In January, Personal Income rose by 0.1%, a slowdown from the 0.3% increase in December (which was revised down from a 0.4% increase) and 0.4% in November. The Personal Income number was well below expectations for a 0.4% increase.
Disposable personal income, or after-tax income, fared even worse, suffering a 0.4% decline. That reversed a 0.4% increase in December. Prior to January, we had been seeing a nice trend in disposable personal income, with increases of 0.5% in November and 0.4% in October.
While income grew more slowly than expected, personal spending — also known as personal consumption expense or PCE — rose at a faster-than-expected 0.5% (0.4% had been forecast) and acceleration from the 0.3% rate in December, and matching the rate in November and October. Since savings is income minus spending, if spending increases faster than income, it means that the savings rate is going down.
However, if you dig a little deeper, the numbers were not quite as bad as the headline suggests. Wage and salary payments actually grew much faster in January than December, and that goes for both private payrolls and government payrolls. On the private side, goods-producing payrolls increased by $5.2 billion in January versus a decline of $3.2 billion in December, while payrolls at service producing firms posted an increase of $10.8 billion, almost double the $5.5 billion increase in December. On the government side, annual pay raises for both civilian workers and the military kicked in and resulted in a $6.1 billion increase, far more than the $2.7 billion in crease in December.
So if payrools were doing better in January than in December, why was the increase in incomes so much lower? Well employer contributions for social insurance are treated as a reduction in personal income, and unemployment tax rates have increased in many states. The higher tax rates for unemployment insurance accounted for $10.2 billion of the $11.6 billion total increase in employer contributions for social insurance.
In addition, there seems to be a big problem down on the farm, as farm proprietors’ income dropped by $7.9 billion in January after a $5.9 billion rise in December. In contrast, non-farm proprietors, which is what we usually think of when the term “small business” is used, posted a $4.7 billion increase — a major acceleration from the $1.8 billion increase in December.
Biggest Reason Behind Weak Growth
The real reason for the weak growth in total personal income came from capital income, not labor income. Rental income fell $0.9 billion versus an increase of $1.9 billion in December. Given the high vacancy rates that are putting pressure on rents around the country, the surprise was that rental income rose in December, not that it fell in January. I would expect this source of income to be weak on balance for the rest of the year.
Income from financial assets was by far the biggest swing factor in the report. Income from dividends and interest payments plunged $20.8 billion in January, more than wiping out the $11.0 billion increase in December. Low interest rates help out when you want to borrow, but also mean that you end up with a lousy rate on your CDs.
Income from Social Security and other transfer payments posted a $16.1 billion increase, a slight acceleration from the $14.5 billion increase in December.
Personal Taxes posted a massive $59.0 billion increase in January vs. virtually no increase (up $0.9 billion) in January. This appears to be based on budget projections of lower tax refunds in 2010 than in 2009. That appears to be a one-time-shot type of thing; it is not likely to be repeated in coming months. However, it resulted in a decline in disposable personal income of $47.6 billion or 0.4%, and that is an amount that will leave a mark. Once you factor in inflation, real disposable personal income fell 0.6% in January. OUCH.
PCE Jumps to 0.5%
The decline in disposable personal income did not affect spending in January, though, as PCE accelerated to a 0.5% pace from 0.3%. Put in dollar (rather than percentage) terms, that is an increase of $52.4 billion, or almost twice the $26.4 billion increase in December.
It is good for the economy in general, and for retailers in particular, for spending to increase — at least in the short term. More spending means more shoppers at Macy’s (M) and more people eating at the Olive Garden, which is part of Darden Restaurants (DRI). However, if increases in spending are not matched with increases in income, it means that the savings rate has to fall.
The savings rate in the country is already FAR too low to be sustainable over the long term. As a result, we do not generate enough investment capital domestically, and we have to import it. This importation of capital is the flip side of the trade deficit — quite literally — since as a matter of accounting identity, the trade deficit has to be matched with a capital surplus.
This creates a major dilemma. A falling savings rate is good for the economy, but over time, a low savings rate is very bad for the country. Conversely, a rising savings rate slows the economy and a high savings rate is good for the economy. We have a very low savings rate (although somewhat better than it used to be) and is shown in the graph below (from http://www.calculatedriskblog.com/).
How do you get to a high savings rate without the savings rate increasing? It simply can’t be done. The best we can hope for is for the savings rate to rise the “right way” — with income rising faster than spending, not from spending falling faster than income falls. That is exactly the opposite of what happened in January.
The graph shows a 3-month moving average, so it mutes out some of the month-to-month noise. The savings rate in January actually fell to 3.3% in January from 4.2% in January. While 3.3% is a heck of a lot healthier than the sub-2% rates we were regularly running in the middle years of this past decade, it is a far cry from the 9 or 10% rates that were the norm in the 1960’s and 1970’s.
For 30 years now we have had the wind at our back in the form of a falling savings rate. For the next decade or so, we will be facing a stiff headwind as we try to rebuild the savings rate back up to more healthy levels.
Assessment
Overall this was a disappointing report; however, I would be more concerned if the weakness in income was coming from payrolls rather than from capital income. Not that declining capital income is a good thing, it’s just less bad than declining payroll income.
The increase in spending is a good thing for first quarter GDP growth prospects, but if incomes do not catch up it will be hard for it to be sustained. The reversal of the trend towards higher savings is an ephemeral short-term boost to the economy. We need for the savings rate to rise over time, not fall, but as it rises, economic growth would be much slower than it would be with a falling or even a flat savings rate.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
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