Optimism over the economic recovery has increased over the past week as several economic indicators have come in better than expected. First, and perhaps most surprisingly, Housing Starts and Building Permits rose sharply in November. While the increases were mainly due to sharp increases in volatile multi-family housing projects, investors were nonetheless encouraged. Second, we received some manufacturing data that suggests the factory economy is improving. The Empire Manufacturing and Philadelphia Fed indices came in well above expectations. And finally and most importantly, Initial Jobless Claims dropped sharply for a second straight week, raising hopes that the struggling labor market is finally poised for a rebound.
For our part, we continue to believe that the strength of the economic recovery will largely be a function of the consumer’s willingness to continue spending in the face of numerous headwinds. Among these headwinds are still-high debt levels, inadequate retirement savings, falling housing prices, tight lending standards, a weak labor market, and stagnant incomes. Reflecting these challenges, the various measures of consumer confidence remain stuck at recessionary levels. However, consumer sentiment metrics have never been great indicators of the consumer’s willingness to spend, especially in recent years. The reality is that consumer spending has been much more resilient than we had expected given the circumstances. But will it continue?
At this point, we can confidently say that the data on consumer spending is ambiguous at best. Retail Sales for November, reported by the US Census Bureau, came in at +0.2% – below the consensus expectation of +0.6%. However, the holiday shopping season got off to a blistering start during the Thanksgiving weekend as shoppers came out in force to take advantage of steep retailer discounts. Following Thanksgiving, shoppers stayed at home for a couple weeks until picking up the pace during this past week. The International Council of Shopping Centers now expects sales within its index of 24 major retailers to be up 3.5% for the combined months of November and December. This level of growth would be considered healthy but below the 3.8% reported for the 2010 holiday season.
Our strong suspicion is that growth in consumer spending will moderate as we move into 2012. The strength we are seeing during the holidays is likely a function of steep retailer discounts, a drop in gas prices, and some pent-up demand. We cannot expect these temporary drivers to continue forever. Moreover, recent data suggests that consumer savings rates are declining yet again, which indicates to us that the consumer is taking a break from his long-term project of repairing his balance sheet. The Bureau of Economic Analysis reported that personal savings as a percentage of disposable income decreased to 3.8% in the third quarter of 2011 compared to a recent high of 6.2% in the second quarter of 2009. We believe the savings rate will revert back to 6% or even higher in the coming quarters, which will be a drag on consumer spending and economic growth.
Volatility within the financial markets continues. Doom replaces euphoria, and vice versa. We would suggest that investors neither get overconfident nor overly pessimistic. The economy is growing, stock prices are reasonable, and the US appears to be the best place in the world to invest (for the time being). Large-cap, blue chip companies with solid dividend yields should continue to garner more investor support as their attributes become better appreciated. The rotation to quality should continue.