Sustained Drop in Consumer Spending Could Steer Economy Over the Edge

by: The Mays Report

The release of the Personal Income and Outlays report added more to speculation that we're headed into recession. With personal income only increasing 0.1 percent and personal consumption expenditures falling an unsettling -0.2 percent, the market was understandably stunned as neither of these figures met analyst expectations.

Consumer spending saw its first notable decline since September of 2009. One of the most likely reasons for that spending decline was the decline in wages and salaries, which dropped $2.2 billion in June after rising $15.0 billion in May.

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Personal Income and Consumer Spending 06-2011Source: The Mays Report

The largest decline in spending was on durable goods, which declined -0.4 percent in June and has declined for the last four months. This decline is in line with what producer prices for durable goods have shown us recently, that inflation cannot be passed down the value chain due to lack of demand. I was very surprised to also see a decline in spending on non-durable goods which consist of staple items like food and clothing. Spending on services was also muted during the month.

Personal Consumption Expenditures of durable and non-durable goods and services.Source: The Mays Report

Profitability becomes a concern when you see consumers begin to pull back on purchases of even staple items. Companies who operate upstream in the value chain tend to have better results.

Tempur-Pedic International Inc (NYSE:TPX), a company that operates up and mid-stream in its value chain, has improved its profit margins by improving its operating performance. In contrast, La-Z-Boy Incorporated (NYSE:LZB), a company that has operations both upstream and downstream in its value chain, has had its profit margins pressured by the cost of raw materials upstream in its manufacturing segment and price pressures downstream in its retail operations.

Stagnant incomes combined with high unemployment is the recipe for the low GDP growth we are seeing. Combine that with inflation and not only do we find ourselves in a recession, we may have stagflation. Given that the country is already operating with a large budget deficit, stagflation will be next to impossible to eradicate should it take hold. Although we are beginning to see the prices of crude goods moderate, an ever weakening dollar will make it increasingly difficult to douse inflation and thus keep stagflation at bay.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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