U.S. Federal Budget deficits and consumer spending
The below graph reflects the large growth in U.S. Federal Budget deficits post-2008 crisis. After hitting double-digit deficits, tax receipts are improving, government spending is slowing, and the annual budget deficit is declining.
Consumer spending in the United States was supported by rapid appreciation of housing and equity prices until 2008, with home equity lines of credit and marketable securities-related credit fueling both domestic demand as well as imports. Since 2008, equity prices have recovered, and bond prices have risen—though housing prices have lagged. The Case-Shiller National Average of Housing Price Index stands at 136.70, versus the June 2006 peak of 189.93—still 28% below peak levels, while the S&P 500 is almost 10% above its 2008 peak. Interest rates remain low, supporting purchases of capital goods, such as autos. Large government deficits, to include unemployment insurance, have filled in this consumption gap.
Is the U.S. economy focusing too much on reflated asset prices?
Much of the current “recovery” of the U.S. economy may be concentrated too heavily in reflated asset prices, which may allow the wealthier Americans to resume spending patterns. However, for the large majority of U.S. consumers, a variety of negative factors persists, and may not be corrected in the near term, as indicated by a Philadelphia Federal Reserve report.
Indeed, there are a variety of factors out there that suggest that consumer spending in the United States is coming under increased pressure and appears to be losing momentum. In the near term, tightening credit conditions, a cooling housing recovery, and large government deficits could constrain U.S. consumerism. Looking forward, it’s hard to be optimistic about the U.S. consumer sustaining the current level of pre-crisis consumption. The monetary steroids are wearing off, and the economic pain of too much consumption relative to too little re-investment could be felt with increased intensity.
This bodes poorly for equity markets. Positive developments in Asia and the European Union would certainly support global growth, though without the energetic U.S. consumer to continue to increase consumption relative to U.S. GDP, positive prospects could diminish. As reflected in the above graph, the U.S. Government has dug deep to support the economy, as has the U.S. Federal Reserve Bank (Fed) in terms of record low interest rates. If the Fed tapers its accommodative monetary policy and the government cuts spending, exactly how much can the consumer or investor step in to take its place?
Should public demand (in the form of consumption and investment) fail to support economic growth, investors may wish to consider a more defensive approach to investing in equities. Broad based indices with significant exposure to large U.S. blue chip companies, such as the State Street Global Advisors SPDR S&P 500 ETF (SPY), the Blackrock iShares S&P 500 Index (IVV), or State Street Global Advisors SPDR Dow Jones Index (DIA) may outperform indices with greater exposure to more domestic economy-sensitive shares, such as the Blackrock iShares Russell 2000 Index (IWM), Blackrock iShares Russell 1000 Growth Index (IWF), and smaller market capitalization companies found in the State Street Global Advisors SPDR S&P MidCap 400 (MDY). Blackrock iShares Russell 1000 Value Index (IWD) may also provide a more defensive exposure to U.S. equities should valuations remain attractive and stable in the face of softening economic data.