By: David Joy
Chief Market Strategist
Columbia Management

Pace of recovery hinges on consumers

The advance estimate of second-quarter U.S. gross domestic product (GDP) confirmed the deceleration of the economic recovery. It fell to an annual growth rate of 2.4 percent, down from 3.7 percent in the first quarter and 5.0 percent in last year's fourth quarter. The report reinforced some trends that have been well in place, and revealed others that are perhaps beginning to emerge.

Personal consumption rose for the fourth consecutive quarter, but the rate of growth slowed as the consumer sector remained under pressure. The contribution from the change in inventories also slowed to the smallest since the recovery began. The trade deficit widened, further detracting from the period. Export growth continued for the fourth consecutive quarter, but was overwhelmed by the fourth consecutive quarterly increase in imports. And strength was evident in capital spending, especially in the equipment and software category.

On the other hand, there was evidence of a reversal in non-residential structure spending, which rose for the first time since the second quarter of 2008, while residential investment grew for only the second time since the fourth quarter of 2005, suggesting a possible bottoming in construction activity. While this improvement is welcome, the level of spending remains depressed. Spending on non-residential structures remains 31 percent below its Q2 '08 peak, while residential activity is still 55 percent below its peak in Q4 '05.

The key question is whether the second quarter represents a so-called soft patch from which the economy will re-accelerate, or whether the headwinds of high unemployment, consumer deleveraging, expiring stimulus spending and the prospect of higher taxes conspire to keep the recovery sluggish.

The consumer sector will largely dictate the outcome. Somewhat encouraging was the third consecutive quarterly increase in disposable personal income, which led to a savings rate of 6.2 percent. So, consumers continue to repair their balance sheets, and although this retards economic activity in the near-term, it is building the wherewithal to spend in the future. For how long the de-leveraging process among consumers persists is uncertain.

Federal Reserve data on consumer credit in June will be released this Friday, and is expected to show another month of contraction, making the second quarter the seventh consecutive period of decline. The last time consumers de-levered for an extended period was during the time of the 1991 recession, when credit outstanding fell five times in seven quarters. Of course, this time around the contraction is proving to be far more pronounced.

After an unprecedented 16 years of uninterrupted expansion in credit, including the 2001 recession — when consumers would normally retrench — the corrective process has further to run. The household financial obligations ratio tracked by the Federal Reserve, a broad measure that includes mortgage debt payments and other financial obligations as a percent of disposable income, peaked at 18.9 percent in the second quarter of 2008, and had fallen to 17.4 percent by the end of this year's first quarter. While the use and availability of credit varies over time, it is interesting to note that during the last extended period of consumer deleveraging, this ratio peaked at 17.5 percent in Q4 1989 and corrected to 16.1 percent by Q4 1993, a period of four years. Including the second quarter, the current period of deleveraging has, so far, run for less than two years and began from a much higher level. And if we and we are headed back to 1993 levels of indebtedness, it has a lot further to go.

The July employment report is also scheduled for release on Friday, and is not expected to show any acceleration in job creation. The consensus expects that approximately 90,000 private sector jobs were created, while overall job loss totaled 65,000, owing to a loss of census workers. The unemployment rate is expected to rise to 9.6 percent. If the actual report is anywhere close to forecast, then it will provide little encouragement that the consumer is about to awaken in any meaningful way.

Important disclosures:

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.

Investment products, including shares of mutual funds, are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.

Securities products offered through Columbia Management Investment Distributors, Inc. (formerly known as RiverSource Fund Distributors, Inc.), member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC (formerly known as RiverSource Investments, LLC).