Is The Consumer Doing Well?

Let’s look at various indicators of the health of the consumer to try to get a picture of where economic growth is headed in the second half now that the first half is mostly in the books. Technically, first half GDP is subject to many revisions, but most investors have moved their focus to the second half of 2017 and 2018. I will still review the revisions to Q2 GDP growth, but it’s likely the report was solid regardless of the changes which will be made.

The chart below is the most bullish on the consumer because it shows tax deposits were up over 8% year over year in June. This is hard data which is more valuable than the estimates based on surveys. The negative aspect of raw hard data is that it could be reflecting one-time changes, masking weakness. It’s important to not get too confident based on this chart because it is now estimated that only 50% of people born in 1985 will earn more than their parents. I think demographers could consider changing the millennial generation name to the lost generation. Wages are being lost to the older baby boomers who are working past the age of 65. The percentage of younger people earning more than their parents has fallen from over 90% in 1940 to 50% now. This could be a long-term suppressant on federal tax deposits in the next decade.

As I mentioned, the surveys show wage growth is much lower than the tax deposit growth. The chart below is my favorite wage growth survey which is done by the Atlanta Fed. As you can see, growth has fallen in the past few months. The non-smoothed growth peaked in September 2016 at 4.1% and is now at 3.2%. The 3-month average growth peaked at 3.9% in October and November 2016 and is now at 3.1%. If you look at the previous cycles, the size of the decline we have seen is usually associated with a recession as wage growth is a lagging indicator. The weird part of this chart is that job growth has been strong. If you adjust wage growth for PCE inflation, the decline is mitigated because core PCE inflation is now only up 1.4%. If wage growth is falling in a tight labor market, imagine how much it would fall when the labor market weakened. We might see negative median wage growth in the next recession if the trend of lower highs and lower lows continues.

The chart below is one that I have never seen before. It breaks down personal income growth by how much is driven by transfer payments which are entitlement government spending programs. We don’t want too much growth to come from transfer payments because that means the government is driving income growth instead of the private sector. The private sector is what funds the government. Without the private sector, the government can’t dole out transfer payments. The private sector is cyclical, while the government spending is counter cyclical which is another reason why we want to see a healthy private sector growth and low government spending. A second trend to keep in mind is that the population is aging which means more baby boomers will be getting transfer payments. There is an upward push to the percentage of income generated from transfer payments which should continue until the average age stops increasing.

As you can see from the chart, the personal income growth had been tightly correlated with the income growth excluding transfer payments. As you can see, in the past 18 months, personal income growth excluding transfer payments has lagged growth including transfer payments. That’s disconcerting. Unlike the Atlanta Fed wage growth which isn’t too problematic when adjusting for core PCE, the year over year personal income growth excluding transfer payments when adjusted for CPI has been negative since 2016. That’s the first negative stretch since 2013. If you only looked at the pink line, you’d think America was in a recession. The grey bars which show the percentage of income growth coming from transfer payments have been increasing in the past few years, preventing a recession in 2013 and 2016.

As you can see, there is mixed data on the consumer making it tough to tell how healthy it is. Let’s try to get a better picture by looking at its spending in specific sectors. The chart below shows restaurant and bar traffic compared with the CPI growth difference between food bought at home and food bought at restaurants and bars. When the grey line goes up, it means that inflation is higher at home which is good for restaurants. When the grey line goes down, it means inflation is higher at restaurants which is a negative for restaurants. As you can see, from 2014 to 2016, there was improvement in restaurant traffic growth even as it faced inflation growth compared to home eating. Lately, even with expenses from eating at home increasing, traffic has weakened which shows how weak the consumer has gotten.

As you can see from the chart below, automakers are having problems which is another reason to think the consumer is weak. Actual year over year light vehicles sold declined at every major manufacturer besides Toyota in July. Analysts came into the month with very low expectations and only half of them beat expectations showing that the auto cycle appears to be rolling over.

Conclusion

In this article, I laid out everything you need to know about the health of the consumer. Consumer spending drove annualized GDP to grow at a 2.8% clip in Q2. The question is whether it can continue that pace. In the long-run transfer payments can’t drive income growth, but in the short term it shouldn’t be a problem. However, even with the increased reliance on transfer payments, auto sales are collapsing and restaurant sales growth is negative. When doing your research, you must determine if auto sales and restaurant sales are one off indicators or if they are a sign of systemic weakness which is about to envelope the economy.

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