Monday, July 6, 2009

The fantasy-to-reality consumer transition will take time

It appears that it will take some time for consumption to rebound in the U.S., which could lengthen the recovery of this latest recession.

In order for consumption to rebound, we need some stabilization in the declining consumer revolving credit, combined with increase in consumer confidence. However, both continue to decline. We note that the increase in consumer confidence since April '09 is likely due to what we believe to be a non-warranted 33% increase in the equity market since the March lows.
What we are looking for is a combination of deleveraging, higher savings rates followed by stabilization in unemployment, all of which represent a slow recovery.

Although we are seeing some deleveraging in consumer balance sheets, as the revolving credit continues to decline (Figure 1), we have not yet seen a correction in revolving credit as a percentage of disposable income (Figure 2). We believe this is mainly due to continuing rise in unemployment (Figure 3), which we do not view as a lagging indicator in this recession. We also believe that more and more of the currently employed consumers are becoming cautious as they may be next. This also explains the continuing increase in savings rate.

Figure 1

Figure 2

Figure 3

Higher credit card default rates, decline in home equity loans (as the housing market has yet to hit a bottom) also provide support for our view that consumption recovery will not begin in Q3, nor in Q4.

We would like to see savings rate climb to 8% (from 6.9% in May), the level at which it stabilized in the late 80's. In addition, although it may sound extreme, we would also like to see revolving credit as a percentage of disposable income to decline to 4% - 6% (from 8.5%), where it was in the late 80's. During the mid-to-late 80's, we believe consumers were 'wowed' more by credit cards. Unfortunately, over time, the increased awareness of credit cards, changed American consumer behavior and started the enormous leveraging for which we are now paying. Of course, although we are hoping for consumers to once again become realists, the federal government's policies and unfounded optimism may lengthen the fantasy-to-reality transition.

Lastly, the Fed will provide an update on change in consumer credit on Wednesday at 3pm (ET). The current consensus stands at -$7.5 billion, which we hope will be met. We note that although this data is somewhat lagging, again, the trends we see will provide us a clearer picture of a maybe-recovery.

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