SERIOUS MONEY:THE FIRST quarter ended with a whimper for equity investors as the stock market in the world's largest economy recorded its fifth consecutive monthly decline for the first time since 1990 and only the sixth time in the past half-century. Stock prices have made little headway since the late 1990s and have been trounced by gold and low-risk US Treasury bonds over the period.
All eyes are on the financial sector to gauge the immediate outlook, which is hardly surprising given its rising share of gross domestic product in recent decades alongside the increased importance of the loosely regulated non-bank system.
Estimates of losses attributable to subprime mortgages have grown from less than $100 billion (€64 billion) last summer to more than $500 billion. The scale of the financial sector's woes is beyond dispute, but investors would be well advised to cast a glance towards the US's beleaguered household sector.
US households have run a deficit, with spending exceeding disposable income, in just 15 years since 1930. Nine of those years were recorded since the late 1990s. Households ran a persistent surplus for more than 40 years through to 1998, but have since become increasingly dependent on cheap borrowings and asset gains to fund consumption.
Incremental borrowing reached 13 per cent of disposable income in 2005 and, despite the housing market downturn, is still running at almost 9 per cent.
The lower rate of debt accumulation did not deter consumers as they turned to their equity holdings to plug the gap. Indeed, households' net sales of equities reached a record high of more than 8 per cent of disposable income last year.
Unfortunately, the sources that funded households' reckless spending sprees are disappearing. Increased mortgage borrowing accounted for more than 80 per cent of the net change in household debt in recent years.
The increase in mortgage debt was attributable not only to home purchases but also to the withdrawal of home equity. Mortgage equity withdrawal averaged more than 5 per cent of disposable income from 2004 to 2006. The figure dropped to 3 per cent in 2007 and should post a further decline this year as the housing recession shows few signs of moderating while the destruction of housing wealth is accelerating.
The Case-Shiller composite index of house prices dropped almost 11 per cent year-on-year in January and has declined at an annualised rate of more than 23 per cent over the past three months.
The housing recession will weigh on consumption not only through the increased unavailability of mortgage equity withdrawals but also via the traditional wealth effect, given that the value of the housing stock has already declined by roughly $2 trillion.
The negative impact on consumption from the destruction of household wealth far outweighs a similar decline in stock prices because home ownership is more widely dispersed and the number of low- to middle-income families with negative equity in their homes is substantial.
US households can no longer depend on bricks and mortar to fund their spending and the sale of corporate equities is unlikely to plug the gap for long. The stock market's increasing importance as a source of funding stems from the record level of share repurchases. The corporate sector has been the largest purchaser of equities in recent years due to strong cash flows and restrained investment in the aftermath of an industrial recession. However, domestic non-financial sector profits declined in the fourth quarter of 2007 and the outlook for the current year is hardly awe-inspiring. Share repurchases are likely to be curtailed to conserve cash flow, and households will feel the blow.
Asset disposals and incremental borrowing can no longer support household spending so consumers have to rely on traditional income streams. But here too the trends are not encouraging.
The unemployment rate has already increased by almost half a percentage point from its cycle low and would be higher but for a declining participation rate. Data suggests the labour market continues to deteriorate and, along with rising gas and food prices, the outlook for household spending looks bleak.
The headwinds are showing up in consumer surveys. The US Conference Board's current situation and expectations index dropped abruptly in March. The assessment of labour market conditions deteriorated sharply, while the expectations index fell to its lowest level since 1973. A consumer recession seems inevitable.
[ www.sequoia.ie ]
:quality(70)/cloudfront-eu-central-1.images.arcpublishing.com/irishtimes/VR3765MFOBH2NMV2QNICYDF67M.png)