Economics: Checking in with the Consumer
New York: September 15, 2003
By John R. Stephenson

Recently released economic data show something different - an improving net worth (assets minus liabilities) for the U.S. household sector. Continued gains in the real estate sector (tangible assets) and improving stock markets are driving the total assets of U.S. households higher and creating a climate of increasing consumer confidence (see figure 1). This should augur well for stock markets over the next few years as rising consumer confidence is highly correlated with increased consumption. Simply put, if you feel good about your economic prospects you are more likely to go out and splurge on those nice-to-have items.

Figure 1: U.S. Household Sector - Assets

Rising asset values create a climate favorable for consumption. With the consumer accounting for two-thirds of the U.S. economy, a more confident consumer should help spur increased economic activity and job growth. With mortgage rates at record lows and strong returns coming from the real estate sector, many investors are piling into this asset class. Overall, increased consumption should translate into improved corporate profits and healthier earnings reports which should lead equity prices higher. Many potential stock market participants are on the sidelines sitting pretty with lots of available cash. This coupled with the fact that the vast majority of the baby boom generation has yet to hit retirement age and is looking to the stock market for higher yields to fund their retirements. All this is positive for the U.S. equity markets with the possibility of another great bull market just around the corner. In a rising stock market, look to financial service companies particularly the brokers, companies such as Goldman Sachs (GS) and Morgan Stanley (MWD) as they are very highly levered to the economic cycle. Their core business of advisory services and capital markets activity will do extremely well in rising stock markets and their relatively light cost structure translates into earnings growth and hence higher stock prices.

In spite of this apparent good news, problems exist with consumer balance sheets, most notably the fact that households continue to pile on more and more debt (see figure 2). This is not an immediate concern as long as interest rates stay low and housing prices remain strong. Of concern, however, is the fact that mortgage debt is rising faster than home prices with homeowners’ real estate equity ratios setting yet another low of 54.3% of the value of the real estate holdings down from 55.3% in the first quarter of this year.

If the economy takes a turn for the worse, asset prices deflate and interest rates run out of room on the downside, then there could be a huge pile of unserviceable debt and higher unemployment. For now, things look encouraging, but if the consumer is unwilling to pare back his debt load we could experience a substantial economic slowdown in five to ten years time.

Figure 2: Consumer Debt