Net Worthless: People As Corporations
US Households haven't shaken their 'junk bond' credit rating, given their poor income statement and balance sheet. Reversing Mitt Romney's famous quote "corporations are people", Bank Of America remains skeptical of this self-sustaining recovery - expecting second half growth to slow significantly as businesses and households react to the risk of a major fiscal shock (and in the short-term, momentum looks unsustainable). From an income statement perspective, 'a paycheck just ain't what it used to be' with food and energy prices rising and payroll growth (typically a good proxy for income growth) is disappointingly timid leaving real disposable income diverging weakly from a supposed job recovery. The balance sheet perspective has been helped by the rise of the equity market but the recovery in net worth in the last three years has barely outstripped income growth, leaving the ratio deeply depressed. The upshot is that the recent pick-up in consumption is not being fueled by income or wealth gains, but mainly by drawing down savings. Many households remain deeply distressed and react to higher costs of living by drawing down savings further. In sum, a true virtuous cycle still seems a long way off. As weather effects fade and gas pain builds the data should soften.
Bank Of America Merrill Lynch: If people were corporations
We are skeptical. Looking out to the second half, we expect growth to slow significantly as businesses and households react to the risk of a major fiscal shock. Moreover, even in the near term, some of the momentum looks unsustainable. To see why, let’s reverse Mitt Romney’s famous quote that “corporations are people” and look at the household sector as though it were a corporation. In our view, given their poor income statement and balance sheet, US households haven’t lost their “junk bond” credit rating.
Income Statement: Slipping
Normally a strong job market means both solid income growth and high consumer confidence. Unfortunately, these income and confidence channels are weak today. Despite the drop in the unemployment rate, workers are very worried about job security. Most of the drop in unemployment is due to people exiting the labor force. A better measure of the health of the job market is the ratio of employment to working age population. By that gauge there has been no improvement. Surveys of consumers continue to show deep skepticism about the labor market.
While there has been a notable pick up in payrolls, real disposable income is the ultimate driver of spending in consumption models. Normally, payroll growth is a good proxy for the direction of income growth, but in the past year, real income growth has slowed even as payrolls pick-up.
Indeed, the gap has gotten even bigger in the past three months, with payroll growth accelerating to a 2.2% annual rate, while income has actually fallen slightly. This is because virtually every other factor that goes into the calculation of real disposable income has been weak: wage growth continues to slow, gas prices have been cutting into real incomes, non-wage income such as rent and proprietor’s income has weakened, the growth in transfer payments such as unemployment insurance has slowed and the growth in taxes has been strong. As they say, a paycheck just ain’t what it used to be.
Balance Sheet: A Long Road Back
We are equally concerned about the household balance sheet. The recovery in the stock market has been partly offset by the continuing drop in home prices. In the standard life cycle model of the consumer, households attempt to build their net worth to cover there future spending needs, particularly for retirement. During the asset price boom, the ratio of net worth to income surged, setting up the baby boom generation for its looming retirement. The crisis pushed the clock back to the mid 1990s. The recovery in net worth in the last three years has barely outstripped income growth, leaving the ratio deeply depressed.
A Constrained Consumer
The upshot is that the recent pick-up in consumption is not being fueled by income or wealth gains, but mainly by drawing down savings. The saving rate is prone to revisions, but assuming we can trust the data, the saving rate has fallen back to its lowest level in the economic recovery.
In our view, US households want to raise, not lower, their saving rate. The retirement savings of the baby boom generation were devastated during the crisis, the large budget deficit creates worries about both higher taxes and cuts in future entitlements.
The job market has gotten more uncertain. And most people no longer view the housing and stock markets as reliable sources of capital gains. All of this points to a desire to increase savings.
We think the drop in the saving rate is partly unintended and temporary. Many households remain deeply distressed and react to higher costs of living by drawing down savings further. In addition, mild winter weather may have drawn forward spending on autos and at retail establishments. As the weather effects fade, so could the consumer. The surge in gas prices will likely both constrain the rebound in the saving rate and hurt spending on other items.
In sum, a true virtuous cycle still seems a long way off. As weather effects fade and gas pain builds the data should soften. We expect consumer spending to underperform relative to the overall economy on a trend basis. And growth will likely be particularly weak in the second half. We expect businesses to recognize the risks of the fiscal cliff first and pull back on hiring. Then with weaker job growth and with the growing awareness of the cliff, consumers will likely start delaying some discretionary spending.
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