Consumers: Wallets Open, but Not Too Wide

The forecasting community seems to have acquired a binary character. On the one side, a group of economists and strategists seem to worry over a further weakening in an already weak economy, even uttering warnings of another recessionary dip. On the other side, many, including the Federal Reserve, look for something of an acceleration to the pace of the economy's growth. Of course, forecasting over a period of months is as much a game of statistical quirks as it is one of economic fundamentals. But a look at those fundamentals, especially the all-important consumer, suggests that continued slow growth is the more likely pattern going forward, though if there is to be any deviation, it will likely lie on the side of a modest acceleration.

Consumers could, of course, go on a buying binge. They have certainly done so in the past. If households were to deplete their savings or return to debt as a way to ramp up their spending faster than their income growth, the economy would surge for a time. It might look good, especially for those presently forecasting an economic acceleration. But the gains would almost certainly be short lived. The savings loss and debt run up involved in such a spending surge would quickly impose a need for retrenchment and so ultimately lead to an economic decline. It would be a poor trade-off indeed for the economy and for investors. A more conservative consumer would be much better—one who keeps his or her spending growth about in line with the rate of income expansion, even if it remains slow, and so ensures a durable if unimpressive recovery.

The behavior of households to date strongly suggests that just such a conservative approach will likely prevail. Indicative is how people handled the bonus and dividend surge late last year. As 2012 drew to a close, many firms, anticipating tax increases in 2013, telescoped the bonuses and dividends they would normally have disbursed in 2013 back into the closing months of the old year. December 2012 saw a remarkable jump of 33.9% in dividend payouts, and even more unusual, bonuses drove an almost 25% annualized increase in all private wage and salary disbursements. Households treated this boon flow with great sobriety. Recognizing the extra income as a one-time event that had been taken from future payouts, consumers held back. Savings jumped, rising during that December to 8.7% of aftertax income, from an average of only 3.7% during the prior six months.1

That same conservative stance has held sway so far this year. Income growth during the first half of 2013 suffered because much of those special December payouts came from monies that would otherwise have been disbursed in January, March, or later. Overall household income actually fell at an annualized rate of 4.4%. But households clearly saw this drop as no more fundamental than the late-2012 surge. Instead of adjusting their spending down, households used some of the savings built during late 2012 to maintain moderate spending growth at an annual rate of about 3.0%. In the process, households brought their savings rate back down by midyear to a more normal 4.4% of aftertax income. At this level, the adjustment would seem to be near complete, allowing households going forward to hold to their conservative approach and expand their level of consumption at about the same pace as their income grows.2

That likely income growth should equal an annualized rate of about 4%. Some employment growth will contribute: it is trending up at about 1.7% a year. Adding to that, wage growth (including the effects of overtime) should hold to its recent annualized trend of 2.4% a year. The sum of these influences—the expected 4% overall income growth—is faster than in the first half and so could produce the mild acceleration looked for by the Fed and other forecasters, though hardly enough to alter the underlying slow-growth picture. Since consumer prices are expanding at a pace of about 1.5% a year, such a nominal income and spending trend should produce a real annualized expansion in consumer spending of about 2.5%, faster than the barely 1.0% annualized rate of real advance registered during the first half of the year. With the consumer accountable for nearly 70% of the economy, the net effect of this modest improvement, all else equal, would bring in real overall gross domestic product growth about 1.0% faster than during the first half, conservatively something in the 2.0–2.5% range.3

1Data from the Department of Commerce.



* I would like to thank Steven Lipper, Lord, Abbett Investment Strategist, for suggesting this line of analysis.

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

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