The Us Consumer In 2009

Analysis THE US CONSUMER: BEWARE! US consumer expenditures have held up quite well since their December 2008 low. In fact, personal consumption expenditures have increased from $9.83 trillion (annualized rate) in December 2008 to $9.927 trillion in April, an annualized growth rate of nearly 3%. This is remarkable given the terrible employment situation, very tight credit conditions and the general doom and gloom carried by the media and most economists and commentators. The resiliency of consumer spending so far in 2009 is rather fortunate since it accounts for some 70% of US GDP. Furthermore, it has significantly contributed to many recent observations of green shoots in the US. Importantly, it has most likely been a key factor in the spectacular change in investors sentiment since March, leading to much higher equity prices which themselves appear to be feeding the recent more upbeat consumer sentiment. Here is the math between December 2008 and April 2009 from the National Income Accounts (numbers do not add up precisely due to other items): Change Change Change Change Change Change Change

in Wages and Salaries: in Personal Transfers: in Personal Income in Personal Taxes in Personal Disposable Income in Personal Savings in Personal Expenditures

- 79 ($B annualized rate) +143 + 8 - 278 +285 +190 + 96

Contrary to general belief, Personal Transfers have not played a crucial role so far, only helping to maintain Pretax Personal Income $8B positive in the face of sharply declining labor income. It is the $278B decline in Personal Taxes that has boosted Personal Disposable Income by $285B. And while consumers have boosted their savings by $190B, they used $96B to increase their expenditures on goods and services. The Making Work Pay Credit provision of the American Recovery and Reinvestment Act of 2009 reduced personal current taxes $49.8 billion at an annual rate in April and $11.2 billion in March. The total cost of this program is officially estimated at $19.9B for 2009, $$66B for 2010 and $30.2B in 2011. March and April amounts presumably include catch up amounts for the early part of 2009 before the tax bill was adopted. From May onward, the benefits to Personal Income should be closer to the $19.9B annualized estimated cost. This program is the bulk of the tax incentives for 2009 included in the Obama stimulus program. The increased AMT exemptions only amount to $2B in 2009. Tax relief is much higher in 2010 when the Making Work Pay Credit will total $66B and the AMT exemptions will reduce Personal Taxes by $82.7B.

It remains that Personal Taxes declined at an annualized rate of $278B during the first 4 months of 2009, substantially more than the stimulus program cost. Reduced income and net capital gains are likely responsible for the bulk of the decline. What should we expect for the remainder of the year? The effective tax rate for individuals was 9.8% in April, very close to the decade low of 9.4% reached last year with the Bush administration tax refund in April. It is doubtful that the effective rate will get much lower, meaning that disposable income will likely no longer be boosted by much lower taxes.

The other two areas to watch are Wages and Salaries and Personal Savings. Wages and Salaries are dropping rapidly owing to reduced employment, reduced workweeks and restrained wage increases:

Employment declined 345,000 in May, a significant slowdown from the 642,000 average job losses during the preceding 6 months. But the US economy is still losing jobs at a high rate (the recessions of 2001 and 1991 never saw a number as bad as -345,000). More importantly, 2

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the average workweek has continued to shrink as corporations push more and more workers into part-time work. As David Rosenberg, chief economist at Gluskin Sheff, remarked: The number of part-time workers rose 129,000 last month and by 2.5 million since the recession began a year-and-a-half ago. So it’s not as if all the laid off full-time workers are losing their jobs; nearly one-in-three are being pushed into part-time work. But a record share of the 2.7 million working part-time — more than one-third — are working part-time because they have no choice (due to the weak economy). The number of people working part-time but want full-time work has risen a record 70% over the past year. Remarkable and disturbing.

So the strategy remains one of cutting back on hours worked at the same time — not as many layoffs but the effort to economize on the wage bill remains intact. What has happened this cycle is that the shift towards part-time and away from full-time has led to a dramatic reduction in the average workweek to a record low 33.1 hours. If we took into account the total decline in labour input in May — the aggregate hours worked index sagged 0.7% MoM — the total job loss in May exceeded 900,000. In fact, this was almost exactly what the population and payroll concept adjusted Household Survey showed, to very little fanfare (-833,000).

