U.S. Consumers: Spend More? Bah, Humbug

Sometimes, something says something good about the economy’s growth prospects. Two quarters of relatively strong advances in real gross domestic product (GDP) and more recently falling oil prices and strong November jobs numbers offer such signs. They are welcome. Still, reason remains to curb levels of enthusiasm. The employment figures have given plenty of false signals in the past, and many of the same forces dampening growth so far in this recovery remain in place. Especially for the consumer, fully 70% of the economy, seems unwilling to act as aggressively as in the past and so is less likely to propel the overall pace of growth.         

The most recent good news is a pickup in the pace of hiring. Recent reports for November indicate 321,000 new jobs created during the month and upward revisions in previous months’ estimates.While this is indeed news, it is important to keep in mind that individual months in the past have shown surges that have then petered out. In January 2012, for instance, payrolls rose by 360,000 only to slow to a disappointing 96,000 by April. What is more important, and as a consequence more encouraging, is the general improvement this year over 2013. Every month this year, except weather–depressed January, has reported payroll increases over 200,000. Only five months showed such gains in 2013 and a still smaller portion in 2012. The 2.0% growth in payrolls so far this year compares to only 1.7% in 2013 and a 1.6% yearly rate averaged between 2010 and 2012. The jobs picture still has many troubling weak spots, but the trend is encouraging.

Presumably, the additional jobs will increase household incomes, encourage more consumer spending, and so accelerate the pace of overall economic growth. If the percentage point increase in employment were to translate directly into income, it would raise wages and salaries growth from the 4.3% pace averaged during the last twelve months toward 5.1%. Since wages and salaries constitute about half of all income in this economy, overall income flows would accordingly rise from the 3.9% recorded during the past twelve months toward 4.6%. With taxes still rising as a percent of gross income, spendable income growth would then register about a 4.5% nominal annual rate of increase. And if households were then to spend the increase, the overall pace of nominal consumer spending would accelerate from the 3.9% rate averaged during the past twelve months to about 4.5%, or about 3.0% in real terms. That would accelerate the economy’s overall 2.3% rate of real growth averaged during the past four quarters up to about 2.8%, an improvement but still short of the economy’s long-term average growth rate of 3.2% and its average growth rate of closer to 3.8%.     

But these are big “ifs.” For one, it is not apparent that the recent accelerated pace of employment growth can persist. False starts in the past issue a warning, and all the factors that so far have kept back hiring remain in place. Managements certainly continue to carry scars from the great recession that temper their impulse to expand, what the great economist John Maynard Keynes referred to as their “animal spirits.” Continued uncertainty about costs and the ultimate requirements of the Affordable Care Act and even the Dodd-Frank financial reform legislation will continue to reinforce such hesitations. Meanwhile, households, too, have shown an atypical caution about spending. Compared to past recoveries and the past in general, they have spent less aggressively in this recovery and saved more. On average, households have saved well over 5.0% of their after-tax income in this cycle, low by international standards but high by past American standards. What is more impressive, and indicative of how they will likely behave going forward, is how households, whenever their savings rates have fallen below trend, have quickly corrected by slowing their rate of spending.   

On balance, then, the consumer should hold to a comparatively slow rate of expansion even if the improved hiring trend is durable. It should come in below a 3.0% yearly rate. The current quarter may prove an exception, however. The recent precipitous drop in oil and gasoline prices will leave the consumer at least temporarily better off. Because energy absorbs almost 10% of the average household budget, the recent drop in price amounts to about a 2.5%  jump in real spendable income, a good portion of which consumers will no doubt use to improve the holidays, making the fourth-quarter GDP look better than the fundamentals and longer-term prospects described above. But unless the oil price declines go deeper still (not especially likely), much less if oil prices bounce back up (entirely possible given the volatility in the Middle East), the pace of consumption growth and overall growth in the new year should continue at a still substandard rate.

1 Employment data from the U.S. Department of Labor
Data from the U.S. Department of Commerce

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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