Tuesday, August 14, 2007

Justifiable Concerns re the US Consumer

“It is unwise bordering on imprudent to assume that terrible will not follow bad,” Catalano said.

MarketWatch/Smart Money (Greg Robb), calculatedrisk.com quote of the day (Tanta)
August 10, 2007

The US consumer is in the spotlight today as the outlook from several key retailers is not encouraging. There is good reason for investors to have concern not just for consumer related issues but in a much larger context, as the above chart shows a serious shift in US consumer borrowing preferences.

To maintain current lifestyles, the chart highlights the obvious future purchasing power risk that results due to a shift from deductible, low interest mortgage debt to non-deductible, higher interest credit card debt. This will only pressure the US consumer further and, in the process, will not only impact consumer related businesses but increase the risk of defaults to both mortgage lenders (remember the $1 trillion mortgage resets due over the next 12 months) and credit card lending institutions.

A key indicator to watch, therefore, is the Fed’s “Household Debt Service and Financial Obligations Ratios”. According to this data*, the US consumer shows little to no signs of major stress. The risk in relying on this data is that it is both slow to update and backward looking. It is logical to assume, however, that things are pointed to more difficult times ahead. Moreover, the speed with which a US consumer spending slowdown might occur could catch the Fed behind the curve on this issue, if Bernanke & Co. are not careful.

There is a larger macro story here and it deals with a potential real test of the decoupling thesis the bulls have repeatedly noted over the past year. The argument made is that consumer demand outside the US plus capex driven spending will help the world economy achieve the IMF’s projected global growth rates of approx. 5% and enable the US consumer time to repair any damage to his/her personal financial balance sheet.

If so, then global growth opportunities should help mitigate the credit risks underway. If not, then terrible could follow bad very quickly. Either way, change is in the air, and just as with the $400 trillion of credit derivatives, the consequences remain to be discovered.

Chart source: Strategas
Note: To view a larger image of the chart, simply click on the image

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