Is the Consumer Really Back?

Jason Stipp: I'm Jason Stipp for Morningstar. There's no denying that the fate of the US consumer and the U.S. economy are closely connected, but just how crucial is the consumer and how is he feeling today? Here with me to offer some insights is Morningstar's Bob Johnson. He's associate director of economic analysis. Thanks for joining me, Bob.

Bob Johnson: Good to be here today.

Stipp: So you recently described the effect of consumer spending as sort of a whip effect on the economy. Can you explain a little bit about what you mean by that?

Johnson: Sure, it's like a giant whip or a "crack the whip" the game where the handle of the whip is the consumer. And it actually doesn't move very much, but at the very tip of the whip is something like investment spending that is very, very volatile. And you might see consumer spending go down two percent, but you might see investment spending go down, as it did this time, as much as 30 percent. So a little move in consumer moves a lot of the other categories even more.

Stipp: So certainly because the consumer is just such a huge part of the economy overall that you can see a little improvement there, but it creates this sort of follow on effect on the down and on the upside as well.

Johnson: It goes up both ways and the consumer, as you say, is 70 percent, but what it really affects is the business investment spending, and so forth, down the other end of the whip, which really moves the economy around.

Stipp: Sure. So give us a sense, then, of how far--it seems like consumers have been improving. Recent reports showed some improvement there. How much farther do we have to do to get back to normal? Have we completely recovered or do we still have some ways to go?

Johnson: Well, where we are, believe it or not, it's a hard number to believe, and I'll break it down just a little bit. But consumer spending, in real dollars, that is inflation adjusted, is higher than it's ever been in U.S. history now, as of last month's report. So I think that's a pretty amazing number. We covered the ground we lost. Now, keep in mind it wasn't all that much ground. It was around a two percent decline in consumer spending overall. Now we've gotten every last drop of that back and a little.

Stipp: OK. So, I think that we have seen in retail sales reports some real spending is going on out there. Consumer wallets seem to be opening up a little bit. I think for a lot of people, they're wondering, "How is this happening when unemployment still seems quite high?" We've seen some improvement there, but we're still at elevated levels. Where is the money coming from?

Johnson: Yeah, very good question. A couple places where it's not coming from. It's not coming from debt. The consumer debt levels are down from where they were at the worst of the recession. We've actually spent down, so the good news is that they're not spending it from a bunch of loans. That's the good news. It would appear that a lot of the money is coming out of savings, gains that have been made in the stock market. And given that some of the higher-end stores, the Nordstroms, the Saks, and so forth, have been particularly strong might be indicative of the fact that some of it's coming out of savings and the stock market returns. We are up in the 70 percent range in the market and some of that money, inevitably, gets spent.

Stipp: So we're seeing a flip side of that negative wealth effect, that we had in the depths of the downturn, is coming back around now and people see their portfolio levels up a little bit. They feel a bit wealthier and perhaps that leads them to spend a little more money than they had been spending during the downturn.

Johnson: Absolutely. And I guess the other thing I'd want to say, a lot of people are like, "Well, now the savings rate's going to go back to the same crummy result before, and then we're going to be in the same old problems again." I don't really think we're there. I think when we got to five, six percent savings rate, I think that number was high because everybody was scared, really scared and panicked, and saved more than they really needed to, if you will. And I think that now the number's down around three percent. So we've kind of cut it in half, but it's still off the zero that we reached at one point in time.

Stipp: Now that we've seen a nice pop in the stock market and maybe that wealth effect, it probably has some end to it after the market has come up. And we also saw some stimulus last year, that helped to spur spending in the auto area, for example. What's it going to take to keep this engine going? Do we need to see further government stimulus? Do we need to see further stock market gains? Or are there more fundamental factors that will get consumers to continue their spending trends?

Johnson:  I think that the next step in the puzzle is the manufacturing component to come back, which it has. And then see them hire more people and bring the employment number up which we're seeing. And then that leads to more service jobs around the periphery of the manufacturing businesses. And I think last month's job growth of 290,000is indicative of what can happen and if we get a few more months of that, that will put a lot more income in the hands of consumers and I think that's going to be the key driver in the next six months, along with more hours worked and maybe some gains in real wages.

Stipp: Last question for you. It's always nice to see some of these assumptions play out on the ground in some anecdotal evidence. What stories do you have from the street that indicate that we are seeing a real recovery for the consumer?

Johnson: There are two things that are going on out there. There are a lot of things happening in the tech sector and then there's other things happening in the restaurant sector. And those are two consumer discretionary items where they're a little volatile and maybe extras, so that when people spend there you know things are getting better. In the case of restaurants, just pick a name. Most of them are doing very well right now. If you look at Starbucks, if you want to pick one name brand, the traffic in their stores was up in the most recent quarter for the first time in 13 quarters. That's more than three years.

So that's one of the signs that's going on there and you've got everybody from Brinker doing well, Cheesecake Factory and the mid cycle restaurants and then even on the low end, McDonald's continues to do well and report great sales results. So that's the restaurant side and that's discretionary and that's doing well.

On the tech side, where to start? Intel's excellent earnings this quarter were largely driven by consumer spending. We've seen articles that the netbooks are beginning to lose favor and conventional notebooks that are more expensive and more highly featured are actually selling better. Apple/Macintoshs are growing much faster than the entire industry and yet they're two to three times the price of other computers, on a list price. If you adjust it for a few things it's not as drastic. But the Apples are more expensive and people are flocking to them.

Stipp: Certainly nice to see some of those positive signs. Bob, thanks for your context and the insight on the consumer today.

Johnson: Great to be here.

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