Counting On The Consumer

Brian Selzer

OCEAN CITY — The U.S. economy’s dismal first-quarter performance is now in the rear-view mirror, and we expect growth to pick up for the remainder of the year.

Consumer spending, which accounts for 70% of gross domestic product (GDP) in the United States, is one of the driving factors.

Our colleagues in BofA Merrill Lynch (BofAML) Global Economic Research expect to see a 3.2% annual rate of growth in U.S. GDP for the second quarter, and project that expansion will continue at a 3% rate during the second half of the year. The BofAML U.S. Economics Team sees consumer spending growing by more than 3% for the second half, a substantial improvement from the 1% rate in the first quarter.

Contributing to the outlook for more robust consumer spending in the U.S. are factors such as improvements in job growth, household net worth and credit growth and a decline in financial obligations.

Job growth is increasing at the fastest pace in years, as nonfarm payrolls have increased by over 200,000 a month since January. As the labor market has improved, consumer confidence has returned to pre-recession levels and the household savings rate has fallen back below 5%.

Household net worth has improved as well, standing almost 20% higher than the pre-recession peak. BofAML Global Economic Research estimates that it grew 10% on an annualized basis in the first quarter, well above the 7% long-term average.

Individuals who have seen the values of their homes or investment accounts recover in the past five years have typically been more comfortable raising their spending levels.

In fact, credit card debt and other forms of consumer revolving credit have been on the rise, currently growing at an annual pace of more than 2% – the fastest since 2008.

More significantly, annual growth in non-revolving credit (for purchases of vehicles and other durable goods) has exceeded the historical growth rate of 7% for more than three years.

On the back of rising consumer confidence, the Consumer Discretionary sector of the S&P 500 has rallied more than 200% in the past five years compared to 133% for the index overall1. In our view, this gain has left relative valuations stretched, with an average ratio of price to earnings for the sector roughly 20% higher than for the overall market, according to BofAML Global Research. With the exceptional momentum in profit growth starting to fade, the sector has been experiencing negative earnings revisions in the past few months.

Elevated expectations are being tempered to reflect more moderate economic growth in the near term. There are still pockets of relative value in the sector, however. We like select specialty retailers, particularly some of the luxury brands. The economic recovery has not been uniform, and much of the job growth has been concentrated in the higher income brackets. Wage growth has been skewed as well, with average income levels for college graduates now roughly double those of workers with only a high school diploma. In addition, only those fortunate enough to own their home or hold investments have participated in the tremendous asset rallies since 2009.

In a recent article, we noted that housing growth is stabilizing. We have a favorable outlook for stocks in the household durables and home improvement industries, as home sales continue to rise and the labor market improves, stimulating household formation.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)

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