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In all, average weekly hours are dropping about 2% yoy, with no slowdown recently. AVERAGE WEEKLY HOURS

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As Jeff Frankels, a member of NBER's recession-dating committee, noted: Hours worked suggests that the hope-inspiring May moderation in the job loss series may have been a monthly aberration. If firms were really gearing up to start hiring workers once again, why would they now be cutting back as strongly as ever on the hours that they ask their existing employees to work? My bottom line: the labor market does not quite yet suggest that the economy has hit bottom. Growth in average hourly earnings, the other component of weekly income, has been moderating significantly in the past 3 months: AVERAGE HOURLY EARNINGS

David Rosenberg continues: Average weekly earnings — the wage-based proxy for personal income — has slowed to a mere 1.2% YoY, and as the chart below illustrates, is testing critical support levels. They actually fell 0.2% MoM in May and over the last three months, have deflated in rare fashion at a 0.7% annual rate. (…) Be that as it may, what is important is the growing pool of unemployed, which soared 787,000 in May — the fifth highest on record. There are 14.5 million in the ranks of the unemployed, and this swelled by a record six million over the last 12 months. So, it really is only one part of the story that companies are no longer cutting as many jobs as they were at the peak of the firing wave at the start of the year — nobody is hiring the new entrants who are coming into the labour force (the labour force expanded 350,000 last month). There is currently a record 12.8 million unemployed Americans who are now looking for full-time positions that do not exist — almost doubling in the last year. Now what do you suppose that is going to do to the prevailing wage rates? 5

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All in all, Wages and Salaries, the principal component of Personal Income will decline for some time to come since all its contributing factors are continuing to weaken: 1. Employment is still declining at a good clip, almost 4% yoy in May; 2. Employed workers are working fewer hours than ever and the number of hours worked has lately been declining at a 2% annualized rate; 3. Hourly earnings, which were 3.1% above last year in May, rose at a 1.8% annual rate between December 2008 and May 2009, slowing down further to a 1.3% annual rate during the last 2 months. Given these trends, it would be surprising if Wages and Salaries do not decline 3-5% yoy for the remainder of 2009 compared with a 0.5% average gain during the January-April period. A 3% decline would reduce Wages and Salaries by nearly $200B annualized. Personal Savings have been skyrocketing from virtually zero in April 2008 to over $600B in May. Had savings remained near zero, personal expenditures would have been 6% higher in May. The savings rate is now 4% but it needs to go up given that • •

household debt is now 130% of disposable income, up from 90% in 2000; household credit is now 26% of household net worth, up from 15% in 2000;

Were households to bring their debt to 100% of disposable income (20% of net worth), it would reduce spending by some $3 trillion. If done over 5 years, personal expenditures would be

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reduced by $600B per year (that is the May 2009 annualized savings) or about 6% of their current level. Let’s take a look at the May 2009 data: Wages and Salaries: 6465 ($B annualized rate) Personal Transfers: 2061 Personal Income 8001 Personal Taxes 1182 Personal Disposable Income 10909 Personal Savings 620 Personal Expenditures 9926 If Wages and Salaries decline $200B, Transfers rise $30B (average of the last 7 months) and Personal Taxes are calculated at 9.5% (a reduction of $50B), Personal Disposable Income will decline some $120B to about $10,800B. If Savings are $600B annualized, Personal Consumption expenditures will drop $120B or another 1.2% from the May figure. Remember that the above assumes a 4.0-4.5% savings rate. Many people are expecting it in the 6-10% range in future years. Each 1% change is roughly $100B in spending.

To conclude, the math is not positive for consumer expenditures during the remainder of 2009. Everything points to a negative trend that could take expenditures below their December 2008 low of $9.8T. If so, most of the green shoots observed recently will just die, the nascent inventory cycle will peter out without final demand rising, housing will suffer even more, especially since foreclosures will become even more prevalent in coming months, banks will experience a new wave of mortgage and credit losses, the stock market will turn down and consumer confidence will vanish. I must also mention the impact of the recent rise in oil prices. In the last 6 months, retail gasoline prices have jumped $1.00/gallon (62%). This reduces Americans’ purchasing power for discretionary spending by $130B annualized. June 10,2009 7

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