GARY SHILLING: Recession Is Coming, And It’s All Due To The Consumer
- Consumer spending does remain strong. 0.8% growth in February was the best number in 7 months.
- Retail sales and consumer confidence have also been strong.
- But the numbers can’t last. Personal income growth as just 0.2% in February.
- Thanks to college tuition and the car market, consumer debt is growing again.
- The housing market is still miserable.
- State and local spending is still depressed.
- There’s still plenty of excess capacity, restraining business investment.
- It call comes down to the consumer: Due to weak wage growth a retrenchment is inevitable, and that’s what will cause the recession.
For several months, I’ve been forecasting a recession in the U.S. this year, arguing that weakened consumer spending — the key to the economic outlook — would tip the economy back into a downturn.
But what about recent positive data and markets? Do they affect my forecast? Bullish investors will say I’m wrong, pointing to the 29 percent increase in the Standard & Poor’s 500 Index (SPX)from its October 2011 low.
— Consumers Are the Linchpin: The U.S. economy is being fueled these days by strong consumer spending, which increased in February by 0.8 percent, its best showing in seven months, after rising 0.4 percent in January. Retail sales rose 1.1 percent in February — the fastest pace in five months — while same-store sales advanced 4.7 percent. These numbers correlate with recent gains in consumer confidence and sentiment.
I don’t see this pace continuing. Personal-income growth continues to be weak — up just 0.2 percent in February — meaning this recent exuberant consumer spending is being fueled largely by increased debt and tapping of savings.
At the same time, pay per employee is rising slowly and continues to fall in real terms. So increased job growth remains the key to any increases in real household after-tax income, which declined in February for a second straight month and gained a mere 0.3 percent, compared with February 2011.
— Spending, Saving and Debt: The support that consumer spending has received from less saving and more debt appears temporary. Household debt — including mortgages,student loans, and auto and credit-card loans — has fallen relative to disposable personal income, though. In my analysis, this is largely because of write-offs of troubled mortgages. Nevertheless, revolving consumer credit, mostly on credit cards, is no longer being liquidated.
Non-revolving consumer credit continues to rise in response to growing sales of vehicles — most of which are financed — and in student loans, as the poor job market keeps students in school or sends them back. Tuition increases encourage more borrowing, while interest costs on past-due loans mount.
It would seem, then, that contrary to my steadfast belief that consumers are being forced to save more and reduce debt to rebuild net worth, they have been doing the opposite lately. In making the case for a long-run savings spree, I continue to point to the volatility of stocks starting in 2000. That volatility ended the belief of many individual shareholders in the 1980s and 1990s that ever-rising stock portfolios would substitute for savings and put their kids through college, finance early retirement and pay for a few cruises in between.
But with the 2000-2002 dot-com-led stock collapse and the 2007-2009 subprime mortgage-driven nosedive, investors have suffered through two of the five stock-market declines of more than 40 percent since 1900. Furthermore, the S&P 500 index was flat in 2011 and has experienced 13 years of drought since 1998. In response, investors continue to exit U.S. equitymutual funds and pour money into bond funds.
With the house-price collapse and the earlier huge withdrawal of home equity, consumers can no longer use their homes as leverage for oversized spending. The profligate postwar babies need to save for retirement, and they can. Many are in their 50s, their peak-income years. Their offspring’s tuition bills have disappeared with graduations and, if their kids are like our four, they no longer have as many smashed-up cars to replace. Also, those with jobs should be encouraged to step up saving for contingencies, due to employment uncertainty.
— Consumer Retrenchment: The data so far aren’t conclusive, but evidence of U.S. consumer retrenchment is emerging. Consumer confidence has moved up recently but remains far below the levels of early 2007 before the collapse in subprime mortgages set off the Great Recession. Real personal consumption expenditures growth has been volatile in recent months and falling on a year-on-year basis. Voluntary departures from jobs, another measure of confidence, may be decreasing. And consumer spending will no doubt have a big slide if my forecast of another 20 percent drop in house prices pans out.
Housing activity remains depressed, with the only signs of life coming from the multifamily component, which is being driven by the appetite for rental apartments as homeownership declines. Homeowners are losing their abodes to foreclosures; many can’t meet stringent mortgage-lending standards; some worry about homeownership responsibilities in the face of job uncertainty; and many have no desire to buy an asset that continues to fall in price.
— What Oil Threat?: Recently, there has been great concern about $4 per gallon gasoline and whether, as in 2008, those high prices will act as a tax on consumer incomes and force drastic cutbacks in other purchases.
These concerns are overblown. American consumers have reacted to rising gasoline prices as you would expect in tough times: by consuming less. Demand (DOEDMGAS) in the mid-February to mid- March four-week period was down 7.8 percent from a year earlier, mainly due to more efficient vehicles. Americans drove 264.4 billion miles in December, up 1.3 percent from a year earlier, but they used 2.5 percent less gasoline and diesel fuel.
As a result, the recent surge in gasoline prices has had a relatively small impact on consumer purchasing power. The $14.8 billion increase from October 2011 to March 2012, compared with the year-earlier period, amounts to about 0.3 percent of consumer spending. After including the reduced costs of natural gas, propane, electricity and heating oil, the net increase of $5.8 billion is only about 0.1 percent of household outlays.
And the recent weakness in commodity prices has included crude oil, whose price per barrel fell to $102 in the early days of April, from slightly more than $110 in late March. The increase in gasoline prices appears to have stalled, with the average pump price remaining below the dreaded $4 per gallon mark for several weeks.
Consumer spending is the only major source of strength in the U.S. economy this year. State and local-government spending remains depressed because of deficit woes and underfunded pension plans. Housing suffers from excess inventories and may face a further 20 percent drop in prices. Excess capacity restrains capital spending. Recent inventory building appears involuntary. So consumer retrenchment will tip the balance toward a moderate and overdue recession.
Tomorrow, in Part 2, I’ll examine the employment picture and how renewed job weakness will affect corporate profits and consumer spending.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own.)
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