We have written extensively on the pages about weak household spending. As we’ve mentioned before, the only way to increase spending is either through higher incomes or through more borrowing. The borrowing looks to have decidedly peaked.
Wages growth has been weak as well, although yesterday’s quarterly report on median weekly real earnings showed some signs of improving.
One of the aspects affecting how and where consumers spend is likely related to what we see happening with home ownership versus renting. Home ownership levels are today at levels not seen in many decades.
Instead, consumers are opting to rent.
Over the past 10+ years we’ve seen the number of households that are homeowners decline, while the number of households renting has grown.
It isn’t just the Millenials either who are preferring to rent versus own.
With this rather profound increase in households opting to rent versus own, rising rental rates will have a bigger impact on aggregate spending abilities.
Rental rate increases so far in 2017 are on track to see the biggest gains since 2007, leaving consumers in a tough spot with wages up just 0.8 percent in June while rents are up 3.8 percent on an annualized basis over the past couple of months. Housing costs are having a greater impact on overall inflation than we’ve seen in quite a few years.
While rising rental rates may make buying a home look relatively more attractive, home prices have been rising a much faster rate than wages as the inventory of homes on the market has been at exceptionally low levels. If the Fed is successful in raising longer-term interest rates, the increase in mortgage costs will put home ownership further out of reach for some who may be hesitant to take that risk in the first place.
Which brings us to how the various generations choose to spend, with Millennials living up to their reputation by spending a greater portion of their income on restaurants, groceries, technology and clothing.
Many consumers still have mortgage/home ownership PTSD after the unprecedented pain felt during the financial crisis. The decades of rising rates of homeownership, induced in large part by federal policies and legislation, has mostly been wiped out. This data illustrates how the generations most affected by the financial crisis have shifted to a more asset-light lifestyle. This shift is a tailwind to those companies providing goods and/or services consistent the sharing economy.
In general, I tend to be a very positive person. I’m decidedly in the glass-is-half-full camp and even though no one would accuse of me being a morning person, I love watching the sunrise, large cup of joe in hand of course, with a smile on my face as I contemplate what mischief I may get myself into as the day unfolds.
I say this because the ubiquitous “Consumer is doing great” refrain is putting me in the uncomfortable position of feeling like a perpetual Debbie Downer, a role that is not in my nature, but I feel obligated because the mainstream financial media is telling a tale that needs a reality check.
If households are doing oh so fabulously, then why this?
In the first nine months of 2016, around 32 percent of U.S. vehicle trade-ins carried outstanding loans larger than the worth of the cars, a record high, according to the specialized auto website Edmunds, as cited by Moody’s.
The non-recovery recovery is lifting off and yet one-third of trade-ins during the first three-quarters of last year were underwater? The delinquency rate for subprime auto loans is at the highest level in at least seven years while used vehicle prices are dropping sharply, as the market is flooded with off-lease vehicles. The NADA’s Used Vehicle Price Index was down 8 percent year over year through February 2017, the eighth consecutive monthly decline and the sharpest monthly decline since November 2008. Asset-backed securities based on auto loans are starting to show signs of stress and a growing proportion of the auto loan asset-based security market is now made up of “deep subprime” deals.
Yeah, that doesn’t bring back any housing crisis nightmares.
Oh and then there is this sticky little bit that paints a seriously less-than-rosy picture of household finances, the Sentier Research Median Household Income Index. The red line is the index and the black line is the unemployment rate. The index was set to 100 back in January 2000 and today is at a whopping 98.7. Yep, that’s a brutal seventeen years later and the median household is worse off, yet the talking heads keep telling us that things are going oh so great.
We’ve also talked here at Tematica about the lack of wage gains. Recall that just a few weeks ago we learned that,
From February 2016 to February 2017, real average hourly earnings decreased 0.3 percent, seasonally adjusted. The decrease in real average hourly earnings combined with no change in the average workweek resulted in a 0.4-percent decrease in real average weekly earnings over this period.
