Despite the economic uncertainty of the past year, everyday Americans have been resilient. Consumer spending has remained steady in the face of high inflation, rising interest rates, housing market challenges, and layoffs in sectors such as tech. While it has helped that the anticipated recession anticipated has not substantially materialized, this fact is partially due to the strength of consumer finances. How do consumer balance sheets look today and how might this impact the economy and markets in the coming year? Let’s take a look.
Personal savings have helped to cushion consumer finances.
From a financial planning perspective, there is nothing more important than planning, saving and investing to meet future goals. After all, how much you save is completely within your control, unlike the short-term direction of the market. In-turn, personal savings and spending are also equally important for the economy. When times are good and consumers are optimistic about their jobs and financial outlook, they tend to spend more. This boosts sales for small businesses and large corporations alike, which then hire workers, make investments, and develop new products. This in turn creates new jobs and boosts wages which increases consumer activity even further. Therefore, how consumers are feeling is an important economic indicator for investors to consider across all business cycles.
During the pandemic, consumer spending plummeted which led to record savings rates from early 2020 through much of 2021. At its peak, consumers saved over one-third of their paychecks, an unprecedented rate that is seven times the historical average. Although this occurred under difficult circumstances, these savings helped shore up consumer balance sheets and create a cushion for the inflation that came later. Whether an ill-advised program or not, the net effect of government stimulus checks through measures such as the CARES Act, also helped consumers make purchases and pay off debts during this time.
Since then, savings rates have fallen as consumers have spent more money on dining out, attending events, and just living their life once again. Still, the savings trend over the past three years is well above average with individuals saving 8.3% of their disposable income. This is viewed in terms of "cumulative excess savings" - i.e., the total dollar amount that individuals save beyond what they typically save. This figure rose to $2.1 trillion at its peak.
Since mid-2021, these excess savings have fallen as spending has picked back up, declining by $1.9 trillion. Automobile sales have recovered from a low of around 12 million cars per year to 15.7 million recently. Dining activity is 23% above pre-pandemic levels, and travel activity has jumped this summer with almost 2.6 million travelers per day. While this spending shrinks financial cushions, it also supports economic growth.
Some investors fear that this trend could result in economic problems in the near future. While there could be a slowdown in consumer spending, this isn't guaranteed. History shows that there have been long periods during which consumers saved very little, including throughout the mid-2000s. While it's prudent for consumers to save more from a financial planning perspective, the reality is that savings rates have fluctuated significantly over time - in both good and bad economic environments.
Household debt service has risen but is still historically low.
Additionally, trends such as wage growth due to the strong job market can potentially support both spending and savings. The latest report from the Bureau of Labor Statistics shows that wages rose 4.8% year-over-year. While this has generally been slower than inflation, hourly earnings are still rising at their fastest pace in 40 years. This is happening at a time when the national unemployment rate, at 3.5%, is near historic lows. Job openings have fallen to 9.6 million, but this still represents 1.6 openings per unemployed person across the country. Many believe also that the net structure of the employment rolls has changed since the pandemic with many people now no longer being counted as “employed” or “unemployed.” This change due in part to the pandemic and the “Great Resignation” is tending to skew the unemployment numbers more favorably than what they truly may be.
Other trends have helped to support consumer finances, including the steadily growing economy and this year's market rally. While household net worth has not yet recovered to its pre-pandemic peak, it reached $150 trillion at the start of the year. This is according to the latest report by the Federal Reserve on the Financial Accounts of the United States.
Aggregate levels of household debt remain high across student loans, auto loans, credit cards, etc. But even with that, what households pay every month in payments has remained at reasonable levels. Debt service levels, with and without mortgage payments, are still below average at 5.7% and 9.6% of incomes, respectively. This is even more true when compared to periods such as during the housing bubble when debt service ratios were above 13%. Rising interest rates will likely worsen this picture over time. But many feel this may happen steadily as many homeowners continue to benefit from mortgages that were locked in at much lower rates.
Consumer sentiment is only slowly improving.
Of course, how consumers feel can differ from their actual financial picture, especially as they look to the future. Consumer confidence has suffered over the past year due to inflation, and economic and political uncertainty. Fortunately, this is slowly improving as the economy stabilizes. Many consumers expect inflation of 3.4% in the next year which could then decline to 3% over the next 5 years. While these represent high inflation rates compared to the Fed’s target of 2.5%, they are far better than what many had feared we were in for just six months ago.
The bottom line? Consumers have been an engine of economic growth over the past three years. Although savings rates have fallen, the strong labor market and manageable debt service levels have supported consumer spending and the broader economy. From a financial planning perspective, investors should continue to save appropriately, ideally with the guidance of a trusted advisor, to achieve their long-term goals.