Why the spending slump?
Why has the US consumer been so reluctant to spend? The first and obvious reason is that higher wages are the single biggest driver of consumption growth, yet signs of wage improvement remain mixed. Even if wage growth does start to accelerate, consumers are unlikely to revert to their old spending habits any time soon.
The reason: The multi-decade debt binge, which supported household consumption prior to the financial crisis, has now come to an end.
Between 1945 and 2007, household debt grew at an average annualized rate of over 9%, much faster than nominal income growth. This trend, which eventually hit a wall in 2007, represented a huge tailwind for household spending. Historically, household consumption has increased by roughly 0.2% for every one percentage point increase in household debt.
Since the recession’s end, household debt has been growing at a much slower pace, less than 1% annualized. Going forward, it is not clear whether older, still-indebted households (even if borrowing has slowed, debt levels are still well above the long-term average) can borrow at the same rate they did before the crisis. In other words, even if wages pick up, consumers will be without the tailwind of debt-fueled consumption.
Higher consumption fuels economic growth, so there are several implications for markets if consumers spend less. Among them: more modest growth, low-for-long interest rates and a household sector that comprises a relatively smaller percentage of the economy than it did at the peak in 2007.
For equity investors, this means being selective when buying consumer stocks, given that retailers are facing a bigger battle for market and wallet share. It also requires looking at other parts of the market, such as technology stocks, that are less reliant on household consumption trends.