According to a report issued by the Federal Reserve, consumer credit contracted for the fifth consecutive month in June. This decline marks the longest sustained drop in available credit to consumers since 1991, and the last quarter was the weakest for consumer credit since 1980. Consumer credit shrank by $10.3 billion for the month or an annual rate of 4.92%. A survey of 33 economists by Bloomberg had predicted that the decline in credit would have been closer to $5 billion, but the actual results were more than twice that amount. With unemployment continuing to grow, as even the better-than-expected month of July saw nearly a quarter million job losses, households are saving more and borrowing less.
Revolving credit lines, such as credit cards, declined for the tenth straight month. Even though credit card companies such as American Express (NYSE:AXP) are starting to show improving charge off rates, they are still high historically speaking. In fact, industry-wide credit card defaults in June were 64% higher than a year ago. We would expect to see the revolving debt continue to decline until the job market turns around, and that could take quite a few more months. Non-revolving debt such as car loans dropped sharply in June as well, but it will be extremely interesting to see how the next few months numbers are effected by the “cash for clunkers” program.
The market has taken off this summer on the euphoria that the worst is behind us, and economic growth will surely return. Of course, we are hopeful that this is the case. However, the Fed’s report on consumer credit suggests that consumer spending will be strained going forward. We think that is will take a considerable amount of time before the average consumer is comfortable spending again. From all the evidence we see, consumers are shrinking their personal balance sheets; personal savings is rising and consumer credit is falling. Even as confidence over the direction of the market has improved for the last quarter or more, these trends are not abating. Home equity loans, which are not tallied in this report, are almost certainly down a lot as home values have drastically fallen and many homeowners are underwater on their mortgages. Wages and salaries have fallen 4.7% over the last twelve months, the most since record keeping began in 1960.
The prospect of a consumer driven recession appear to be getting dimmer instead of brighter. It begs the questions, if consumer spending has accounted for around 70% of our economy, where do we expect to see enough growth to pick up the slack? Manufacturing activity is continuing to decline, so exports will not drive the recovery unless there is a significant further devaluing of the dollar making American-made products more affordable. The obvious answer is that the government will spend enough to pull the GDP up somewhat. That is not exactly the most impressive nor sustainable driver of economic growth.
Nevertheless the market continues to rise, pricing in economic recovery. The latest report from the Fed regarding shrinking consumer credit fortifies our belief that the market is overbought in the short term and a pull back is likely.