THE BOTTOM LINE: How are Americas consumers holding up?

Americas consumers have been carrying the global economy on their shoulders for so long now that we have come to take them for granted. But the ground has shifted beneath their feet in the last few months, so it is worth keeping track of how they are holding up.

Recent analysis has focused on the collapse of the U.S. housing sector. Housing starts have declined to 1.4 million, from a peak back in January 2006 of 2.3 million, a huge drop. Talk of the housing sector bottoming out is clearly premature, even if starts have. What happens next is that the inventory of unsold homes must be sold, and there are at least 6 months of inventory in the system, (40-50% more than typical) and that assumes that sales do not plunge even further.

So much for housing. The real issue for forecasters is whether this malaise spreads to other parts of the economy. If the housing sector is labouring under a large inventory overhang for the next 6-9 months, house prices might continue to decline. Presently, house prices are running at around 2% below year-ago levels, nation-wide, it is much worse in some regional markets. The effect of falling house prices on borrowing and spending plans is probably just beginning to hit home.

Consumers have remained engaged so far, despite these issues. Consumer confidence is running high, and, in the fourth quarter of 2006, when the housing collapse was front-page news, consumer spending was strong. Importantly, inflation-adjusted growth was even stronger, boosting GDP growth. Falling gasoline prices contributed to this by putting some purchasing power back into consumers pockets. But Christmas also saw extensive discounting by retailers, which means that every dollar spent produced an exaggerated increase in real economic growth.

And then there is the weather. The cold weather since mid-January has erased most memories of the extraordinarily warm weather we saw in November through mid-January. A lot of activity is affected by the weather for example, housing starts virtually stop in some parts of the country in the winter. Seasonal adjustment by statisticians ensures that we can see through these seasonal effects to isolate trends in economic data. But, assuming warm weather boosted housing starts in December, the seasonal adjustment process would automatically inflate that number even more. This is almost certainly making economic growth seem higher than it really is.

All this to say that we may be getting false comfort on the health of U.S. consumers and the economy as a whole from the recent statistics. Indeed, retail sales were flat in January, which may be a better reading than the data from December. The effect of lower gasoline prices is already waning. Income growth is still solid at around 5%, but with inflation running at well over 2% it will not take much of a retrenchment to bring growth in inflation-adjusted consumer spending down into the 1-2% range. This would produce a rude awakening for financial markets.

The bottom line? The U.S. consumer has outperformed expectations so persistently that it would be folly to forecast their demise. Maybe U.S. consumers will keep spending forever but with the negatives stacking up, better to prepare for a retrenchment and then be pleasantly surprised.