Don't Count on the Consumer

The U.S. economy remains mired in a deep recession. How deep, well fourth quarter’ GDP declined 6.3% which was the biggest drop in output in 26 years. GDP figures for the first quarter are not available yet but are expected to be down an equivalent amount. Earnings and profits will also be down substantially in the first quarter after falling 20% in the fourth. These are horrendous results.
There have been encouraging signs in recent weeks and the panic has subsided but the recession is not over. The economy is still contracting and though the rate of decline seems to have moderated there are still problems to overcome. Hope is growing that things will improve even though the banking system is not yet operating normally. In Federal Reserve Chairman Ben Bernanke's words, there are signs of "green shoots," through snow in early spring. The economy is no longer in free fall but it is still in intensive care and the markets may be getting ahead of themselves.
The outlook for jobs however remains bleak. The unemployment rate is officially 8.5% in the U.S. and 11.2% in California. However, the real national unemployment rate is over 10% when you add in those that have been looking for a full time job for more than a year and those under employed (working part time but seeking full time). One out of every ten adults is unemployed and it will only get worse before it turns around.
Unemployment will continue to move higher as businesses downsize in response to falling sales and constrained credit. We have at least eight more months of rising unemployment before it starts to turn around. The unemployment rate is a lagging indicator because businesses will not begin hiring until the economy is expanding and well into recovery.
The lag is usually significant as the charts of previous recessions show below. These graphs were compiled by JP Morgan Asset Management which allows their charts to be reproduced. The gray bars are recessions and the black lines show the market low. The green line is the total return of the S&P500 which increases from the market lows. It is interesting to look at the orange line representing the unemployment rate because it typically builds higher even after a recession is over and the markets have moved significantly off their lows. In many cases, unemployment remains high for months after a recession is over.

The recovery from this recession will be held back by weak consumer demand. The American consumer will not be rejuvenating the economy by borrowing and spending. In fact the consumer isn’t consuming. He has started saving again and paying off debt. Americans have recognized that they need to have a contingency plan in case they lose their jobs or ever want to retire. The current argument that the average taxpayer will spend their tax refunds is faulty. Most taxpayers will save their refunds in case their salaries or jobs are cut. After watching their portfolios self destruct and the equity in their homes disappear, the average American is not spending recklessly. For the first time in twenty years the personal savings rate is on the rise. Debt payments as a percentage of disposable income have begun to fall. The American consumer is scared of losing what they have worked so hard to achieve and is finally planning for that rainy day.