Personal Income Falls

The pattern of two steps forward and one step back in the economic data took a big step back today with the release of the personal income and spending numbers. Personal income fell by 1.3% for the month, reversing a 1.3% increase in May, and a 0.2% gain in April. Disposable Personal income suffered a 1.3% decline following increases of 1.6% in May and 0.8% in April.

The reason for the swing was the timing of some of the Stimulus Act spending. In May, Social Security recipients got an extra one-time $250 payment, which increased personal transfer income by $166.1 billion and caused the May increase. In June, the absence of these one-time payments caused transfer income to fall by $131.7 billion. If one strips out this effect, personal income fell by 0.1% in June after being unchanged in May. Private wages fell by 28.6 billion in June following an $11.3 billion decline in May.

This was the 10th straight month where private wages were down. However, the rate of decline had slowed each month since January, when private wages and salaries fell $133.0 billion, so June also marked a reversal of that positive trend.

While personal income was falling, spending actually rose by 0.4%, following a 0.1% increase in May and a 0.1% decline in April.  This caused the personal savings rate to fall to 4.6% from 6.2% in May. The increase in the personal savings rate, as seen in the graph below (from http://www.calculatedriskblog.com/) has been dramatic. This month’s decline does not show up on the graph since it shows the 3-month average of the savings rate.

What is apparent is that the savings rate is still very low by historical standards, but well up from the extremely low levels of the last few years. With the massive destruction of wealth caused by the implosions of the housing market and the stock market (although that part has been partially reversed), people need to save to repair their balance sheets. I suspect that the savings rate is going to return to the 8 or 9% level that was the norm until the mid-1980’s and stay there for an extended period of time. With income down, and people spending a smaller percentage of their income, it means that overall demand is much lower.

If not for government automatic stabilizers and the Stimulus Bill, the overall trend in incomes would be much worse. Demographics are part of the reason that the savings rate is going up, since the Baby Boomers are in a scramble to save for retirement, which is right on the horizon for most of them. If they don’t save (or unless the housing market miraculously turns around and forms another bubble), large numbers of them will simply be unable to retire. The competition for Wal-Mart (WMT) greeter jobs will be intense and sales of cat food will soar (and not for Mr. Whiskers, either).

In large part, the economic growth of the 1990’s and the first part of this decade were a mirage driven by the falling savings rate. This is now being reversed and the economy faces a serious long-term headwind because of it. Keep in mind, though, that once people retire, their savings rate tends to go negative as they live off what they had accumulated over their lifetimes. Thus in about five years, demographics will be forcing the savings rate back down again.

On the plus side, the higher savings rate means that we are capable of funding more of the growing federal debt internally, rather than borrowing from China and OPEC. The rise in personal savings is being offset by an increase in government dis-savings, otherwise known as the budget deficit.

Net-net, though, the overall national savings rate is still going up, but not by nearly as much as the chart indicates. Then again, keep in mind we were running pretty hefty budget deficits even when the personal savings rate was close to zero. That was the combination that led to the country being deep in hock to China. We are still going into more debt abroad, but at a slower rate than we have been in recent years. This is borne out by the shrinking trade deficit.

Long-term, the need to increase the overall personal savings rate is going to be a major negative for the retail industry and all others that depend on discretionary spending. In the short-term, however, I would note that the retailers in general have come in with better-than-expected earnings (very low expectations going in) and are getting estimate increases for this year (and next year to a lesser extent). Still, it should slow their overall long-term growth rates, and as a result should cause them to trade at lower relative P/E’s than they have in the past.

I continue to see retailers that cater to the middle class as being the most vulnerable. Discounters like Family Dollar (FDO) and TJ Maxx/Marshalls (TJX) are likely to pick up share from chains like The Gap (GPS). Yes, there will be some pick-up as the economy finds its feet again, and the effects of the Stimulus Bill are likely to be much bigger in the second half than they were in the first half.

However, this is not going to be a V shaped recovery. History, both domestically and abroad, has shown that recessions caused by financial panics and balance sheet issues tend to last longer and lead to weaker recoveries than do recessions caused by the inventory cycle or by tight monetary policies.

Higher savings rates mean that people will be contributing more to their 401K’s and IRA’s. This should be good news for asset management firms like T. Rowe Price (TROW), so it is not like there will be no offsets to this trend.

To the extent that money finds its way into the stock market, it will be a positive for equities. Clearly, though, an increase in the savings rate caused by income going up more than savings would be greatly preferable to what we have been seeing in this period — a rise in the savings rate caused by spending falling faster than income is falling. This is particularly true when it comes to income from the private sector.

Rising income from transfer payments can help in the short term, but cannot be a long-term solution. When we see private salaries and wages rise as the reason behind an increase in disposable personal income, that will be a cause for celebration. We are not there yet, and we took a step backwards from it in June.

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