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Unhappy Holidays

Overstretched and insecure, consumers are reluctant to open their wallets.

Consumer spending is the main engine of the U.S. economy, accounting for more than two-thirds of gross domestic product (GDP). But for the past two years, the engine has been sputtering. Much of its fuel, in the form of steady paychecks and easy credit, has evaporated. And many of its parts are aging: nearing retirement, the 78 million baby boomers are trying to rebuild the wealth lost in their homes and their 401(k)s. (Household net worth at midyear was down almost 19%, or $12.2 trillion, from its 2007 peak.) With the personal saving rate rising to an average of 4% in 2009, pundits speculate that a new frugality is taking root.

Indeed, consumer spending declined by 0.2% in 2008 and will probably fall by 0.6% in 2009, says Nigel Gault, chief U.S. economist at research firm IHS Global Insight. That’s a stark contrast to the 3% to 4% annual growth that was typical for most of the past two decades. Even the recession year of 2001 experienced 2.7% spending growth, Gault points out.

When will the engine rev up again? There are some grounds for believing sooner rather than later. For example, consumer spending rose in August for the fourth straight month; the 1.4% increase was the biggest since 2001. Consumption rose 3.4% in the third quarter, according to the Commerce Department, while the economy grew at a stronger-than-expected 3.5% annual rate, signaling the end of the Great Recession.

But don’t strike up the band just yet. Much of the third-quarter boost was due to federal stimuli, in particular the “cash for clunkers” car discount program, which ended in August. Consumer spending subsequently fell 0.5% in September. Wage growth remains flat, and many economists forecast GDP growth of less than 3% in 2010.

Then there’s unemployment and its underappreciated cousin, underemployment, both of which are dismayingly high and likely to remain that way, say economists. David Wyss, chief economist of Standard & Poor’s, predicts the unemployment rate, which reached 10.2% in October, will remain above 9% through 2012. “I don’t see us getting back to normal 5% or 6% unemployment until 2013 or 2014 — if we’re lucky,” he says.

No Confidence

Consumers seem to sense that as well, and it continues to shake their confidence. The Conference Board’s widely watched Consumer Confidence Index fell in October for the second straight month, to 47.7. Although that score is still far from the historic low of 25.3 recorded in February, in general a reading of 90 or above indicates a healthy economy, says Lynn Franco, director of The Conference Board Consumer Research Center. Moreover, on one question — consumers’ income expectations six months out — “pessimists outnumbered optimists for the first time,” says Franco.

Consumer Confidence Index, Oct. 2008 through Oct. 2009

Similarly, the Reuters/University of Michigan’s Consumer Sentiment Index also dropped in October, to 70.6. The scale typically reads in the 80s or above during expansions, according to University of Michigan economist Richard Curtin, director of the consumer-sentiment surveys. Recent readings in the 70s signal that the worst is over, but the slide in October may indicate that consumers feel the recovery “may not have the legs they once hoped for,” says Curtin.

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