CSCMP's Supply Chain Quarterly
November 18, 2018
Monetary Matters
Monetary Matters

The state of the American consumer

Comment
Taking the pulse of the American consumer today reveals shifting spending patterns and some areas of concern, but overall a healthy prognosis.

Consumer spending makes up nearly 70 percent of U.S.gross domestic product (GDP) and plays a major role in driving the American economy. Trends in consumer behavior therefore matter for most supply chain managers. So, how is the U.S. consumer sector doing?

Consumer fundamentals are healthy

Article Figures
[Figure 1] Job openings outpace unemployment
[Figure 1] Job openings outpace unemployment Enlarge this image
[Figure 2] Real mean household income by quintile
[Figure 2] Real mean household income by quintile Enlarge this image

For the last several years, consumer spending has been the engine that has kept the American economy growing. Between 2014 and 2017, annual growthin inflation-adjusted (real) consumer spending outpaced growth of broader gross domestic product by an average of more than seven-tenths of a percentage point. That dynamic has shifted in 2018, and over the first half of the year, it was real GDP that took the pole position. But this reversal didn't come from a marked slowdown on the consumers' part. After a surge in spending during the fourth quarter of last year, during which a very strong holiday season ushered in a 3.9-percent annualized rate of real consumer spending growth, consumers took a breather in the first quarter of this year, then sprang back into action with a 3.8-percent growth rate in the second.

Surveys of consumer opinion reveal exceptionally positive views on the economy. The Conference Board's Consumer Confidence Index jumped in September to its highest level since September2000, while the mid-October reading of the University of Michigan's measure of consumer sentiment also remained elevated. Measures of consumers' views on whether it is a good time to buy big-ticket items like cars and large appliances are also fairly high.

What is driving this optimism? A very strong jobs picture has also been a major factor. The labor market has been steadily improving during what is now the second-longest economic expansion in American history, and it is unusually "tight"—companies are reporting a high demand for workers, and it is easier to get a job right now than usual. The rate of headline unemployment—or the number of people who officially say they do not have a job and are looking for work—was 3.7 percent in September, the lowest level in the last 48 years. Additionally, the number of available job openings has been greater than the number of Americans looking for work since this March. (See Figure 1.)

This tightness in the job market is pulling workers who had previously been discouraged in their job searches off the sidelines. The U.S. Bureau of Labor Statistics' "U6" measure of unemployment, which includes discouraged workers and those who are part-time but would prefer to be full-time, was 7.5 percent in September, 0.1 point from the lowest since April 2001. And the proportion of "prime-aged" (25-54) workers who are participating in the labor force—either by working or by looking for work—has been on an upswing since late 2015.

When businesses can't get the workers they need, they often raise wages to make their available positions more attractive or to hold on to the talent they do have. This pressure is finally producing an uptick in aggregate wage growth. Average hourly earnings of all employees of private businesses grew 2.8 percent versus the year before in the third quarter, while the U.S. Employment Cost Index for wages and salaries in the second quarter was up 3.0 percent; these readings were both the fastest year-on-year growth rates since the Great Recession. On top of that, the Tax Cuts and Jobs Act of 2017 put some extra cash in workers' pockets as a result of lower tax withholdings. In short, real disposable income is on the rise. In addition, total household net worth has risen strongly in recent years, thanks to growing home and equity prices, and surged past its pre-recession peak in 2012. The result is that American consumers are feeling wealthier—a plus for consumer spending and retail sales.

We have also not yet seen the kind of risky spending behavior that marked the period leading up to the Great Recession. The ratio of household debt payments to disposable income in the US (the "financial obligations ratio") has only seen a gradual increase since 2014 and remains substantially beneath its pre-recession high. The same goes for the total amount of inflation-adjusted debt carried by the average household. Indeed, this adjusted debt total declined in the first half of 2018. And, as revealed by new data in July, Americans' rate of personal saving has been steady since 2013, holding at a level higher than it was for most of the period since the late 1990s. Consumers are putting more aside for a rainy day than previously thought.

Certainly, there are features of today's consumer economy that could foretell trouble ahead. One wildcard remains the Trump administration's still-escalating tariffs. In addition to disrupting supply chains, ramped-up tariffs on imported goods typically translate into higher prices, cutting into purchasing power. Such price spikes have already become evident for certain types of goods, including washing machines, which were targeted with tariffs in January. Another area of concern is outstanding student loan and auto loan debt, which in the second quarter was upmore than 75 percent since the end of the recession. Such rapid borrowing growth warrants caution.