So over the past year real average weekly earnings have fallen and yet, consumer credit keeps growing. In the fourth quarter of 2016, consumer credit rose 6.5 percent on a year-over-year basis and averaged 6.2 percent year-over-year growth during 2016. Think about that for a second – falling wages but borrowing more. Does that sound like things are improving and does that really sound like a sustainable trend? Declining incomes coupled with rising credit doesn’t bode well for future buying trends.
Today we’ll get the latest on Consumer Confidence and the S&P/Case-Shiller home price index update. I’m sure the mainstream financial media will be clapping their hands over just how glorious it all is.
I’m going to go find myself a spot of sunshine and plot my next move with bonds.
The era of low-to-zero interest rates on top of struggling household income levels led to the proliferation of zero-rate financing on everything from cars to hot tubs to luggage and electronics. With the Federal Reserve raising rates amidst less than robust retail sales, rising credit card balances and weak income growth, retailers will be pressured to maintain these incentives.
Now, with interest rates climbing, the cost of these arrangements will rise, pinching profits at companies that derive a large chunk of their sales from shoppers who prefer to pay in bite-size pieces. Most retailers will likely absorb the higher costs to stay competitive because customers may turn elsewhere if they are asked to pony up interest charges.
While price-to-earnings ratios have continued to expand in the Trump Trade, now at levels well above historical norms, we are seeing more indications of pressures on margins, which means those earnings may be weaker than expected. On top of the impact of rising interest rates, we may start to see some wage pressures, which would also weigh on margins. If that is the case, those multiples will look even richer. With earnings season right around the corner, the Tematica Team will be closely watching margin trends as corporate profits have been declining in recent quarters as a percent of GDP.
Wondering why Americans are so angry with D.C. despite the headlines insisting that the employment situation is fantastic? Just look at incomes and taxes.
According to a recent Pew Research Center Report shows, while median household income has shrunk by 13% from 2004, expenditures have risen by nearly 14%, driven almost entirely by the cost of housing. In fact lower-income families spent close to 50% of their income on rent in 2014.
In 1971 61% of all Americans lived in middle class households – today that number is just under 50%. In 1971 4% of Americans were in the highest income category, today that number is 9% and that is because over the past nearly 40 years, the higher a family’s income, the greater the income gains.
Income gains have been highly disproportionate between 1971 and 2014 with the following rates of increase:
Median income of all upper-income 47%
Median income of all middle-tier 34%
Median income for lower-tier 28%
This looks an awful lot to me like what we are seeing in the business world, where the level of complexity in the tax code and sheer volume of regulation makes it increasingly difficult for the little guys to compete with the big guys who are able to afford armies that deal with all that paperwork and find the loopholes, (or donate to a politician who can make one for them). Small companies struggle to grow, while the big ones gain more and more market share thanks to the protections afforded to them by just how expensive it is on a relative basis for the little guys to operate.
Just take a look at how the U.S. tax code has grown over the years. Even those in the IRS don’t know what the rules are at this point!
As for just how far families have come since the financial crisis, according to the Federal Reserve, 47% of all Americans would not be able to come up with $400 for an emergency without having to borrow or sell something.
Roughly 60% of the country is living paycheck to paycheck.
So where are Americans spending what they do earn?
According to the Tax Foundation, in 2016 Americans are expected to roughly spend the following:
$1.6 trillion on food
$2.1 trillion on housing
$360 billion on clothing
$4.1 trillion (Total)
Total tax bill is expected to be roughly the following:
$3.34 trillion in federal taxes
$1.6trillion state and local taxes
$4.9 trillion (Total)
This means that families will be spending 19.5% more on taxes than they do on food, housing and clothing. Let’s keep that in mind when we discuss providing “free” education and “free healthcare.”
But that tax burden isn’t exactly spread equally across the nation, according to the same analysis an estimated 45.3% of American households which is roughly 77.5 million, will pay no federal individual income tax either because:
They have no taxable income (roughly 50%)
They are able to take advantage of enough tax breaks to remove all tax liabilities (roughly other 50%)
So who is paying for all that government spending, outside of course of the amount being allocated to future generations through borrowing?
Top 0.1% pays over 20% of all federal income taxes.
Top 1.0% pays roughly 44% of all federal income taxes.
