Soft patch solace.
The investment community always seems to struggle with understanding the American consumer and often appears deeply influenced by a misperception that US household spending is driven by real estate values. Yet over the past two decades, stock market wealth has been far more instrumental than home prices in determining the direction of US core retail sales activity. This relationship reflects the reality that roughly 20% of American income earners on the higher end account for nearly 50% of discretionary spending and own 90% of the stock market.
In this context, the Fed's latest Flow of Funds report shows the good news that American household wealth continued to improve in 1Q11, signaling an increase in spending potential. Specifically, household net worth edged up roughly $900 billion sequentially to more than $58 trillion and is up almost $3 trillion versus 1Q10, led by a near $3 trillion recovery in securities holdings, easily offsetting a more than $1 trillion drop in real estate values.
As we've noted before, eased credit conditions also augur well for employment gains. Given the results from the latest Fed survey of senior credit officers on bank lending standards, one should expect job gains in the next six to nine months. Such findings are further backed up by hiring surveys and temporary staffing trends. Furthermore, a review of more than 700 nonfinancial US publicly-traded companies covered by Citi's equity research analysts shows that there is a nearly 17% planned increase in capital spending this year and capex always has been accompanied by more employment.
Bad weather in the Midwest (especially flooding related), the Japanese earthquake and a spike in energy prices also have muddied the economic data news flow of late. But oil prices have receded, taking some of the pressure off consumers, with every penny per gallon of gasoline prices equating to more than $1 billion of annualized consumer spending. Japanese industrial production has bounced back which looks like component shortages are being resolved, too.
Our confidence in the consumer could be disrupted by some policy mistakes in Europe and Washington as contagion from a possible debt default might unsettle credit markets and force a renewed widening out of credit spreads from current tightness best captured in the high yield market for American investors and Greek bond spreads relative to Bund yields, but also Swiss Franc/Euro exchange rates.
As noted earlier, credit conditions are very important for corporate capital costs used to assess capital investment, employment and working capital investment. The EU requires broad support for any bailout program and austerity measures must pass parliamentary approval despite being politically unpopular. The US cannot look on dispassionately since domestic debt and deficits are very much front and center given the looming early August debt ceiling limit and the political drama that may lead up to it.
From our perspective, some of these major uncertainties need some degree of visibility for investors to stand up and take on some additional risk and that may not be evident until possibly mid-August at the earliest. Indeed, with investors now beginning to worry that economic softness could be more persistent despite news of Japanese production recovery and normal summer vacations in July (within the US) and August (in Europe) that might distort industrial activity, it might even be September before investors are convinced that things are not as bad as feared.
NOTE: This text is adapted from a Citi North American Equity Strategy note entitled "Soft Patch Solace," published on June 24, 2011.