However, all things considered, the U.S. consumer sector's many strengths are supportive of continued robust spending and lend it the resilience to weather shocks. In order to keep up with the consumer demand that IHS Markit anticipates, businesses will have to rebuild their inventory stocks in the coming quarters.

An inconsistent recovery

In aggregate, things are looking good for the American consumer. However, the gains from the recovery have been distributed unevenly with some sectors of the population recovering faster than others.

As recorded in the U.S. Census's "Income and Poverty in the United States" report, which was released this September, median real household income grew for the third straight year in 2017, ramping up 1.8 percent. But not everyone has enjoyed an equal share of these income gains. By 2013, only the top 5 percent of households had recovered the same level of average income they had enjoyed in 2008. By 2015, growth of average household income for the top 80 percent of households had risen past the zero mark, but those in the top 20 percent were still far ahead. Even in 2017, the bottom 20 percent of households were still slightly underwater compared to 2008. This imbalance between households at the upper end of the income distribution and households on the lower end worsened in 2016, when the top 5 percent of households saw the fastest relative growth among all the income cohorts. (See Figure 2.)

When looking at household net worth instead of income, the difference is even starker. Median real household net worth in 2016 was still more than 30 percent beneath its level in 2000, thanks to the fact that real estate assets and equities, whose price growth has far outpaced wage growth, tend to be held by wealthier households.

However, there are signs that the wealth is beginning to spread. In 2017, growth of the average income of households in the 20th to 40th percentile outpaced the highest earners. In addition, the usual weekly earnings of full-time and salary workers in the 10th percentile—those near the very bottom—grew faster than any of the cohorts above them in seven of the last eight quarters.

In sum, the evidence is clear that the recovery since the Great Recession has favored wealthier households—but this imbalance has shown signs of easing since 2017, likely thanks to the tight labor market. This broadening of the recovery has implications for the distribution of goods that are sold. Luxury retailers and discount stores have been doing well to date, but now businesses offering goods and services aimed at the middle class are likely to gain some more traction.

What's ahead?

Given the healthy positioning of U.S. consumers, the retail sales outlook for the holiday season is strong. Real consumer spending is currently on track to score a respectable 2.6 percent growth rate in 2018, according to IHS Markit's latest forecast. We forecast total retail sales and food services to grow 5.2 percent in 2018. Holiday retail sales1 grew 5.3 percent in 2017 over the year before, which was the best year since 2005; we currently forecast continued strength this year with 4.7-percent growth.

Not all categories of consumer spending will do equally well. Auto sales have been a driving force for consumer spending in recent years, powered by pent-up demand after the Great Recession. This dynamic has now mostly played itself out, freeing up dollars for consumers to spend on other goods and services, which will see a boost. The pace of auto sales over the next three months will be below the levels of a year earlier; we forecast retail sales at motor vehicle and parts dealers to fall at a 3.0-percent annualized rate in the fourth quarter, down from a 0.3-percent growth rate in the third. Tariffs also threaten to do damage to sales of automobiles and other durable goods in the medium term.

While solid consumer fundamentals are a tailwind for all retailers, those with a prominent online presence are on track to capture a larger share of consumer spending going forward, including during this holiday season. Nonstore retailers' sales were up 11.4 percent year-on-year in September and are expected to maintain comparable or higher rates for the next two years. The relentless growth of the e-commerce sales channel has given brick-and-mortar establishments serious headaches; retail store closings hit a record in 2017 and are on pace to surpass it again this year. E-commerce as a share of retail sales excluding gasoline, auto dealers, food and beverages, and food services reached an all-time high of 17.5 percent in the second quarter, and we expect this to surpass the 20 percent mark by mid-2020. After growth of 11.4 percent in 2017, we forecast online holiday sales to grow 12.0 percent this year.2

In sum, U.S. consumers are in a strong position, bolstered by a tight labor market, the benefits of which are gradually spreading across all income levels. This means that supply chain managers should expect to see robust purchasing activity going forward, which is forcing retailers to bolster their stocks of inventories—even as an increasing proportion of these inventories flow to nonstore merchants.

 

Notes:

1. IHS Markit defines holiday retail sales as not-seasonally-adjusted November plus December retail sales excluding autos, gas, and food services.

2. Online holiday sales are defined as not-seasonally adjusted November plus December electronic shopping and mail-order retail sales.

Chris G. Christopher, Jr., is executive director of the U.S. Macro and Global Economics practice at the research and analysis firm IHS Markit. David Deull is a senior economist at the economic research and analysis firm IHS Markit.

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