Top 20% pay roughly 87% of all federal income taxes.
On average, those in the bottom 40% of the income spectrum end up getting money from the government.
For those who think the rich need to pay their fair share, just how much more of the burden can be shifted and to what end? What magical thing is going to happen when say the top 20% are paying an addition 13% of federal taxes, which would make them the only ones paying taxes!
Keep in mind too, that taxes paid by the wealthy tend to fluctuate a lot more because their incomes are more volatile. That invariably leads to more and more government debt as we’ve seen governments have a nasty habit of spending any additional money that comes in, but are incapable of tightening their belts when times are tough.
Bottom Line: We need a tax code and welfare system that incentivizes income generation, that rewards working hard and doesn’t penalize those who may need assistance for a time when they try to get back on their own two feet. The tax code cannot be successfully used to rectify societal frustrations between the haves and the have-nots as inevitably, it will come to harm those that need help the most.
Obama claims the country is better off? Uh, what? Last week President Obama told a small group of wealthy donors that by almost every metric, the U.S. is significantly better off under his leadership than under Bush’s. Oh dear God this is just getting embarrassing! Can we please have a little reality check here?
The most basic metric for how well the country is doing is median household income – are families making more today than in years past? Errrr, not so fast there Mr. President. As the chart below shows (the red line) we are still well below we were when you took office… and that is despite the massive amount of government spending and monetary policy stimulus! Or perhaps, this is in fact because of all that insanity? In fact, median household income, after taking inflation into account, is where it was back in 1989, twenty-six years ago!
One of the reason household income is so low is that despite the often touted “unemployment rate” the more important number, the percentage of people in the country actually working is down to levels not seen since the early 80s and well below the ratio during George W Bush’s Presidency.
On top of that, 2.2 million Americans are in part-time jobs who want to work full time, still far above the level at the start of the recession and during George W’s entire Presidency.
So people are making less and fewer people are working… what about the debt burden on those who do have jobs? When Obama took office, the total Federal Debt was 10.7 trillion. Today it is over 18 trillion and expected to be well over 19 trillion by the time he leaves office. That’s more than an 80% increase in the debt burden shouldered by the American people in just 8 years, nearly doubling!
This has also been the weakest economic recovery in the nation’s history. For the first time ever, U.S. GDP has contracted twice since the recovery and on an annual basis remains well below historical norms. Normally after a recession, we experience a period of above average growth which helps repair the damage experienced during the recession. Not only did we never get that above average growth, but the economy continues to stumble along at very weak levels.
Just exactly what is it that you are looking at Mr. President? As the “most transparent Administration in history,” (snort, chuckle, eye roll) how about if you show us?
This morning I had the great pleasure of being on The Sam Sorbo radio show. One of the things we discussed is the push to increase the minimum wage. A while back I first introduced the concept of BUC (see below) which is proven true again with the unintended consequences of raising the minimum wage.
Politicians, particularly nearing election season, love to trot out the minimum wage debate, claiming that by raising the minimum wage they will help lower skilled and lower paid workers. That just sounds dandy as who wouldn’t want those living at or below the poverty line to have a better life? Let’s all just hug over the brilliance. Err, but wait, the are likely some sort of consequences to forcing a business to pay someone more than they otherwise would.
1) Raising the minimum wage costs businesses more (shock!) which means that many will not be able to afford to employ as many workers.
Oops. In fact a report by the Congressional Budget Office in 2014 estimated that raising the federal minimum wage from its current $7.25 to $10.10 would actually reduce total employment by around 500,000. Keep in mind too that the CBO is notorious for its overly optimistic projections, so my bet is that it would likely be much worse. Obviously any plan that results in half a million people losing their jobs is tough to stomach, but there’s more.
2) When politicians talk about minimum wage earners, the assumption is that those earning minimum wage belong to households in poverty, but the actual data, (yes, there I go again with that pesky information over emotion) reveals this isn’t the case. Many low-wage workers are in fact not members of low-income families; remember those summer jobs in our teens? The CBO estimated there would be about $31 billion in increased earnings from raising the minimum wage from $7.25 to $10.10. Fantastic! But wait, just 19% of that would go to families in poverty! Wait, what!? Yup, the rest would go to families earning more than 3x the poverty threshold! So a bunch of folks lose their jobs and only 19% of the increase goes to those in poverty!?
