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Today's Market WrapUp 02.27.2008 Mon Tue Wed Thu Fri Puplava Archive Change We Can
Believe In
Barack Obama’s campaign is running on the slogan, “Change we can believe in,” which aptly describes the likely future state of the U.S. consumer. This is not an article on how the U.S. consumer is dead, but looks at the likely decline of consumption’s importance in GDP using Japan as a historical guide with the focus centered on demographics and interest rates. The core demographic for consumption is the age group that is entering their prime in terms of income generation from climbing the corporate ladder, whose higher incomes translate into greater consumption. The distribution of consumer spending reflects a bell-shaped curve in which the middle-aged demographic represents the largest income brackets while the younger and older populations represent the lower income brackets. This can be seen in the figure below with the middle-aged group (35-44) having higher incomes than the lower (25-34) and upper (>65) age groups. Figure 1
This concept is important as a rising population of the higher income demographic relative to the lower income demographic represents a shift in total aggregate spending. When the higher income bracket population relative to the lower income bracket falls, so too will the rate of change in aggregate consumer spending and vice versa. As a rise in the rate of change in consumer spending increases with the higher earning income’s relative population, so too does the stock market which reflects a rise in GDP from the rise in consumption. This correlation can be seen when looking at the history of Japan in over the last 50 years. Japan’s post WWII baby boom crested in 1990, which was roughly the same year that Japan’s Nikkei 225 index peaked. Since the baby boom demographic peak seen in 1990, Japan has suffered from a rising retiree population and a deceleration of consumption spending as the higher income earners retired and the lower income earners grew in relative numbers. It is no coincidence that the bottom of the Nikkei 225 also coincided with the trough in the relative population ratio of the 35-49 year old to 20-34 year old groups, with aggregate consumer spending likely to rise at an accelerated pace over the next decade in Japan as the higher income population grows in relative size. Figure 2
How does the U.S. historical script compare to Japan’s? As is shown below, there isn’t as great a fit as was seen in Japan’s experience when looking at relative populations. However, looking at the S&P 500 corrected for inflation presents a better fit as does looking at the absolute number of middle-aged workers. Figure 3
Figure 4
Figure 5
The same general pattern of a rise in consumption with an increase in the middle-aged population demographic was seen when the baby boom generation reached their middle-ages. Personal consumption expenditures as a percent of GDP grew from 60.6% in 1967 to 70.5% in 2007 which coincides with the rapid growth in the 30-49 population demographic. Figure 6
The growth in consumption as a percent of GDP was not only attributed to a rise in the relative population of the 30-49 demographic, but was also a function of attitudes regarding debt and savings due to trends in interest rates. As the baby boom generation came into their own, they also displayed a departure from their parent’s generation that could still remember the Great Depression and had a much higher savings rate. Total household debt surged from the late 1970s to the present which helped drive personal consumption expenditures relative importance to GDP on top of rising incomes for the boomers. Figure 7
This attitude shift towards debt and savings was brought about by the decline in interest rates that coincided with a decline in the average savings rate. As debt became cheaper through a fall in interest rates, consumers took on more and more debt. The movements of the share of personal consumption expenditures to GDP inversely coincided with interest rates as shown in figure 9 below (interest rates are inverted, right side). Figure 8
Figure 9
What the above data shows is the correlation of demographic trends and interest rates with consumption. A rise in the relative population of the higher income brackets coincides with a rise in the growth rate in aggregate consumer spending, which then coincides with a rise in the stock market from corporations benefiting from an increasing rate of consumption. The flip side of the coin is also true, that a fall in the relative population of the higher income demographic group as well as a rise in interest rates tends to put the breaks on the rate of consumption and thus corporate profits and the stock market. Of particular interest, though not shown above, was that the demographic proportion of the 35-49 year olds relative to the 20-24 year olds in China bottomed roughly in 1998, along with its stock market, and is set to peak in 2015 which indicates China’s boom has several years ahead. The U.S. economy and stock market face several headwinds going forward over the next decade. One is the decline in the ratio of the 35-49 population demographic relative to the lower income 20-34 demographic that peaked in 2000, which was the top in the NASDAQ and the top of the S&P 500 when correcting for inflation. Additionally, it is likely that we have entered into a secular inflationary environment with which interest rates are likely to rise going forward, though they may continue to fall in the short-term. The case for a secular shift in inflationary pressures was put forth in a previous WrapUp (03.28.07) and will not be covered here. The two trends below will become secular headwinds with which the economy and markets will have to overcome. Figure 10
Figure 11
Today’s Market The markets began early morning trading on a down note before moving into positive territory when regulators announced the removal of lending caps on Fannie Mae and Freddie Mac. Also moving the markets today were comments from Ben Bernanke who was testifying before the Financial Services Committee on Capital Hill today, who hinted at further rate cuts ahead as the economy deteriorates further. The Dow Jones Industrial Average rose 9.36 points to close at 12694.28 (+0.07%), the S&P 500 lost 1.27 points to close at 1380.02 (-0.09%), and the NASDAQ gained 8.79 points to close at 2353.78 (+0.37%). Treasuries rose with the yield on the 10-year note rising 1.0 basis point to close at 3.85%. The dollar index was down, falling 0.54 points to close at 74.22. Advancing issues represented 44% and 46% for the NYSE and NASDAQ respectively, reflecting a mixed market. Chris Puplava Copyright © 2008 All rights reserved.
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