considerably outpaced spending. In fact, the rate of increase in spending so far this year has been roughly half of the increase in wage and salary income. So, it's been a big surprise. The U.S. consumer does one thing very, very well and that is spend every dollar they have--and frankly, they haven't done that the last seven or eight months. I expect that to reverse itself in the fourth quarter.

Glaser: And how about inflation? We had some new Consumer Price Index data. We're still kind of in that low-inflation environment. Do you think that will have an impact here?

Johnson: I think that last holiday season we also had a very low-inflation environment. So, I think it's going to be certainly better than what we saw in July and June when we had big food-price increases. I think we'll be down from those levels. We're at 1.7% growth versus 2.1% in the middle of the summer. So, we've backed that inflation rate down a little bit. And as I mentioned, I think gasoline prices will come down further. So, I think we'll get down to 1.5% by the end of the year, which might still be just a little bit ahead of last December's number.

Glaser: So, if these are the factors that are kind of helping the consumer, what's holding them back? What's keeping these numbers from really getting much better?

Johnson: I think one of the things that's out there that's holding it back is, frankly, housing has started to go up a little bit again--and we've talked about the new-homes market. But the other thing that we saw in today's Consumer Price Index release is that rents are beginning to move up, and I actually thought this overall report might show some deflation--that we'd actually see a decrease in prices from month to month--but what held us back was that rent expense went up. And so, that's been one of the things that could potentially hold back the economy as consumers have to pay more for their housing.

Glaser: How about these volatile stock markets?

Johnson: They're certainly not a help. There is the so-called "wealth effect," in that people who feel wealthy in the stock market tend to spend more of their cash. And that usually helps out a lot. So, that's one of the things that will probably hold us back. Even if the markets recover, all of this volatility has probably got everybody a little bit scared again. And I don't know how much it's true anymore, but the old rule of thumb used to be as the market goes and year-to-date returns as we enter the holiday season is kind of how well we do in the holiday season. Unfortunately, markets are just kind of right at that line between gains and losses. So, it's not clear that it's going to be a big boost or a big hindrance to the holiday season this year.

Glaser: But looking at where we're expecting the spending to be coming from, is it mostly from wealthier households who maybe have more exposure to stocks or is it from lower-income families?

Johnson: I think we are about on the cusp of a major shift. We've seen a lot of people that service the high end do very well--and they may very well continue to do OK--but people that service the low end, think maybe a Wal-Mart (WMT), have not done as well. And I think that may be just about to flip, because if you look at what's coming down--gasoline prices, natural gas, food starting to move down just a little--those are all things that are a bigger portion of low-income households' spending. So, I think that, as those prices come down, the low end of the market is about to get a big help. And I think that may surprise some people about what does well over the holiday season.

Glaser: Bob, I appreciate your take today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.