This morning’s update on personal income and consumer spending is a complicated beast. On first glance, it looks like the great American income machine has stumbled, and stumbled badly. But looks can be deceiving. Maybe.
The first order of business in digesting today’s report on personal income and outlays is looking at the big negative: disposable personal income dropped by a hefty 1.9% (seasonally adjusted) in June. This is income that’s left over after Joe Sixpack has paid his bills and so it’s a key number about his capacity for running to the mall and picking up an extra TV. In short, this is the front line measure of the American economy’s growth potential. GDP, after all, is overwhelmingly dependent on consumer spending. As such, the 1.9% drop in DPI–the first slump since April 2007 and the biggest decline since August 2005–looks ominous, as our chart below suggests.
But the DPI drop isn’t quite as painful as it appears. Note in the chart above the large bump in May that precedes June’s drop. The rise in DPI is courtesy of the government’s stimulus checks. The stimulus is temporary, of course, and so its effects are beginning to fade. No great surprise. If we take out the anomalous jump in May’s DPI, June’s level of DPI is at an all-time high.
The key issue is deciding how much additional DPI fading awaits. Logic suggests we’ll return to trend, short of another round of stimulus. By that reckoning, DPI will fall in the coming months, perhaps to the $10.6 trillion level for August or September. That not-unreasonable assumption means that the market has to brace itself for more red ink on the DPI ledger. Such declines will look troubling, but they won’t signal much more than the aging effects of stimulus checks. Up to a point, that is. Indeed, one might reasonably think that DPI is due for some additional retrenching due to the various economic ills of late. In that case, DPI declines may run on for longer than the optimists expect.
The good news is that wages were still rising in June, advancing a respectable 0.2%. That’s a sign that Joe Sixpack’s still working and receiving a paycheck. For the moment, that’s the best news we have, although Friday’s report on the rise in the jobless rate to 5.7% and the ongoing loss of nonfarm payrolls last month strongly suggests, if not insures that we can expect the months ahead to be challenging in terms of how many people lose their paychecks. Let’s just say that the toughest days still lie ahead.
So much for income. Let’s turn to spending. As the above chart illustrates, personal consumption expenditures continue to climb. In June, PCE rose 0.6%. That’s down from May’s 0.8% rise, but it’s clear that Joe Sixpack was still spending at a strong pace in June, at least in nominal terms. Indeed, a 0.6% jump in PCE isn’t too shabby, as they say.
But let’s not think that all’s well. The durable goods component of PCE took a hit big hit in June, falling 1.5%. This cyclically sensitive measure of consumer spending offers evidence that Joe is in fact feeling stressed and he’s responding by avoiding purchases of big-ticket items, such as appliances. Looks like buying an extra TV will have to wait after all.
And there’s more bad news on spending if we look at PCE in inflation-adjusted terms. By that measure, spending slumped by 2.6% in real dollars in June. Inflation, in short, continues to take its toll.
Overall, let’s be clear: the economy faces more challenges. For the balance of the year, and perhaps deep into 2009, strategic-minded investors will be tested by more than a little. That raises the possibility of more investor-friendly valuations in asset classes, although the price of entry will be remaining calm as a bearish aura swirls about.
For now, the economic numbers are surprisingly decent, or at least less threatening than we expected given the backdrop. But the data will get worse before it gets better.