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Where Have All the Consumers Gone?

A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.
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Retail sales rose less than expected in March after declining for three consecutive months. Since the U.S. began collecting data in 1967, only twice has it seen three-month stretches of waning retail sales in non-recessionary times. 

This is puzzling. Why would consumers spend less as the economy picks up steam? And why haven't consumers gone shopping with the one percent extra income that collapsing oil prices have handed them? 

Last year, most forecasters assumed consumers would promptly spend their energy savings, resulting in a blowout Christmas season. Because it makes up 70 percent of gross domestic product, consumer spending was the only sector that could push the economy from its tepid 2.3 percent real growth rate to the 3.5 percent to 4 percent rate some economists had been predicting since the recovery started. Forecasters also pinned their hopes on consumer confidence readings, which hit a 10-year peak as shown by the University of Michigan survey. 

Those prognosticators must not be aware of the low correlation between consumer confidence and spending. Our work shows that changes in consumer sentiment often lag, rather than precede, shifts in outlays. 

Investors, too, have been optimistic. The consumer discretionary component of the Standard & Poor's 500 Index, which includes retailers, auto producers and media companies, is up 19 percent in the last six months, compared with 10 percent for the broader S&P 500. Many of these companies are domestic-only and aren't suffering from the strong dollar and weak foreign sales the way multinationals are. The ratio of stock prices to earnings for consumer discretionary stocks over the last year is 19.7, up from a five-year average of 16.5. 

What’s holding consumers back? Many economists blame severe winter weather, the usual scapegoat for disappointing retail sales. Yet according to the U.S. Commerce Department, people stuck at home didn't order heavily online, either.  

One explanation for consumer hesitancy came in March’s payrolls report, which showed that employers created an anemic 126,000 jobs. The preceding 11-month average had been a much higher 284,000 new jobs. Most of them, however, are in low-paying sectors such as retail trade and leisure & hospitality, rather than high-paying manufacturing, utilities and information technology. Also, recent layoffs in the energy sector are of mostly well-compensated workers. 

Another reason consumers aren't opening their pocketbooks is that U.S. businesses are still cutting costs, and ultimately most costs are for labor compensation. With slow economic growth and almost no inflation, revenue growth has been limited. The robust dollar has made it hard for U.S. multinational companies to generate profits now that overseas corporate earnings translate into fewer greenbacks. 

What's more, many employers are opting to hire part-time workers who can be paid less than full-timers and don't have to receive benefits. The net effect of these forces is essentially flat real wages and median incomes. 

Much of the money the U.S. Federal Reserve pumped into the economy through massive bond-buying was used to purchase equities, which pushed up their value. The Fed hoped this would enhance households' net worth, induce more consumer and business spending and generate jobs. But the hoped-for “real wealth effect” was muted because equities are held mostly by high-net-worth people who don’t change their spending habits appreciably as their portfolios rise.  

Household net worth has risen along with home prices, albeit very slowly. Prices are still 17 percent below their April 2006 peak. Since the start of the recession at the end of 2007, the value of residential real estate has been flat, while stocks are up 37 percent. 

Those who thought consumers would immediately spend their energy savings apparently didn’t know that the household savings rate spiked after the tax cuts and rebates in the 2008 and 2009 stimulus measures. Households only later spent some of their windfalls. That’s true today, too: The household savings rate jumped from 4.5 percent in November to 5.8 percent in February. 

Savings will probably continue to climb as consumers, who earlier lacked the money to save, use their energy windfall to replenish savings and reduce debt. Baby boomers were negative savers in the 1980s as they established households and spent heavily on cars and home furnishings. Their low-saving habits persisted into middle age, and now they must save with a vengeance or work until they die. 

The recent weakness in retail sales also may be the result of intensifying deflation. Retail prices were down 3 percent in February from a year earlier, according to the U.S. Commerce Department. Consumers may be adopting the deflationary mindset that has plagued Japan for two decades. Japanese consumers are trained to wait for still-lower prices before buying. Meanwhile, inventories and excess capacity mount, forcing prices down further. That confirms consumers' suspicions, so they wait for still-lower prices. The result has been slow or zero economic growth since the early 1990s. 

Deflationary expectations are a worry for the world’s central banks, many of which want inflation around 2 percent as a cushion against deflation. Their worries are valid: Inflation is running well below target. 

History shows that when times are tough, U.S. consumers increase, rather than decrease, their savings. Plummeting energy prices are providing the extra wherewithal. Investors who anticipated purchasing-power gains would lead to greater consumer spending must be sadly disappointed. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
A Gary Shilling at insight@agaryshilling.com

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net