As autumn emerges, so does a clearer picture of the American consumer—thanks to Miami. I recently spent some time in the hot city, staying at the Faena Hotel. Our hostess, wanting to show us a good time, reserved table service in their famed Living Room lounge. What I heard from locals were apologies that we showed up on such a slow night. To be clear, it was mobbed, but apparently it was not as busy as the summer or a year ago.
I made sure to do what I call “channel checks” throughout the trip, querying residents and vendors about prices and activity in the city compared to last month and a year ago. It turns out that what happens in Miami happens in the rest of the nation: The economy is stabilizing from such a high level that it feels like a recession. But it is not in a recession. Not yet, anyway.
High inflation and interest rates have created a “vibecession.” In other words, despite overall good economics, it feels like a recession to many people. Sure, some risks lie ahead, particularly in the auto sector, where rising loan payments could create headwinds for some households. However, there are mostly signs of stability in consumer behavior, supported by wage gains and lower mortgage rates.
It is important to consider the direction of the economy because the Federal Reserve cut interest rates at its September 18, 2024, meeting. The stock market has historically performed well one year after the Fed’s first rate cut in a monetary softening cycle—so long as the economy is stable.
One year after a Fed rate cut, the S&P 500 has risen an average of 17 percent. However, investors face increased risks if a recession ensues. For example, the index dove 13 percent and 17 percent, respectively, when coupled with the 2001 and 2007 recessions. Fortunately for those whose fortunes are tied to the stock market, there are more signs of the economy stabilizing than shrinking.
Spending is stabilizing, not shrinking
In August 2024, Bank of America’s aggregated credit- and debit-card data showed a modest 0.9 percent year-over-year (YoY) growth in household spending. This follows a slight 0.4 percent decline in July. Like The Living Room’s attendance, this dip seems less like a slowdown and more like normalization after a long stretch of revenge buying.
The resilience in consumer activity, driven by wage gains, indicates that consumers are still holding up despite the vibecession. Year-over-year growth may not be soaring, but it is steady, signaling that the core consumer base remains intact, even if households are being more deliberate about where and how they spend. Sick of inflation, consumers at lower income levels are searching for bargains but still buying. Households at higher income levels are still buying, too; they have just shifted what they are shopping for.
Services outpace goods
Demand for services is outpacing goods. Consumers are channeling more of their spending into experiences—restaurants, travel, and leisure—while goods, particularly retail, have seen a drag in recent months. This shift reflects the pent-up demand for unavailable or underutilized services during the pandemic and the continued swollen pocketbooks of those in the higher-income strata.
A welcome relief in housing costs
The “owners’ equivalent rent” (OER) component found in inflation indices like the Consumer Price Index (CPI) has shown no relief in housing costs. However, in previous columns, I have explained the flaws in using survey data like OER and why most developed nations instead prefer to use “harmonized” housing data when calculating inflation. Actual rents are down 0.7 percent YoY.
Additionally, declining mortgage rates have pushed the median U.S. housing payment down to $2,534, roughly $300 below April 2024’s high. This should provide some welcome relief for a significant segment of the population, potentially freeing up more disposable income for other purchases.
Although property taxes and insurance costs are still creeping up, this trend in better housing affordability is especially important for investors tracking inflationary pressures. Housing costs are a major contributor to overall inflation; a cooling housing market would give the Federal Reserve more room to cut interest rates. That would provide further relief for a significant segment of the population, potentially freeing up more disposable income for other purchases.
Auto loans are a sign of weakness
The growing burden of auto loan repayments is concerning. Since 2019, median monthly car loan repayments have surged by about 30 percent, driven by a combination of higher vehicle prices and increased interest rates. Prices of used cars and trucks have decreased considerably over the last year. Still, older Millennials and Gen Xers have taken on significantly higher car loan payments, with some households now facing monthly increases of over $400.
Should the labor market weaken, these households could be forced to cut back on spending elsewhere to keep up with auto loan obligations. That stress on consumers could spill over into other areas of the economy.
Wage growth remains strong
Up until now, wage growth has helped offset those higher auto payments. Nominal wages (i.e., not inflation adjusted) rose by roughly 34 percent cumulatively since 2019.
Lower-income households have seen the most significant gains, but higher-income households are now starting to experience faster wage growth as well. Despite some softening in the labor market, wage growth remains a robust factor supporting consumer spending.
Deposit balances are a safety net and a source of spending
Bank of America data shows that median household savings and checking balances remain more than 33 percent above 2019 levels in nominal terms despite the revenge buying. Adjusted for inflation, these balances are up about 10 percent across all income groups.
This savings cushion provides a buffer for consumers, allowing them to absorb rising costs without cutting back too dramatically on spending. This is a key reason why consumer spending has not cratered, even in the face of persistent inflation and rising interest rates.
However, it is worth noting that the savings rate has been declining in recent months. If inflation continues to erode purchasing power, consumers may begin to draw down on these balances more aggressively. I believe prices are on the right path. By October 2022, CPI remained stubbornly high at 7.7 percent. Yet, I argued that it could be “cut in half by the second half of 2023.” And it was. I have since predicted further improvement, and that has, fortunately, occurred. Still, trends change. I will monitor this trend closely, as it could signal a shift in consumer behavior if savings start to dwindle.
Spending is normalizing, not collapsing, and key areas like moderating housing costs and wage growth are providing economic tailwinds. However, I will watch potential risks, particularly in the auto loan sector, where rising payments could create vulnerabilities for some households.
I have previously explained how lower interest rates can hurt the economy by pushing it down the slope of the “J” path. Additionally, I assess an elevated chance of a recession over the next year. Among my previously listed concerns, I also fret about the yield of the two-year Treasury (about 3.6 percent) being roughly 1.7 percentage points lower than the federal funds rate (the interest rate set by the Federal Reserve). That is a 50-year low, according to DataTrek.
Per DataTrek, over those 50 years, the average difference between the yield on the two-year Treasury is +0.42 (in contrast to -1.7, which is more than three standard deviations from the mean). There have only been three other instances in the last half century when the spread was more than -1.0, and each time, the U.S. entered a recession in the following year. The “good” news is that each case required a catalyst to push the economy into a recession: an oil price shock and war in June 1989, the bursting of the technology bubble in January 2001, and the Great Financial Crisis in November 2007. The bad news is that decades-high inflation and the ensuing interest-rate hikes by the Fed could be the catalyst this time.
Still, for now, I remain mostly invested in a manner that reflects my base case that the U.S. economy will eventually benefit from interest-rate cuts and help avoid a recession over the next 12 months. In my personal portfolio, I am nearly 100 percent invested in various equities; I shudder at the thought of my portfolio’s value over the next eight weeks but will slog through it unless trends change.
There is always so much going on
If it seems as if there is a lot going on in the economic world, trust your instincts. The seven-month period from February 2024 through August 2024 has been nothing special in that regard. Bespoke recently published a graphic of that busyness.
I am sure you could add more if you go back just five years—a pandemic, sky-high inflation, rocketing interest rates, wars, bank collapses, the price of a barrel of oil at $120, breaks in the supply chains, housing shortages, tech-sector layoffs, surging unemployment, a recession, natural disasters, etc. Whatever the universe throws at us next, I will consider how to weigh that information and adjust our investment portfolios to protect our capital.
For some additional insights, please visit my LinkedIn page.
Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
