The U.S. economy has, historically, been driven by its robust consumer base. Its 300 million citizens spent some US$10.1 trillion on personal consumption in 2008. This represented a full 70.1% of America’s entire gross domestic product and was, by far, the single largest component of GDP. However, more recent figures paint a different picture. The reversal in the economy has accompanied a retrenchment in consumer spending. As the origins of the current recession can be traced to over-leveraged individuals and corporations, a move to shore up balance sheets in the boardrooms and at home has been an appropriate response.
Watching the numbers
With the U.S. as the main trigger for the global recession, all eyes have been on it for clear signs of recovery. The U.S. Federal Reserve provided its most bullish assessment of the economy in more than a year, and suggested that a recovery may have already begun. At the conclusion of its two-day policy meeting in August, the Fed said that “economic activity is levelling out.” The commentary signals that the U.S. economy has halted the longest period of decline since the Great Depression. However, the Fed cautioned that economic activity is likely to remain weak in the near term. Accordingly, the press release also stated that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
Source: U.S. Bureau of Labor Statistics
Not surprisingly, recent economic data has been receiving considerable attention and the numbers are mixed. The July data for employment provided the best non-farm payrolls figures (a loss of 247,000 jobs) seen since August of last year. As well, unemployment edged lower for the first time in 15 months. Still, it is important to keep in mind that these numbers were still negative. Job losses continued to mount and unemployment remained high. Retail sales figures painted a similar picture and were a disappointment to the market. Annual growth remained stuck in negative territory at -7.9% in July in spite of significant success for the “cash for clunkers” program, which propelled auto sales to a 2.4% monthly advance. The U.S. economy has now been in retreat since the fourth quarter of 2007 and hopes of a consumer-led recovery still appear on hold. It is reasonable to expect that for the next while, the economic numbers will be mixed as the U.S. heads out of the recession. As a result, mixed responses from the world’s capital markets should also be anticipated. Nevertheless, there is room for optimism.
The latest data from the U.S. Bureau of Economic Analysis revealed a dramatic increase in household saving. In June, the savings rate stood at 4.6%, down from May’s 15-year high of 6.2%, but still well above the low levels posted between 2005 and 2007 and the near-zero levels recorded in early 2008. Meanwhile, the dollar value of these savings soared to an average US$566 billion (annualized) in the second quarter, the highest value seen since these records began in 1959. Clearly, the lessons of the nation's recent behavior have come home to roost during this recession. At the same time, the fiscal sobriety has also come with the cost of reduced economic activity. What is unclear right now is how much balance sheet repair households will continue to make before returning to more normal spending patterns.
The Canadian economy is less dependent on consumers, with individual spending representing a smaller 55.7% of total GDP. Another key reason that a return to growth is anticipated sooner is that the same degree of balance sheet rebuilding seen in the U.S. is not needed in Canada. Without the tax incentive of mortgage interest deductibility, Canadians have not been as aggressive as their U.S. counterparts when borrowing. While low by historical standards, Canada’s savings rate fell only to an average of 3.7% in 2008. Statistics Canada’s estimates that the savings rate rebounded in the first quarter to 4.7%. More conservative borrowing and lending practices have set the stage for a more rapid return to growth in Canada.
Eventually, consumers will be satisfied with their new levels of savings and more typical spending patterns will return. In the interim, investors have continued to allow cash to build up. Despite the gains seen so far, they continue to question long-held beliefs with respect to market efficiency. Fewer are willing to be passive and buy the index as their portfolios end up holding all companies, both good and bad. This is particularly true as markets experience more sideways trading, as the global economy struggles towards improving growth and the markets continue to reprice the surviving companies. Looking forward, evidence of a resumption of stronger consumer spending will eventually help draw more of this parked cash off of the
sidelines. History has shown, however, that trying to time this return of cash to the markets is fraught with risks. Taking the time to develop a financial plan with the help of a professional advisor and making regular contributions through an investment program can ensure that market upswings are captured.
Source: Richard J. Wylie, CFA, Vice President, Investment Strategy, Assante Wealth Management
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