by Brian Pretti CFA, Contrary Investor. March 13, 2009
The wonderful folks at the Fed just released their once every three year Survey of Consumer Finances a few weeks back. Just a few highlights if you don’t mind. The period covered in the current survey was 2004-2007. Although well in arrears in terms of information we hope is meaningful to our current circumstances, it’s the change in character evident in these numbers over the last decade that we believe is most important. Right to the bottom line, as we survey the numbers we believe consumers are going to have a much tougher time “bouncing back” in the current cycle than has been the case in prior cycles. Wild revelation, right? And it’s not just because household liabilities and debt service payments are much higher today than was the case in prior Fed surveys. Income, and specifically the wealth demographic differentiated distribution of income, is a major issue for the here and now, as well as looking forward.
Let’s start right here. As a forewarning, a lot of charts follow. The Fed tells us, “the median value of real (inflation adjusted) family income before taxes was little changed” in the 2004-2007 period relative to the prior three-year time frame. They go on to say that, “in contrast to median income, mean income climbed 8.5%. The increases were most striking for families in the top 10% of the distribution of net worth.” The results are clear in the chart below.
Without question we would home in on the median numbers in terms of longer-term trend applicable to a broad cross section of the US payroll base. The mean numbers are very heavily influenced by the higher end professional community. Certainly during the ’98-’01 period, tech professionals as well as the Wall Street/financial sector crowd helped skew mean income growth numbers meaningfully higher, as well as subsequently skew them lower in the ’01-’04 period with the dotcom and Wall Street busts at that time. But the ’04-’07 period numbers are certainly an eye opener in terms of disparity. If they don’t speak to the massive wage gap domestically, we just don’t know what does. Once again, there is no question that salaries in the financial sector drove the character of the ’04-’07 numbers. Have no worries, that’s not about to happen again any time soon.
But stepping back, it’s really no wonder US households in general took on a lot of debt in the current decade. Why? Their real wages for all intents and purposes have been stagnating decade to date, and modestly deteriorating over the ’04-’07 period. We need to remember that payroll employment growth in the current decade stands in vividly stark contrast to the four decades that preceded the present. With lack of growth in payrolls and paychecks, to be specific, the only stopgap in terms of lifestyle maintenance was increased leverage. The aftermath of which we are contending with now. The following chart could not be clearer on this issue of wildly subpar job growth relative to historical experience. This far into the preceding four decades, payroll employment decade to date had grown at least 15%. In the current? Less than 5%.
During the current period covered in the Fed survey, the increase in family net worth was indeed respectable, but without question it was largely driven by the real estate/mortgage credit bubble. As you can see in the next chart, median family net worth climbed at a rate outstripping the mean. This is because real estate makes up a much larger proportion of middle to lower family wealth demographic balance sheets than is the case at the upper end of the spectrum. The Fed details this in their report. In fact, what is a bit striking is the level of real estate as a percentage of total family assets at the top end of the wealth demographic.
|Family Income Characteristics: Percentile Of Income||House Value As A % Of Total Assets|
|Less Than 20%||47.1%|
This also explains why mean net worth growth in the ’98-’01 period far exceeded the median numbers – the wealthy have much more stock exposure than is the case at lower levels of the wealth strata. In the clarity of hindsight, during the current cycle low end consumption was hurt first with real estate price reconciliation that has already been ongoing for a number of years now. But the implosion in the equity markets since the summer of last year is now attacking the higher end of wealth demographics.
Fact: From year-end 2007 through just the third quarter of 2008 (latest available numbers from the Fed), household net worth declined just over 9%. Without question that decline will move easily into double digit territory with official fourth quarter numbers. In other words, has the decline in household net worth since year end 2007 pretty much wiped out the bulk of the gains achieved over the ’04-’07 period shown above? That’s exactly what has happened.
So when we step back a bit and look at the combo of Fed numbers regarding family income and net worth, and try to bring those trends and numbers forward a bit, we’re left with a picture of households struggling to achieve real income gains while their net worth has backtracked to roughly early 2004 levels, and just not that far away from what was seen at the conclusion of the prior decade. Unfortunately what remains is the leverage taken on to achieve that temporary real estate driven net worth gain that has now vanished. We can see exactly this below.
There is a lot of additional information in the Fed Consumer Finances survey if you’d like to peruse it. You’ll find it at the Fed’s website. But for us, we need to keep the messages and focal points simple. THE issue we take from reading the entirety of the report is that the character of employment and wages will be extremely critical variables for households, and by extension the macro US economy, as the current cycle continues to unfold. Leaked internal memos ate Citicorp just aren’t going to do the trick in terms of healing. We have been harping on this pretty heavily over the recent past. Although we sincerely hope we are wrong, all of the historical relationships we have reviewed convince us wage growth is about to come under very serious pressure domestically. And it’s clear from this current Fed report that in inflation adjusted terms, US wages have already been under pressure during the current decade.
© 2009 Brian Pretti