The economy is picking up and the labor market is strengthening. Nevertheless, without higher wages and increased borrowing, Americans may not support further growth in consumer sectors and related exchange traded funds.
The consumer discretionary sector has outperformed the broader equities market this year. Year-to-date, the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) rose 9.2%, Vanguard Consumer Discretionary ETF (NYSEArca: VCR) increased 7.9% and iShares US Consumer Services ETF (NYSEArca: IYC) gained 7.1%. Meanwhile, the S&P 500 index was up 2.1% so far this year.
However, stagnant wage growth could impeded U.S. consumption and cause the consumer sectors to slow down. Household consumption currently makes up about 68% of gross domestic product, and market observers expect it will rebound to a 3% annualized growth rate in the second half, writes BlackRock Strategist Russ Koesterich for the Financial Times.
Regrettably, consumption growth remains slow. Over the 60 years between 1947 and 2007, annual real household consumption grew by 3.6% on average, whereas real consumption only grew 1.5% since 2008, or 2.3%, excluding the recession
“Sluggish consumption is consistent with the aftermath of other credit bubbles,” Koesterich said. “Households need time to repair their finances. Seven years into the process, household balance sheets are in much better shape than they were in 2007, but it is still not clear that the typical US family can return to their pre-crisis habits.”
Furthermore, household debt, a previous indicator of America’s willingness to spend now and worry later, has declined. Since the the third quarter of 2009, household debt has grew at a less than 1% annualized pace. In contrast, from the end of World War II up until the credit bubble burst, household debt expanded at an average annualized rate of over 9%.
“This is the other big headwind inhibiting personal consumption,” Koesterich added. “Historically, household consumption has increased by roughly 0.2 per cent for every 1 percentage point increase in household debt.”
Koesterich also argues that even if we see some acceleration in borrowing as income growth rises, older and more indebted consumer is unlikely to borrow at the pre-crisis rates. Given the pace of household debt accumulation converges to nominal income growth, it would suggest a 1 percentage point reduction in the rate of household spending, compared to the historical average.
“The obvious way out of this dilemma is faster income growth,” Koesterich added. “Not surprisingly, income growth has historically been the single largest driver of changes in consumption.”
Consumer Discretionary Select Sector SPDR
For more information on the consumer sector, visit our consumer discretionary category.
Max Chen contributed to this article.