In our June 13, 2013 newsletter (please email us for a copy), we asserted that–after six years of U.S. household deleveraging–the confluence of many forces, such as growing U.S. energy independence, rising housing prices, and an improving private sector labor market, suggests U.S. consumer spending growth is still early in the cycle.
According to the BLS, the number of U.S. employed aged 16+ (seasonally adjusted) peaked at 146.6 million in November 2007. This fell to just 138.0 million at the December 2009 trough, i.e. the U.S. lost 8.6 million jobs during the recession. As of August 2013, the number of U.S. employed aged 16+ has recovered to 144.2 million. Since the beginning of 2013, the U.S. had added nearly 900,000 jobs, after adding 2.4 million jobs in 2012. Perhaps more important, the U.S. private sector has been driving most of this job growth. Assuming the private sector (which has recovered over 80% of its jobs lost during the recession) sustains its current growth rate, the U.S. economy is less than a year away from recovering all of its private-sector jobs lost during the recession. Yes, it did take four years, but we are making progress (e.g. the U.S. auto industry is operating at near full capacity and is embarking on a hiring spree).
From CB Capital’s vantage point, we are witnessing significant innovation and business activity among our tech clients–from Pasadena to Santa Monica to Orange County–all the way to San Diego. In our opinion, there is no question that U.S. tech and innovation will continue to lead this U.S./global economic recovery. The Schumpeterian forces driven by the U.S. capitalist system (yes, this does exist in California) is alive and well. As an aside, the sectors that led the last bull cycle, such as Emerging Markets, fossil fuels, precious metals, U.S. financials, etc., typically experience muted activity in the next bull cycle. This is not surprising. I first became bullish on gold and silver in late 2000–purchasing physical and mining stocks when they traded at $275 and $4.50 an ounce, respectively. This decision was driven by many factors, including the sustained lack of mining infrastructure investments, the Greenspan-led monetary easing policy, the downright hatred of precious metals as an investment, and both central bank selling and production hedging (short-selling) by major precious metals miners. Since late 2000, all of these trends–with the exception of global monetary easing–have reversed. A similar scenario has transpired in the fossil fuels industry, when I first became bullish on oil in August 2004. There are no prizes for following the herd or coming in last. and investors should not make–and do not deserve–outsized returns by investing in industries that have already enjoyed a decade-old bull market.
Make no mistake: The next trend is in U.S. tech and innovation. The world can only innovate and increase productivity through the forces of Schumpeterian growth, aided by the U,S. capitalist system and uniquely intelligent entrepreneurial, and risk-taking spirit. Our recent work with clients in the UAV, video gaming analytics, online real-time bidding, and software-defined networking space have further convinced us of this case. Much of this growth will be driven by tech entrepreneurs near the campus of Cal Tech, the area around Santa Monica (a.k.a. Silicon Beach), and all the way down the I-405 to San Diego.
This bullish cycle in U.S. tech (better 4-D seismic equipment and drilling technologies are responsible for much of the recent increase in U.S oil production) is a strong counter-force to U.S. consumer deleveraging. Along with ever-increasing domestic oil production, U.S. tech will lead the recovery of the U.S. private sector, as well as global economic growth.
Aside from a recovering U.S, private sector, perhaps one of the most encouraging signs for U.S. consumer spending growth is the state of U.S. household balance sheets. One of the main themes we have tracked since the early 2000s is one of the overleveraged U.S. household–and since early 2007–the inevitable deleveraging resulting from the housing crisis and the subsequent decline in household credit growth. As shown in Figure 1 below, the asset-to-liability ratio of U.S. households experienced a secular decline (i.e. U.S. households went on a credit spree) from over 14.0 in the early 1950s to just 5.7 at the end of 2007, and then to a post WWII low of 5.0 at the end of 1Q 2009 as the global financial crisis peaked.
After endless rounds of global monetary easing, asset purchases, old-fashioned economic growth, and household/government deleveraging over the last five years, the asset-to-liability ratio has risen back to 6.5 at the end of 2Q 2013–its highest level since the end of 1Q 2002! Moreover, U.S. household net worth hit another record high of $74.8 trillion–$5.8 trillion higher than the pre-financial crisis peak of $69.0 trillion set at the end of 3Q 2007.
In other words, the balance sheets of U.S. households–despite anemic job growth and the prolific growth of student loans (now over $1 trillion outstanding)–are now in their best shape since early 2002! The “wealth effect” from this benign trend, as well as ongoing U.S. job growth, should provide a strong tailwind for further growth in U.S. consumer discretionary spending.
Timing, of course, is everything. History suggests that this ratio could rise even further. Should this occur, then U,S. household deleveraging (and a renewed cutback in consumer discretionary spending) may not be over. We are of the opinion that such fears are overblown. Firstly, much of the extraordinary growth in U.S. household debt over the last 20 years occurred in the housing mortgage sector. Indeed, for every percentage growth in U.S. household assets since 1952, U.S. households incurred 2.67 times as much mortgage debt, compared to 1.93 times of all other household debt. Note that mortgage debt growth as a ratio of household assets growth is down from a peak of 3.81 times at the end of 1Q 2009, due to rising home prices and significant write-downs of mortgage debt over the last five years. Moreover–despite rising mortgage rates–US. housing activity and prices are maintaining their positive momentum. For example, over the last 12 months (ending July 2013), the Case-Shiller Index for 20 major U.S. metropolitan areas rose 12.4%. Given ongoing U.S. job growth, rising U.S. energy independence (U.S. domestic production has risen another 1.3 million barrels/day over the last 12 months), and recent easing of bank lending standards, the positive momentum in U.S. housing activity and prices should last well into next year.
Because much of U.S. household debt growth was incurred in the mortgage sector, a rising housing market would significantly reduce the probability of a renewed deleveraging of U.S. household balance sheets. In addition, the build-up of U.S. household balance sheets would also reduce the number of households underwater in their mortgages. Such a benign trend will further support consumer spending, as well as reduce U.S. systemic risk. We have no doubt that U.S. consumer discretionary spending is still in the early stages of a sustainable upward trajectory. U.S. corporations and consumer brands (with the glaring exception of J.C. Penney) will realize this by early 2014, and will then take advantage of this trend through store expansion, differentiated marketing, investing in new products, and a sustained round of new hiring.