U.S. consumers not so tightfisted after all

Goods consumption data this week hardly suggest the gun-shy consumer that the media is portraying.

Robert Johnson, CFA 4 January, 2016 | 6:00PM

The U.S. economic news this week was another mixed bag. Consumption data, especially on a deflation-adjusted basis, looked great, particularly for the goods-only category, which showed a 1% monthly increase. However, the larger services sector couldn't manage any growth at all, with poor utility usage and a temporary dip in healthcare growth hitting the November statistics.

Consumption growth for the whole fourth quarter may now fall below the growth rate of the third quarter because of slower auto sales and healthcare as well as utility usage. Unfortunately, the housing sector may not be able to offset softer fourth-quarter consumption, as existing-home sales took a tumble on new paperwork regulations that dramatically slowed closings despite good pending-sale data last month. Soft broker commissions on existing-homes sales will weigh on fourth-quarter GDP, too.

Manufacturing looked just a little better order-wise, but not enough to move the economic needle in the short run. More surprising, shipments from order backlogs declined for the second month in a row. Business investment spending is taken from that report, suggesting that business investment will be down in the fourth quarter.

By the way, third-quarter GDP growth was revised down from 2.1% to 2.0% on slower inventory growth. Otherwise, things were mercifully unchanged, with consumers being the key to growth and inventories being the major problem child of the quarter. For reasons not related to fundamentals, it now looks like without some Hail Mary type of help from inventories, GDP growth in the fourth quarter may not be much better than it was in the third.

Consumption data looks surprisingly strong

Between October and November, inflation-adjusted consumption grew 0.3% following no growth in October. More melodramatic is that "goods"-based consumption increased by a stunning 1% (which annualizes to over 12%), while services revenue was unchanged. Unfortunately, services are just under twice as big as the goods category. Therefore, slow results from some services segments masked some very impressive growth elsewhere.

Even services categories weren't all pathetic; restaurants, hotels, and transportation all had an acceptable month. Utilities declined yet again, and housing grew at less than 0.1% month to month, which held back the services category, since these two categories comprise almost a quarter of all services. That's not a great starting position.

Healthcare, normally a services stalwart and 25% of total services, grew just 0.2%, about half its normal contribution. After many months of relatively smooth growth, this month looks like a statistical outlier, likely to be reversed over the next several months.

Movies, though not a big category, had another down month in November. I suspect the recent Star Wars release will move this category back into the black in December. The financial-services sector had yet another down month, its third in six months as brokerage commissions and money management fees remain under pressure.

The popular backstory on consumption is that consumers have all this extra cash from gasoline savings and better employment, but they are refusing to spend it. Some pundits cite retail sales data as proof. They usually go on to say that increased healthcare spending is depressing sales in those categories along with record-high auto sales.

It's important to note, however, that retail sales are suffering partially from some channel shifting away from brick-and-mortar stores and toward  Amazon (AMZN). If one adds Amazon back into the mix, retail sales don't look as depressed. In addition, retail sales, as generally reported, are not adjusted for inflation. A lot of goods have seen prices fall substantially, masking better unit growth and inflation-adjusted growth. Consumers are buying more than ever, often by a lot, but falling prices are hurting the reported data. 

The data below show some winners and losers in both goods and services. We use three-month averaged year-over-year data. The year-over-year data shows many of the trends evident in the monthly data, with a temporarily weak healthcare number in November and grocery stores looking up (monthly growth much stronger than annual data), perhaps because of falling meat prices that encourage more usage and free up cash for other items. The data hardly suggest the gun-shy consumer that the media is portraying. Audio, video, and computers are up 10%, hotels up 7%, transportation up 5%. This looks a lot more like consumers in party mode than beaten-down waifs.

Income growth continues at a decent pace

Lately, we have been a lot more concerned about spending than income, which has been unusually high, with both good employment and hourly wage growth helping out. Wage growth (4.5% year over year) and real disposable income (3.7%) continue to outpace consumption. This has been the trend since early 2014. The gap has even widened a bit lately as warm weather, low utility usage, and more restrained healthcare growth have depressed consumption.

Also, we are convinced that housing consumption as measured by the U.S. Bureau of Economic Analysis isn't a great reflection of consumer cash outflows. It's hard to believe that consumer spending on housing is going up less than 1% a year when prices are going up at close to 6% and mortgage rates are also rising. I can understand how the BEA gets to its number: It's basically the amount of new housing stock, which is indeed going up about a million new units on a base of 110 million. But consumer outflows for mortgages and rent seem to be going up at least as fast as incomes, according to another Federal Reserve report. The gap between the BEA's theoretically valid housing measurement formula and consumer experience may explain some of the widening gap between incomes and spending.

Nevertheless, we think that the consumer has more capacity to increase spending. On top of that, rising wage rates caused by ever-increasing labour shortages may continue to keep income growth high. Unfortunately, few workers available for work could suppress growth in the number of workers.

With the possible exception of another terrible month for utility usage, data continues to point to December consumption growth at least as good as November's 0.3% rate, and more likely 0.4%. That would bring consumption for the entire quarter to 2.3%-2.5%, which would still trail the third quarter's unusually strong 3% growth. Utility usage will explain most of that slowing growth rate along with the auto sector, which isn't growing as fast as it was in the third quarter.

