A Risk Lurking in October's Retail Sales (Koesterich)

by Russ Koesterich, Portfolio Manager, iShares

According to the Commerce Department, retail sales rose 0.5% in October, higher than the 0.3% economists had forecast, thanks in part to a large jump in electronics purchases.

The better-than-expected retail sales figures are the latest sign that the US economy is likely to avoid another recession and is experiencing what I’m calling “The Great Idle.” But a look behind the retail numbers also reveals a major risk facing the US economy.

With unemployment still high and wages growing so slowly that hourly workers are losing purchasing power at the fastest rate in 20 years, you may be wondering where consumers are getting the money to buy new cars or the latest iPhone.

As I mention in my recent Market Update piece, it turns out that surprisingly brisk retail spending is being supported by lower savings and by help from the government.

Lower Savings: Despite numerous predictions of a more frugal consumer, the US savings rate is once again dropping. September’s savings rate was 3.6%, the lowest rate since late 2007. In contrast, the personal savings rate averaged 5.1% in 2009 and 5.3% in 2010. For the time being, consumers appear to be maintaining their spending habits by reverting back to an old trick: Saving less.

Government Help: Government transfer payments — such as Social Security, unemployment and disability payments — have spiked in recent years. As I’ve mentioned before, transfer payments now constitute about 20% of disposable income and growth in transfer payments has been the major factor supporting income growth. Since the end of 2007, overall disposable income has risen by slightly more than $900 billion. Of that $900 billion, more than $550 billion has come from rising transfer payments.

Saving less can continue for a while longer, but not indefinitely. More importantly, the US consumer’s reliance on transfer payments shows why investors should pay particular attention to any budget cuts that come out of the Congressional super committee negotiations. Any near-term tax increases or reductions in transfer payments would hit consumers at a difficult time and could act as a drag on an already feeble expansion.

While the current US fiscal situation is also unsustainable, paradoxically, trying to fix it too quickly may raise the odds of another recession.

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