An increase in the minimum wage would actually result in a transfer of income from people in poverty to people in middle and upper income households.
3) When the employer decides that he/she needs to lay off some workers because the business cannot afford the increase for all its minimum wage workers, those most likely to get laid off are likely to be those with the weakest skills. Reasonable, right? You’d keep those who give you the most bang for your buck. But this means that that those who most need the job to help them develop their skills are the ones most likely to lose theirs! Now they are thrown back into the mailbox economy, where they simply wait for government aid to support them and their families.
As the lovely Sam Sorbo suggested, if we really want to help those are the lowest end of the income spectrum, then we need MORE jobs for the lowest skilled, not fewer. We need more jobs that help these people develop the skills they need to get out of the cycle of poverty and slowly but surely, move into higher paying jobs. How about focusing more on helping this group develop the skills, rather than giving them no options to earn, but rather to be endlessly dependent on government intervention.
Don’t give the man a fish, teach him to fish! Now that, is truly supporting individual liberty.
The headlines keep telling us that we are in an economic recovery with a booming job market. It is just that Joe Consumer is too dumb to know how good he has it. Or maybe not. Maybe there is more to the headlines. I spoke with Rick Amato about just how weak this recovery has been, the weakest in American history, and how the headlines about jobs doesn’t tell the entire story.
The flattening of the yield curve as interest rates fall is bad news for banks that make money by borrowing short-term and lending long, yet another sector that under current conditions is a headwind for the economy. Frustratingly, the yield curve isn’t the only headwind to banks as last week, Morgan Stanley (MS) was the last of the major Wall Street firm’s to report disappointing fourth quarter earnings citing, like many others, weak trading volumes. So far J.P. Morgan Chase (JPM), Bank of America Corp. (BAC), and Citigroup Inc. (C) all failed to meet expectations while Wells Fargo (WFC) met them and only Goldman Sachs Group Inc., (GS) was able to beat.
So just how is the economy doing?
Unprecedented Weak Growth: The long-run average growth rate for the United States is 3%. Typically the economy experiences several years of above average growth rates, which helps households and businesses recover from the recession. No such V-shaped rebound has occurred and we have yet to achieve even the long-term normal rate of growth on an annual basis. Although, the U.S. economy did grow at a 4.6% rate in the second quarter and an impressive 5% rate in the third quarter of 2014, which was the highest in 11 years.
Consumer is still suffering: The income of the median U.S. household was $51,900 in 2013, according to the U.S. Census Bureau. That’s nearly unchanged from 2012, after adjusting for inflation, is 8% lower than in 2007, before the recession began and 9% below the all-time high from 1999! A decade and a half later and household income is still down 9%.
Fewer and fewer working: As of December 2014, the labor force participation rate was 62.7%. This rate peaked in early 2000 at 67.3%, but is now at levels not seen since the late 1970s. This is harmful to the economy because it means there is a smaller portion of the population working to support their families, pay taxes that fund government spending, and support programs such as Medicare and Social Security.
Weak Business Environment: For the first time in 35 years, American business deaths now outnumber business births. The U.S. now ranks 12th among developed nations in terms of business startup activity. Yes, you read that right. According to the US Census Bureau, Countries such as Hungary, Denmark, Finland, New Zealand, Sweden, Israel and even Italy all have higher startup rates than America does. Keep that bit about Italy in mind as you read later on just how benevolent the business environment is in Italy relative to say… Rwanda. This is a very, very big deal and explains a lot of income and employment. The key driver for employment in any economy is the growth of new businesses, and without it a significant level of new jobs and material income growth is darn near impossible.
I always seek to look below the headlines, assessing the underlying data in a more rigorous manner than you often see in the popular media and with a longer term perspective. Earlier this week I spoke with Stuart Varney on the Housing Market. The topic warrants a thorough discussion as it is such an impactful part of the US economy outside of its direct contribution to GDP.
