A view on U.S. Consumer Spending
Personal consumption expenditures have continued to grow in the current year at a 2.7% nominal rate. This has taken place despite headwinds from the payroll tax expiration, fiscal sequestration, a rise in mortgage rates and uncertainty regarding the costs and implementation of the Affordable Care Act. Cyclical recovery has continued in big ticket spending e.g. autos, housing and durable goods. From a balance sheet perspective, U.S. households have continued to repair their balance sheets by paying down or restructuring debt and by refinancing their mortgage schedules. Moreover, in terms of net worth, consumer spending has benefited from the Federal Reserve’s stimulus to asset prices i.e. housing and financial assets. In terms of real income growth, progress has been uneven between income groups and median household income growth remains in check. However, as the broader labor market continues to show positive momentum, we are seeing early signs of tightening in wages and a rise in unit labor costs. Lastly, with a subdued consumer and producer price inflation (low natural gas and gasoline) backdrop, there is scope for real disposable income growth in 2014.
As a key component of U.S. GDP (70%), the outlook for U.S. consumer spending is conditioned on further cyclical recovery in the labor market into 2014. Current labor metrics such as weekly jobless claims (316k), Nov ADP private payroll growth (215k) and a robust November ISM manufacturing report, point to ongoing momentum in labor markets. Manufacturers in particular seem to be more optimistic for 2014 GDP growth as the U.S. fiscal drag (due to smaller sequestration measures) becomes more neutral. As we can see below, consumer confidence has remained in check as of late, mainly due to uncertainty over the costs and implementation of the Affordable Care Act and rising mortgage rates. The spread of future and current consumer confidence readings is a key leading indicator to watch for U.S. GDP growth.
From an investment point of view, we are monitoring unit labor costs which at some point can become a headwind for the corporate profit cycle. As we can see above, corporations have had the upper hand and with a lot of slack in the labor market, labor’s pricing power has been subdued. As of late however, we are seeing early signs of wage growth; despite some working hour distortions due to the Affordable Care Act. At the sector level, we remain cautious with regard to the consumer discretionary and consumer staples sectors. With elevated valuations, peak profit margins and a highly promotional environment we remain cautious on retailers. We prefer to be positioned for a further cyclical recovery into 2014 via corporate spending and cash rich sectors e.g. late-cycle industrials and technology.
With a fairly constructive view on the near-term U.S. fiscal outlook, we view Fed policy normalization as the main potential risk for consumer spending and the broader economy. From a fixed income perspective, we are still cautious on long duration instruments and we maintain our preference for low duration non-agency MBS. As we can see below, housing affordability has been dampened somewhat by the recent rise in mortgage rates. However, housing affordability is still historically attractive and with elevated rents we maintain our ‘slow and steady’ view on U.S. housing. Apart from residential housing, we are also keen to see how commercial real estate recovers into 2014. Corporations have been underinvesting in the past few years and as we can see above, the recent ISM manufacturing index points to a likely pick-up in fixed asset investment. Lastly, an external risk to U.S. growth would be further dis-inflation stemming out of Asia i.e. as the Yen devaluation puts further pressure on Asian goods prices e.g. Korean and Chinese exports.
In conclusion, as the U.S. fiscal drag becomes more neutral in 2014, expectations are on the rise for a pick-up in corporate investments. A medium-term bi-partisan agreement with regard to the U.S. federal budget and the federal debt ceiling would give further confidence and visibility to CEOs and households. As labor conditions continue to mend and inflation remains subdued, we see scope for real income growth in 2014. Such a scenario would bring the Federal Reserve closer to tapering its asset purchase program. Thus, we seek to be opportunistic in taking advantage of any consequent market volatility.
Christos Charalambous CFA
Senior Strategist
christos.charalambous@edgewealth.com
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