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Quarterly Earnings

A Mixed Bag

By Elliott H. Gue, on May. 13, 2016

The bullish case for the US economy hinges on consumer spending (about 70 percent of gross domestic product) offsetting weakness in manufacturing activity and extending the recovery. In turn, a strengthening economy would enable the Federal Reserve to normalize monetary policy gradually.

Bulls often cite lower energy prices and declining unemployment as catalysts for consumer spending because both trends increase households’ discretionary income.

This argument unravels readily in the face of reality.

Personal consumption expenditures have been a bright spot for the US economy over the past year, but haven’t accelerated to the extent predicted by bullish forecasters.

What happened to all the money that consumers have saved from lower energy prices?

On a seasonally adjusted basis, US consumers spend about $460 billion a year on energy-related goods and services—down about $650 million from year-ago levels. This roughly $200 billion in savings has been offset by annual spending on health care services, which surged from $1.926 trillion two years ago to about $1.120 trillion today—an increase of about $200 billion.

Analysts have attributed some of this increase in health care expenditures to the implementation of the Affordable Care Act (ACA), which requires US taxpayers to carry health insurance or pay a tax penalty. This mandate means that US consumers now spend more on health care.

Digging into data on personal consumption expenditures reveals that spending on services has proved more resilient than spending on goods.

In the first quarter, for example, service-related expenditures contributed 104 basis points to US GDP growth; about one-third of that increase came from spending on health care. In contrast, spending on goods subtracted 91 basis points from first-quarter economic growth, with about two-thirds of this decline stemming from a sharp drop-off in spending on products with a useful life of more than one year.

Spending on goods, especially durable goods, historically has served as a more reliable indicator of the US economy’s health than trends in service-related expenditures.

When consumers worry about the economy, they may delay purchasing dishwashers, automobiles and other big-ticket durable goods. However, households are unlikely to cut back on health care spending—or government-mandated insurance, for that matter.

For example, spending on durable goods began to detract from US GDP growth in mid-2000, while service-related expenditures remained strong through early 2001. The US officially entered a recession in March 2001. Weak spending on durable goods likewise preceded the downturn in service expenditures by six months in the 2007-09 downturn.

Several factors could weigh on consumer spending in coming quarters. Car sales topped 18 million annualized at the end of last year—their highest point in about 15 years. Lower gasoline prices likely contributed to this trend, as buyers’ appetites reverted to trucks and sport-utility vehicles from fuel-efficient options.

Rising gasoline prices in coming quarters, coupled with aggressive lending and loose underwriting standards, could cause trouble for car sales.

The growth in spending on health care services should decelerate this year and in 2017 as the immediate stimulus of the Affordable Care Act’s insurance mandate begins to fade.

Bottom Line: Legitimate upside catalysts for US consumer spending are few and far between, while the downtrend in expenditures on durable goods doesn’t bode well for the economy.

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