Earlier this month we learned that the National Association of Homebuilders Housing Market index sagged to its lowest level in a year in May, declining to 45 from 46 in the prior 3 months vs expectations of a rise to 49. Existing home sales have increased a little since 2010, but are now falling dramatically, dropping 7.5% on a year-over-year basis in March. New housing starts also down by 5.9% in March on a year-over-year basis. According to Zillow, close to 1/5th of U.S. homeowners are underwater in their mortgages. Late last week we learned that sales of new U.S. single-family homes rose more than expected in April and the number of homes on the market hit a 3-1/2 year-high. Overall it’s been a mixed bag, but what exactly are we hoping to see and why?
Home ownership rates have fallen to where they were about 20 years ago at 64.8% in Q1. This is the lowest rate since Q2 1995. The rate peaked at 69.2% in June 2004. Such a decline sounds bad… or is it? Is a high level of home ownership really the Holy Grail for a society? Is more always better?
Our interpretation of the data indicates that the peak of home ownership is not something to which we ought to aspire. Not household should own the place in which they reside as the costs and risks cane easily outweigh the potential benefits. Home owners can’t easily move if they need to change jobs. We’ve seen the impact of this in the way the current labor market has been the most inflexible with respect to geography in history. They are unable to rapidly react to changing conditions in the economy that affect their household finances, not to mention the hassle of home ownership and all the costs that are unimaginable beforehand. As a home owner myself, I have seriously questioned the sanity of my purchase decision on many a Sunday spent nursing wounds, covered in Band-Aids post-umpteenth unsuccessful trip to Home Depot during one of my “I am so Bob Vila” weekends.
Why did home ownership rates increase so much pre-financial crisis, to levels that were clearly unsustainable and caused so much pain for so many? Was it just those evil, greedy bankers that somehow tricked people into buying homes? Well, that’s partially true, but is only part of the story and a misleading take on all that happened.
You can also thank the federal government for handing over another example of what I like to call, Lenore’s Law of Unintended Bureaucratic Consequenceswhereby that which a bureaucrat tries to help is ultimately harmed by the interference. Traditionally non-FHA mortgages required a minimum of 20% down, but in 1994 the Department of Housing and Urban Development (HUD) ordered Fannie Mae and Freddie Mac to supplement and eventually to far surpass the FHA’s efforts by directing 30% of their mortgages to low-income borrowers when previously the number had been much lower. This became pretty tough to do, so to meet that goal, Fannie Mae introduced 3% down mortgages in 1997.
In 2000 HUD increased the low income target to be 50% of all loans. Now think about that, what bank in their right mind would want to make 50% of their loans for the year to low income families with exceptionally low money down. That means 50% of your loans are in the riskiest category! To accomplish this Fannie launched a 10 year, 2 trillion dollar “American Dream Commitment” program to increase home ownership rates among those who previously had been unable to own homes. So when the government gets itself all focused on getting people into homes who previously couldn’t afford one, is it really all that shocking that home prices rose like crazy?
In 2002 Freddie joined with the “Catch the Dream” program to accomplish essentially the same thing. Then in 2005, HUD increased the target for low income loans again to 52%! Now here’s a bit of irony. The government wanted more people to own homes, so it makes it easier and easier to get a loan. Now we’ve got more people out in the market to buy homes. Son of gun prices go up. Well now isn’t that exciting! Buying a home looks like a really great investment because the prices are just going through the roof! But wait, rising home prices are great for only half the equation. They are great for the owner who looks to sell but not much fun for the person trying to buy. So in their attempt to increase home ownership by making it easier to buy a home, the government made homes even less affordable.
