What's Behind the Spending Momentum?

by: James Picerno

Let's get right to the point: the American consumer isn't easily distracted. A recession may be looming, the housing market may be swooning, but Joe Sixpack isn't easily discouraged from indulging in the great American pastime otherwise known as shopping.

As as this morning's update on personal income and spending reminds us, Joe's keeping the economy bubbling in 2007. In fact, the extraordinary staying power of the American consumer is that much more amazing as it comes in the face of lesser personal income last month. In theory, income and spending are joined at the hip. If you earn less, you spend less, and when you earn more, you spend more. No explanation is needed. But that seemingly iron law only applies in the long run, and even then there's room for debate in a world of easy loans and a myriad of innovations to keep shopping habits alive and kicking. And once you turn to the short term, well, let's just say that logic and mathematical certainty are as ephemeral as the wind.

Consider the latest reading on consumer spending, which accounts for the lion's share of GDP. On Friday the government reported that personal consumption expenditures (PCE) rose 5.6% in August vs. July. As our chart below illustrates, that's the highest monthly pace since May. Last month's rise is all the more impressive considering that it was accompanied by a lesser rate of increase in disposable income.

The notion that the economy may be bubbling more than some think also finds support in Thursday's initial jobless claims report. Last week's new filings for unemployment benefits fell to a four-month low, which implies that the outlook for economic momentum still looks healthy. Then again, this encouraging news was tempered by Thursday's report on new home sales for August, which confirmed what was already obvious: the housing market remains mired in a slump. Indeed, sales of new homes fell in August to the lowest annualized rate in seven years.

But for the moment, there's no obvious sign that the housing problems are spilling over into the labor market. That may soon change, and more than a few analysts are warning of no less. Perhaps, although Joe's still spending as we write. Even so, before we break out the champagne, it's worth taking a look at the broader context for consumer spending trends. As our second chart below indicates, there's reason to stay cautious about the coming months based on the fact that changes in PCE on a rolling 3- and 12-month basis is slowing.

This is a good time to point out that consumer spending can still grow in the midst of tough times for the economy overall. Take another look at the chart above, and recall that during 2000-2002 the financial markets suffered their worst stretch in 30 years. Yet, consumer spending at the time kept growing for the most part. Of course, the growth was relatively meager.

Is the growth of consumer spending fated to become meager once again? If so, what are the implications for the overall economy and the capital markets? Stay tuned.