The US consumer has been one of the surprise stories of the early months of 2013. The year started off with a tax increase for just about every household in the country as the first compromise on the “fiscal cliff” included an end to the tax reductions put in place in 2008. As a result, there was a general expectation at the beginning of the year that consumers would not boost their spending and would be a drag on the US economy. In fact, the opposite has occurred. In the first two months of 2013, consumer spending, adjusted for inflation, has increased at an annual rate of 3.8%. If that pace was sustained in March, the first quarter would register the strongest growth in consumer spending since the end of 2010.
One reason for the increase in spending is that despite the increase in taxes, consumers are feeling much better about their current financial condition than they have in a very long time. We can see this in the consumer confidence data.
When we look at measures of consumer confidence, they are usually broken down into two categories based on the questions that are asked. There are questions about the consumer’s current situation, such as “Is your income higher, lower or the same as it was a year ago?” and then there are questions about how consumers feel about the future “Do you expect to have a higher, lower or the same income a year from now?” These questions are then grouped into two main indexes: the Current Conditions Index and the Expectations Index. The Current Conditions Index reflects what is going today and the current state of employment and finances for households. Because it focuses on how things actually are today, not feelings about the future, the Current Conditions Index tends to be a better indicator of whether consumers will spend than the Expectations Index.
The University of Michigan’s Index of Consumer Sentiment for March was reported a week ago and while the overall Index was barely up from the level in February, the Index of Current Conditions rose steeply for the second consecutive month to a reading of 90.7 tying the level reached last November 2012 which was the highest level since January 2008.
This increase in the Current Conditions Index is a bit surprising given the increase in taxes. According to the Bureau of Economic Analysis personal income after taxes and adjusted for inflation declined in the first two months of the year and was at its lowest level since last October. Why do consumers feel better about their current situation? Two main reasons:
- Net worth is rising. During the 2007-2009 recession, household net worth plunged 23.6% or more than $15 trillion as a combination of declining equity markets and home values caused assets to drop while liabilities remained basically flat. That decline has been completely reversed since the first quarter of 2009. Today, household net worth is only $1.3 trillion below its pre-recession peak and rising. This improvement, caused by higher equity values, rising financial assets and declining liabilities (debt) has created a wealth effect that is boosting households’ ability to spend. Today, the average household’s debt burden (debt service as a percent of after tax income) is at the lowest level ever recorded. So households are better off financially.
- Home prices are rising. Declining home prices reduce consumers’ ability to spend and make households feel less wealthy. Between the first quarter of 2006 and the first quarter of 2012 the Case Shiller national home price index fell 34.3% as the housing boom turned into a bust. But from Q1-2012 to Q4-2012 home prices have increased 9.0%. Although not a huge improvement, the increase is having an important impact on confidence.
Conclusion. The Current Conditions component of the Index of Consumer Sentiment is one of the better indicators of consumer spending. It is suggesting that consumers feel wealthier and better off in general today than they have in many years. This explains why spending is up in the face of rising taxes. That’s a strong positive for the US economy as consumers have been the biggest laggard in this recovery.
From a commercial real estate perspective strong growth in consumer spending has many positive implications.
- Stronger consumer spending will boost demand for retail space. As spending increases, retailers will expand to tap into that growth.
- The increase in demand for goods will require more warehouse space for distribution. Goods produced both in the US and abroad will have to be shipped stored and distributed no matter what the final channel.
- Wealthier consumers will be more likely to travel so hotel occupancy will also benefit, particularly in top tourist destinations.
US consumers have been the weak link in the current economic recovery. If they begin to increase their spending more rapidly, it will boost the entire US and global economy. The world has been waiting for the US consumer for the past five years. It looks like they may finally be ready to spend again.