Q3 2024 Conversations on Markets

The Soft Landing of the American Consumer

THIRD QUARTER, 2024

CONVERSATIONS ON MARKETS

Conversations on Markets is an extension of Bel Air’s Conversations Series, featuring discussions on topics ranging from investments to philanthropy, entrepreneurship, and conservation. 

When the Federal Reserve started raising interest rates in March 2022, ending nearly 15 years of easy monetary policy, many worried that the swift and significant increases would inevitably slow the economy and trigger a recession. Now, two years later, the US economy has proven more resilient than expected. Markets have navigated persistent headwinds – sustained higher interest rates, geopolitical tensions, elevated valuations, persistent inflation – and gone on to new record highs this summer. So, what lies ahead for the economy as the lagged effects of Fed rate hikes continue to curb growth, employment, and the consumer?

The Consumer Drives the Economy

Historically, consumption accounts for approximately 70% of real GDP, making consumer activity a key indicator for economic growth. As such, tracing the erratic savings and spending patterns of the consumer since the onset of the pandemic can explain how the economy has fared and may even predict the direction of the asset markets.

The consumer savings imbalance began as the lockdowns restricted in-store shopping habits and forced temporary business closures, which caused a sudden recession. In response, the government introduced a range of pandemic relief measures that amounted to over $5 trillion, which resulted in record household savings:

1. The Coronavirus Preparedness and Response Supplemental Appropriations Act, 2020 (Total $7.8B)

2. The Families First Coronavirus Response Act (Total $15.4B)

3. The Coronavirus Aid, Relief, and Economic Security Act (CARES ACT) (Total $2.1T)

4. Paycheck Protection Program and Health Care Enhancement (Total $483B)

5. The Coronavirus Response and Relief Supplemental Appropriations Act, 2021 Consolidated Appropriations Act, 2021 (Total $900B)

6. The American Rescue Plan of 2021 (Total $1.9T)^[1]

[1] https://www.pandemicoversight.gov/about-us/pandemic-relief-program-laws 

Data as of May 31, 2024.

Source: Oxford Economics and Haver Analytics.

Consumer Spending Led to Higher Inflation

As the pandemic subsided and the stay-at-home orders lifted, Americans’ spending habits resumed with full force, reaching above-trend levels helped by over $2 trillion in surplus from the government’s emergency fiscal measures and leading to a surging aggregate demand in the economy. Yet, businesses were still dealing with supply chain bottlenecks as activity restrictions continued to plague various parts of the world at different times. The end result of this demand/supply imbalance was the higher inflation that we have recently witnessed. 

Data as of December 31, 2023.

Source: National Accounts at a Glance, OECD Data Explorer.

Thinner Wallets of Consumers May Be an Optimistic Sign

Over time, the trillions in the bank eventually gave way to a savings deficit, in keeping with the persistently low savings rate that has been the American tradition for decades. TransUnion reports that since April 2023, 440,000 credit card holders have been downgraded to subprime status. Worse, the speed of delinquency rate is at a pace not seen since 2011. Consumers are also falling behind on car payments almost as quickly, causing Kelley Blue Book used-car listings to go up by 6% in May from a year earlier. Moreover, as the delinquency charts on credit cards and autos show below, higher interest rates have disproportionately affected lower-income and younger creditors, who are more likely to fall behind on repayments.

Data as of March 2024

Sources: New York Fed Consumer Credit Panel / Equifax, Apollo Chief Economist

Data as of March 2024

Sources: New York Fed Consumer Credit Panel / Equifax, Apollo Chief Economist.

Notably, the absolute level of delinquency rates is much lower than it was in 2007 and in the early 2000s when interest rates were at similar levels. In addition, one-third of mortgage debt was refinanced in 2020-21, as borrowers took advantage of low rates. As a result, households are now spending a smaller share of income on paying down debts than at any point in the 2010s. Wealthier consumers, who still have excess pandemic savings and have benefited from a rising stock market, continue to drive ongoing economic growth; the top 20% of US households account for nearly 40% of consumer spending. Therefore, it is reasonable to believe that, if employment is reasonably strong and payrolls are growing, the US economy may continue to grow, albeit at a more normal pace of 1.5% to 2.25% year over year. With the recent softening inflation data, along with continued declines in consumer health, the Federal Reserve should have enough cause to initiate the easing cycle this fall.

Data as of December 31, 2023

Source: Board of Governors of the Federal Reserve System (US)                                                            fred.stlouisfed.org

We believe that the expected slowdown is finally here, which could lead to a sustained disinflationary environment. With recent softening inflation data, along with continued declines in consumer spending, the Federal Reserve should have enough cause to initiate the easing cycle this fall. In fact, the European Central Bank and the Bank of Canada have already begun reducing rates in the face of softening data. We believe the anticipated rate cuts will likely uplift parts of the economy that have been negatively impacted by higher rates. As such, we expect a broadening out of the market rally, which has been narrowly led by tech and communication services this year. A diversified and balanced portfolio should be well-positioned to participate in a broadening market environment and sustain periods of potential volatility in the months ahead.