Stability of the housing market remains intact (by Roland Czerniawski)

This week was big on housing indicators, as existing- and new-home sales data as well as Federal Housing Finance Agency home prices were all reported. We will take a look at each indicator, but in aggregate, the reports appeared to show that, despite some noise in the data, the housing market continues to do fine. 

The existing-home sales report was released on Tuesday and showed a large monthly plunge of 10.5%, pushing the number of units sold (4.76 million annualized) to the lowest point since April 2014. The 3.8% drop in year-over-year growth was not as dramatic, since November 2014 was a poor sales month, too. On a year-over-year three-month-average basis, the trend is edging down now because of two consecutive monthly declines.

Does that mean that the existing-home market is falling apart? The answer is no. First of all, there is some evidence suggesting that a new closing rule, referred to as "Know Before You Owe," is now having effects on the timeliness of home-purchase closings. While the National Association of Realtors made a strong case for the new rule being the entire reason for the shortfall, the exact impact on existing sales (final closings) is unclear at best. The good news is the problem here seems to be lenders providing proper paperwork to borrowers, not borrowers having to come up with data that they may not have (which was a huge issue at the beginning of the recovery). If the industry trade rags are to be believed, there seems to be a lot of arguing over what page and in what font the new disclosures must be made.

Future months (especially December) will be crucial to see whether this trend and the delayed closings continue. It will also be interesting to see if there will be a meaningful bounce-back in sales that were supposedly delayed into December. 

Also worth noting, pending home sales were basically flat between September and October and down just under 2% between August and September. A pending home sale generally precedes a closing by two or three months, so November closings should have been down a similar rate to pending sales in earlier months--or 2%, not the 10% fall that we just witnessed. The new required paperwork seems to be a plausible explanation. However, more buyers backing out of deals, credit rejection, nonavailability of credit, and upheaval in the REIT category could also be issues. Next week's November pending-home-sale data should give some further clues.

Our guess is that the new closing rule might have some impact, but the underlying trend in existing-home sales is on a downward path from nearly double-digit growth in the second and third quarters. Declining inventory levels, tight credit, and prices rising considerably faster than wages all seem to be limiting the existing-home market. Nonetheless, existing-home sales are on track for 5.5%–6.5% growth in 2015. It is helpful to remember that the same growth figure for 2014 was negative 3.0%, proving that the housing market has been generally much stronger in 2015. With that said, because of impressive second- and third-quarter existing-home sales, broker commissions on those sales, which account for nearly a quarter of all GDP residential investment, are expected to contract in the fourth quarter.


Another piece of housing news this week was the FHFA House Price Index report. It showed that prices of existing homes financed with Fannie Mae and Freddie Mac mortgages were up 0.5% in October, marking a 23rd straight monthly increase of the index. Year over year, price growth stands at around 6% and appears to be trending up when we use a three-month moving average tool.

Faster growth in home prices has been one of the bigger surprises of 2015. In December 2014, economists polled by The Wall Street Journal expected price growth to be 3.7% in 2015. Instead, we are very likely to close the year above a 6% growth rate. Again, the declining supply of existing homes in the presence of consistent demand appears to be putting upward pressure on prices. While we think higher prices might limit the growth potential for the existing-home market, it is indicative of a strong demand and strong long-term consumer optimism.

Finally, the last piece of the housing puzzle this week was the new-home sales report issued Wednesday by the U.S. Census Bureau. It showed that sales of new homes improved 4.3% in November, marking a second monthly improvement from September's plunge, when sales hit 442,000, a 15-month low at the time. Year over year, sales growth stood at 9.1% in November, while inventory levels also improved.

On a three-month moving average trend basis, it might appear that the new-home sales trend is falling off a cliff, but we think that the slowdown was temporary and conditions have already begun to rebound. Given strong demand for housing and some limitations in the existing-home market, new homes are poised to grow, especially since starts are on track to improve about 10% in 2015. This would indicate that while the rapid growth in new-home sales experienced earlier this year was probably not sustainable, the growth should normalize somewhere near 10% over the coming months, converging to the underlying growth of the construction sector.

Manufacturing data provides no great insights, but the sector may be turning the corner

No one was expecting much from November's durable-goods orders, but our two favorite metrics showed month-to-month improvement, though some of that came from downward revisions to the October data.

We like to look at durable-goods orders because it takes a while to produce and ship orders of these often big and expensive products. Therefore, future months of production and employment will benefit from today's orders. The broader measure of durable-goods orders, which excludes only transportation equipment, showed an improvement in monthly order growth, and four of the last six months have seen increases. Also, the year-over-year data is trending up and should continue to do so as comparisons become easier (manufacturing began to fall apart in November 2014, partly related to falling oil prices).

The even more forward-looking nondefense capital-goods orders (also a great indicator of business confidence) have shown even more improvement than more conventional orders, though things got a lot worse for this sector compared with the fuller report. Again, we like to leave aircraft orders out of our analysis because of the massive backlogs and the volatility.


About Author

Robert Johnson, CFA

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis for Morningstar.