Amid global uncertainty and signs of a sputtering U.S. expansion, American consumers have held steady, fueling economic and earnings growth. How long can it last?
While economic uncertainty grips the globe and the U.S. expansion appears to be heading into its late-cycle lap, American consumers have provided a much-needed foundation of stability and steady growth. How long can it last?
"The consumer continues to be a pillar of support to the U.S. economy," says Paula Campbell Roberts, Morgan Stanley’s U.S. consumer economist. And no wonder: Unemployment and household debt are low; wages and liquidity have been rising; and the strong housing and stock markets certainly don’t hurt. Or, as Roberts puts it: “The economy may be late-cycle, but the consumer looks mid-cycle.”
That bodes well near-term for consumer-dependent sectors, such as housing, information technology, healthcare, and home-improvement, among others. But companies and investors need to be wary of signs of stress and eventual slowing, as the business cycle winds down. In particular, rising credit delinquency, as well as less demand in certain categories, such as motor vehicles, has consistently augured the end of the expansion.
Case in point: U.S. auto sales have historically been a key barometer of consumer health and confidence. They illustrate not only the willingness to spend on big-ticket items, but also the availability of credit and the ability to pay off loans, which are key indicators for the health of other credit sectors, such as residential mortgages and credit cards.
According to the Consumer Cycle Framework that Roberts introduced in her recent report, “The Mid-Cycle Consumer: What to Watch,” declining monthly auto sales have presaged each of the past five U.S. recessions.
Durable Goods Spending Contracts First Before Recession Starts
The U.S. auto market, which has been enjoying a revival these past few years on lower fuel prices, easy credit, and dealer incentives, seems to be taking a breather right now. Spending in the category is slowing, while car-loan delinquencies have begun to rise—although they remain far below levels typically associated with recessions. These key data points suggest that the U.S. is entering the later stages of its auto cycle, according to Morgan Stanley.
Another sector to watch: home furnishings, where historically a slowdown in spending has consistently come ahead of downturns—and with a much shorter lead time, Roberts notes. Right now, however, “growth in spending on furnishings, as well as several other categories, continue to reach peak levels, supporting our view of the continuing health of the U.S. consumer.”
Credit Where Due
What about the health of other areas in the credit market? Morgan Stanley's Delinquency Diffusion Index, an aggregate measurement of year-over-year increases in the delinquency of several types of personal loans, stood at 19.2 (on a 100-point scale) for the first quarter of 2016, up from its low in October, 2014, driven by increases in auto loan and credit card delinquencies in 2015—but far below the 60-point threshold associated with a pre-recession state. Roberts notes that the rise in delinquencies for credit-card loans has since moderated. Meanwhile, delinquencies have declined for mortgages and moderated for student loans.
Delinquency Diffusion Index Has Turned Modestly Upward Off of Low Levels
Note: At Index value of 100, all indicators show rising delinquencies.
Another historical factor in deteriorating credit quality—rising interest rates, which make some loans more expensive to repay—is absent in this cycle, as the Federal Reserve appears unlikely to raise rates again either this year or in 2017, according to Morgan Stanley’s economists.
What could change the consumer credit equation? As business cycles peak, creditors often try to expand their borrower pool by lowering standards. Many lenders have eased their requirements for auto loans, for example, says Roberts, though lending standards remain far higher than during the 2005-06 peak of the credit bubble. Yet, the move down the credit ladder will likely lead to an uptick in delinquency rates for other categories as well.
"While delinquencies have picked up as the credit box widens, levels remain below cycle averages and far from pre-crisis levels," says Roberts. "However, chinks in the armor are likely to widen as the cycle matures."
For Morgan Stanley Research on the state of the U.S. consumer, ask your Morgan Stanley representative or Financial Advisor for the full report, "The Mid-Cycle Consumer: What to Watch" (Jul 21, 2016). Plus, more Ideas.