Oh but that’s OK as Fannie and Freddie are there to save the day and get you into that home that you really cannot afford with little to no money down and a variable rate mortgage that isn’t a ticking time bomb at all! All these subsidies increased the supply of mortgages to low income homeowners, but what was the source of the money to fund these loans? Welcome to the Mortgage Backed Security. Yes, those weapons of mass destruction. Banks would pool together mortgages that could then be sold as a MBS, and with HUD’s desire to get Fannie and Freddie to increase home ownership in the subprime areas, these two agencies were more than happy to back the MBS, which, because they are government sponsored entities, turned subprime loans with very little money down into AAA rated bonds! Serious fairy dust isn’t it? Now the banks were running around gobbling these things up like there’s no tomorrow. Why you ask? Well according to the Basel Accords, banks could seriously lower their reserve requirements by holding these GSE (Government Sponsored Entity) AAA rated bonds, which improved their profit margins.
So here we are supposed to all be fixated on getting us back to the essentially Fannie and Freddie heroin-like-induced excessively high levels of home ownership, when the household balance sheet is in no condition to go there. The personal savings rate is less than 4%, lower than it was in the 1930s and continuing to fall. It is at almost unprecedented low levels in the 81 years of data we have. Abysmal savings yet we want to induce people to buy homes?
The percentage of the population actually in the workforce is where it was over 30 years ago, so we have a lower percentage of the population working, but we want a higher percentage of the population buying a new home?
Oh but we’re told that households deleveraged, it’s all good. Well, if you look deeper into the data, households didn’t reduce debt other than mortgages and that reduction was mostly due to write-downs, meaning the bank got involved and things got a bit ugly for a while. Not exactly a healthy process for the economy.
What about those homebuyers?
The first-time homebuyer in the US has been virtually non-existent. Housing bulls will assume that this means there is pent-up demand, which sound reasonable, unless the reasons behind this decline are deeper changes in the makeup of the demand for housing.
New household formation is still exceptionally low, which is a key step in the process of buying a home.
Young adults are living at home at higher rates, and polls show they are pretty comfortable living with Mom and Dad, unlike earlier generations that just couldn’t wait to get the out of there.
There is a disturbing trend in homebuilders who are designing more and more homes with multiple entrances that make it more comfortable for multiple generations to live under the same roof. This is not a good sign if we want more people to own a home when we see a trend that increasing numbers of them are looking to share just one!
Student loan debt is exploding while delinquency rates are also rising despite the story that the economy is improving. Want to know why? One reason may be we graduate more kids with degrees in psychology than in math, physics or engineering. The economy may be limping along, but maybe with all those newly minted psych majors maybe we won’t feel so bad about it?
The MacArthur Foundation recently conducted a poll that found that renting is more appealing than buying a home by a 30% margin, consistent across all age brackets.
On May 29th, pending home sales look to be coming in lower, with soft foot traffic, rising prices and higher mortgage rates relative to last year are likely to continue to be headwinds to demand for new and existing homes sales.
Bottom Line: When investing it is critical to go into much greater detail than the headlines or lead story provide. At Meritas we go much deeper to understand the longer-term underlying trends and the critical factors that affect the headline topics. Housing has thankfully made a significant comeback in recent years, but we are skeptical that the improvements in 2013 will continue for the next few years without significant strengthening in the economy.
Perhaps the reason so few are saving is because the job situation isn’t exactly rosy, nor are income levels. According to the most recent report from the Bureau of Labor Statistic, the unemployment rate has dropped to 6.7% which looks on the surface to be good news. However, if you look a bit deeper, the source of that improvement is troubling. The labor force participation rate, meaning the proportion of the population either employed or looking for employment has continued to drop, see chart at right, and is now at mid-1970s levels. Without the drop in the participation rate, the unemployment rate would be around 13%, rather than just under 7%. Additionally, according to data from the Minneapolis Federal Reserve (see chart at right), the American economy is experiencing the worst performance for labor markets since the Great Depression.
Some argue that the decline in the labor force participation rate is primarily driven by the inevitable retirement waves of the baby boomers. However, the chart below illustrates that baby boomers are in fact participating in the work force at a higher rate than in decades.
Along with the grim jobs recovery, household income levels continue to struggle, with income levels close to those 20 years ago, see chart above. Bottom Line: The fiscal and monetary stimulus has been unable to get employment or income levels back to anywhere near the levels enjoyed during the start of the 21st century. So far the impact appears to be more visible in rising prices in the stock markets and more recently rising home prices.