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Denis Ouellet, CFA
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Denis Ouellet has been involved in the Financial sector since 1975. Now retired, he is a part-time blogger. Denis has been analyst and head of research for a brokerage company, equity manager for various investment organizations (pension, mutual and hedge funds), head of global equity... More
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  • THE U.S. CONSUMER: STAY COOL! 0 comments
    Mar 6, 2012 1:04 PM

    Real Personal Consumption Expenditures have been flat in the U.S. between September 2011 and January 2012, rising a mere 0.2% in the space of the four most important months of the year. Is the consumer on strike?


    The reality is that U.S. consumers are making crude choices. They also have been lucky on the weather!

    • they are curbing spending on food: real expenditures on food, though volatile, are unchanged in the past 14 months;
    • they have significantly reduced spending on energy goods and services: consumption of energy goods and services have declined 11% since mid-2010, including a near 7% slide in the 3 months to January 2012. To illustrate the mild winter Americans have enjoyed, heating degree days for the Contiguous U.S. declined a huge 17.6% YoY for the 3 months to January 2012. January hdd decreased 20%.

    image image

    This has freed some income for discretionary expenditures. Real expenditures on goods and services other than food and energy have been climbing steadily since September 2011. In the 5 months to January 2012, PCE ex-food, ex-energy have grown at a 3.3% annualized rate, not spectacular but decent in the current context.


    Importantly, as it reflects both pent-up demand and a willingness to fulfill it, real expenditures on durable goods have grown nicely since the summer 2011 lull. In the last 3 months, real spending on durables has risen at a 7.7% annualized rate.


    Employment is recovering, boosting employment income while government stimulus is waning. Since mid-2011, growth in transfer payments has stopped while growth in employment income has picked up. Discretionary spending is more likely from employment income than from transfer payments.


    Employment growth has been accelerating recently:


    That said, one big offsetting item to rising employment income is rising income taxes. The average tax rate has risen steadily in the past year, accelerating in recent months. Personal tax outlays have grown at a 12% annualized rate since October.


    As a result, after-tax income growth has declined to the 3% range while spending growth is a shade below 4%, an unstable situation and a precarious one as gasoline prices, hence inflation, are rising rapidly.



    The following two charts highlight the challenge for employment income: weekly earnings growth is slowing because wage growth has slowed from the 2.0% range to less than 1.9% YoY.

    image image

    Let's run simplistic mathematics from here:

    • employment growth at +250k per month = +1.5-2.0% YoY.
    • wage growth: +1.5-2.0%
    • = employment income growth: +3.0-4.0%
    • Assume taxes and savings remain flattish: PCE: +3.0-4.0%, much slower than the recent 4.0-5.0% trend but more in line with PDI growth.

    What about inflation?

    The PCE deflator has been decelerating from +2.9% YoY last September to +2.4% in January. That happened while core PCE was accelerating from +1.6% last September to +1.9% in January.

    Energy inflation has declined sharply from +20.7% to +6.5% during the same period as gas prices troughed in December, dropping from their April 2011 peak of nearly $4.00/gal. to their Dec. 20 low of $3.22/gal. On a YoY basis, gas prices are up 6% currently but given their early May peak last year, the crunch on a yearly basis is going to hit in late summer and fall unless oil prices retreat seriously from here. If Brent prices remain near the $120 mark, gas prices will reach $4.25 this summer, +15-20% YoY.


    It thus seems unlikely that the PCE deflator will slow much from the current 2.0-3.0% range over the shorter term, leaving little room for a significant acceleration in real spending. As the positive effect of the very mild winter ends, consumer spending is set to display YoY growth rates in the 1-2% range and thus act as a drag on economic growth.

    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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