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A LITTLE INSIGHT INTO GLOBAL MARKETS – VOL 25

23 March 2018

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by Peter Little

The health of the US consumer

 

The US consumer is the biggest driver of the world’s largest economy, so we regularly check on their financial health. In this note I explore:

  • How much debt they have and their capacity to borrow more
  • How much they’re saving and how this may be impacted by tax cuts and wage growth

This analysis should give us an indication of the potential future economic growth as well the potential for banks to grow their assets and for retailers to grow their sales.

US consumer deleveraging:

Executive summary
  • US consumers have grown disposable income much faster than debt since the Global Financial Crisis (“GFC”). This is largely a result of:
    • Increased foreclosures forcing around 5 million Americans to lose their homes, shrinking the amount of outstanding mortgage debt
    • Disposable income growing around 3.2% p.a. (much of this from employment growth – more people with jobs = more disposable income)
    • Rapidly shrinking home equity loans – US banks have largely recognized that a mechanism allowing consumers to spend the appreciation in value of their homes was a failed experiment!
  • With foreclosures returning to more normal levels & incomes growing, more Americans seem keen to enter the housing market at a time when banks are easing lending standards. Banks like JP Morgan and Bank of American stand to benefit most from increasing mortgage lending (at least until the next housing crisis!).
  • Credit card and other consumer debt (overdrafts, term loans etc.) are at low levels relative to history, but burgeoning levels of student debt and elevated levels of auto debt (car loans) may be curbing appetites for consumer debt in this cycle
  • Americans have dipped into their savings over the last couple of years in anticipation of higher wages and lower taxes – the drawdown in savings since early 2016 has funded enough consumption to add around 2.8% to US economic growth. Any additional incremental spending when tax savings and higher wages do materialise will be muted with a lot of the growth already in the base and a headwind from consumers replenishing savings.
Debt

In aggregate, the US consumer has deleveraged significantly since the Global Financial Crisis (“GFC”). At the end of 2007, US households had debt that was the equivalent of 130% their disposable income, 10 years on, at the end of 2017, that ratio was less than 100% (the lowest it’s been since 2002).

  1. Disposable income has increased almost 40% over the 10 years (3.2% p.a.), driven by a combination of:
    • Higher employment (i.e. more people with disposable income)
    • Wage growth (mostly driven by inflation, but also some real wage growth)
  2. Mortgage debt (which makes up almost 75% of US consumer debt) has stagnated as US homeowners lost their homes to foreclosure:
    • Mortgage debt has gone from 95% of disposable income to 68% of disposable income in the last 10 years.
  3. Non-mortgage consumer debt dropped from 35% to 30% of disposable income, though with diverging trends in the underlying categories:
    • Credit card debt and home equity loans decreased relative to disposable income
    • Student debt & car loans increased relative to disposable income.

Debt conclusion: There is scope for US consumers to increase borrowing, particularly mortgage debt (as homeownership rates trend higher) and credit card debt (which is ~25% below its pre-GFC peak relative to disposable income). Banks have reported reasonably good demand for mortgages and lending standards are easing, which should be supportive of increased homeownership and growing bank assets. Recently demand for credit card debt has turned marginally negative, though lending standards are still supportive. Perhaps the biggest headwind to increased consumer lending is the mountain of student debt?

Americans dipping into savings in anticipation of higher disposable income

Savings

Savings have seen significantly negative trends recently. Household austerity allowed US consumers to build up a savings buffer in the wake of the GFC (getting savings rates up above 6%, a level last seen in the 1990’s). Savings levels are now back to their pre-GFC lows as US consumers started dipping into savings from 2016 (a trend which accelerated after the election of Donald Trump in late 2016).

Had US consumers maintained the relatively healthy savings buffer (~6% of disposable income), they would now have aggregate savings of ~$ 900 billion, instead they have $ 380 billion meaning:

  1. They’re in a relatively poor position to weather economic shocks (usually this leads to forced asset sales, depressing asset values and exacerbating the economic shock)
  2. In anticipation of higher incomes and lower taxes, they’ve already partially grown into their anticipated standard of living. This means that:
    • The additional consumption funded by lower savings rates has already boosted US economic growth by around 2.8% in the last 2 years (two-thirds of that since the election of Donald Trump)
    • Incremental growth in spending from an already partially elevated base will be tougher going forward (and potentially there’s a headwind as savings get replenished).

Savings conclusion: US consumers have depleted savings in the last couple of years, ostensibly bringing forward some of the spending that would have resulted from lower taxes and higher wages over the next few years. With much of the consumption boost from higher taxes and lower incomes already reflected in recent economic growth, wage growth will likely need to meaningfully outperform high expectations going forward to generate above trend consumption spending (particularly as consumers potentially need to forgo some consumption to replenish savings).

For a period of 6 years from 2007 to 2013 US home foreclosures spiked, causing around 5 million (out of 76 million) Americans to lose their homes. (That’s 5 million more than would have lost their homes in a more “normal” foreclosure environment.

US home foreclosures

As the US population grows, it typically adds about 800 thousand to 1 million households each year. In the 15 years leading up to the GFC, most new household formations were buyers of homes. In some years there were even more new homeowner than new households as there was a net switch from renters becoming home owners.

US household formation

 

Since the GFC almost all new household formation was in the form of renters (not to say there were no new homeowners, but the demand for home purchases was more than met by the supply of home owners being forced out of the market.

The tide turned in 2017 as the wall of supply from GFC foreclosures seems to have been mostly absorbed and home ownership rates started to tick up.

Unfortunately for Americans diving into to home ownership this late in the cycle, history would suggest that much of the wealth generation from house price appreciation is probably behind us for this cycle and has largely accrued to those able to hang onto their houses through the GFC.

US home owners’ equity

 

Fortunately for the many Americans who are looking to enter the housing market, average affordability is still decent according the National Association of Realtors, who calculate an index that measures the ability of Americans to qualify for a mortgage (to buy a house valued at the median house price based on median American income). This index still suggest that houses are very affordable – anything above 100 is good (though with the affordability trending lower).

US housing affordability

 

US banks are also reporting that on average they are seeing decent demand for mortgages and lending conditions are being eased.

US mortgage lending environment

 

All this suggests that banks should be able to grow their mortgage assets at a decent pace for the foreseeable future. Of the largest US Banks – JP Morgan, Wells Fargo & Bank of America all have about one third in US mortgages and so growth in that area could deliver meaningful asset growth. Wells Fargo would potentially stand to benefit most, though their recent censure by the US banking authorities restricts them from growing their assets. Citibank is more focussed on consumer loans and will benefit least from increased mortgage demand.

Large US banks assets by lending category

 

As far as non-mortgage consumer debt is concerned, that has also grown at a much slower pace than US disposable income. Home equity loans have been the category that has disappeared the fastest, but also the one that’s least likely to make a comeback. Credit card debt and other consumer credit (overdrafts and short-term loans) have also shrunk relative to disposable income and have the most scope for growth, though student loans have been consistently growing relative to disposable income and could potentially have crowded out the appetite for other consumer debt?

US consumer debt as a percentage of disposable income

 

Part of the willingness of consumers to dip into their savings to fund consumption over the last couple of years is the expectation of higher wages, but another source of anticipated higher disposable income is Trump’s tax cuts. Consumers should see disposable income grow by around $ 1.2 trl over the next ten years, with almost half of that coming in the next 3 years.

 Net tax savings from new US tax laws ($ bil)

 

If Americans follow historical trends and spend 60% of the tax savings (i.e. save 40%) – it will take them another 3 years to replenish the savings they’ve spent in the last couple of years.

US consumer savings as a percentage of disposable income

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