In October, personal income rose by 0.2%, the fourth month in a row of increases. Disposable personal income, or income after taxes, increased by 0.4% — also the fourth consecutive rise. This induced people to open up their wallets and spend.
Personal consumption expenditures rose by 0.7%, reversing a 0.6% decline in September. The September decline was largely a hangover from the end of the Cash for Clunkers program. In August, at the height of the program, personal spending surged 1.3%.
The bigger increase in spending than in disposable income means that the savings rate went down, falling to 4.4% from 4.6% in September. As the graph below (from http://www.calculatedriskblog.com/) shows, savings rates have risen dramatically during this recession, but it started at such a low level that it is still far below where it has been for most of our post-war history. Recently, though, savings rates started to head back down.
Declining savings rates will help economic growth in the short term, but in the long-term it is disastrous to have low savings rates. It is sort of like having a Thanksgiving feast, but doing so using your seed corn. You are full and bloated now, but will be starving in the future. In absolute numbers, personal savings rate were annualized at $490.3 billion, down from 510.4 billion in September.
Thus the best position to be in is to have high but falling savings rates. Unfortunately, the laws of mathematics tell you that such a situation cannot continue indefinitely, but as long as savings rates are going down, the economy gets an artificial boost. If you start with high enough initial savings rates, the process can continue for a long time.
A very good argument could be made that a big part of our economic growth, not just for the last decade, but for the last three decades, has been due to a secular decline in savings rates. The long decline in savings rates has corresponded with an increase in the consumer as a percentage of GDP to an all-time record of 71.08% in the third quarter.
Back when savings rates peaked in the third quarter of 1981, the consumer represented only 61.82% of the economy. If we cannot generate enough savings domestically to fund investment, we have to import the savings. This is the flip side of the trade deficit.
Over that same time period, net exports as a percentage of GDP moved from -0.24% to -2.82% in the third quarter. The low point for net exports was the fourth quarter of 2005 when it hit -6.13%. The decline in savings rates since May seems to be playing a role in the recent economic rebound.
Normally savings rates will rise during a recession and then fall as the economy recovers. However we are exiting this recession with the need to still further increase savings rates. This will be one of the key reasons why this economic rebound will be far more muted than previous recoveries, particularly recoveries from previous deep recessions.
Instead, worldwide growth is likely to be led by countries that have room to reduce their savings rates. Chief among those is China, where personal savings rates are north of 40%. Over time, Chinese consumption will grow, and U.S. consumption will remain stagnant or even decline, even as U.S. income recovers as we try to rebuild our savings.
Investments that benefit from the rise of the Chinese consumer are going to be very big long-term winners. Unfortunately, most of the big Chinese ADR’s are not particularly consumer focused. One good way of playing this trend, though, is through the Claymore China Small Cap ETF (HAO), which has the highest exposure to the consumer sectors of any Chinese ETF. Wal-Mart (WMT) also has a growing presence in China, but is far from a pure play there. While in the short term, U.S. based retailers have pared inventory to very low levels and might do OK this Holiday season, in the long term, the need to increase savings rates will act as a brake on their growth.
The destruction of housing equity has put even more pressure on individuals to boost their savings rates, although the rebound in the stock market since March has eased the pressure somewhat. Still, people save because they want to be able to consume in the future, and those needs such as retirement or a child’s education have not gone away — just the money people thought they had to fund those needs have.
For too long, people substituted asset appreciation for actual savings (spending less than you earn). When assets started to depreciate instead of appreciate they were left without the funds to meet those future needs. People would consume first, and then pay later — in other words, consumer-based on debt.
Now consumer credit is contracting, and the credit card companies like Capital One (COF) and American Express (AXP) face mounting delinquencies. The asset appreciation also funded outright consumption rather than just being a substitute for putting money in the bank. Houses were treated like they came equipped with an ATM as the newest kitchen appliance. During the housing boom, mortgage equity withdrawal regularly exceeded 6% of disposable personal income. That game is over and it is not likely to come back.
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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