TIP - Personal Consumption Expenditures: Strong But Vulnerable

2023-11-30 15:15:30 ET

Summary

• Personal Consumption Expenditures, or PCE, data for October 2023 shows deceleration in both nominal and real PCE.
• Real PCE growth has been near the historical median, but durable goods and recreation services have been weak.
• Personal consumption is vulnerable to a significant contraction as it has grown significantly in excess of personal income in recent quarters.
• PCE is vulnerable to behavioral factors that could shift the marginal propensity to consume and/or the savings rate.

Monthly estimates of Personal Consumption Expenditures ((PCE)) contained in the report on Personal Income and Outlays , published by the Bureau of Economic Analysis ((BEA)), constitute some of the most important high frequency indicators of economic activity in the U.S. The value of Personal Consumption Expenditures, represents over 60% of US GDP.

The most recent PCE data, corresponding to the month of October 2023, were published by the BEA at 8:30AM, November 30, 2023. In this article, we will walk our readers through an in-depth analysis of the most recently published PCE data, and then discuss their implications for the U.S. economy and financial asset prices.

Summary Data and Analysis

We begin our examination of the BEAs report on PCE in the month of October 2023, with summary data and analysis which we highlight in Figure 1. We recommend that readers pay particular attention to the percent rank of Month-on-Month (MoM) growth, MoM acceleration, and the surprises relative to forecasts.

Figure 1: Change, Acceleration, Expectations, and Surprise

Nominal PCE decelerated significantly from the prior month (-0.50%) though were in line with expectations. Real PCE also decelerated, but to a lesser extent (-0.17%).

The Impact of Inflation on the Purchasing Power of Personal Consumption Expenditures

In this section, we highlight the impact of inflation on PCE data. Inflation affects the purchasing power of any given dollar amount of money that is spent by consumers. In other words, inflation affects the quantity of goods and/or services that a given amount of money can buy. In Figure 2, we show PCE in both “current dollars” and in “real” terms. The “real” figures adjust the nominal current dollar figures for the changes in purchasing power caused by inflation/(deflation). The purchasing power adjustments to the PCE consumer spending data are made by applying the appropriate PCE price indexes ((PCEPI)), that are published on the same day as the report on Personal Income and Outlays.

Figure 2: PCE in Current Dollars and Adjusted for Inflation

Despite relatively low PCE inflation, Real Personal Consumption Expenditures was relatively weak in October and was particularly weak in the economically sensitive category of durable goods.

For the remainder of this article, all figures will be presented in “real” (inflation adjusted) terms.

Analysis of Annualized Growth of Major Components of Real PCE Over Various Time Periods

In this section we break down Real Personal Consumption Expenditures into major components, scrutinizing their annualized growth rates over various time frames (1m, 3m, 6m and 12m). The purpose of this analysis is two-fold. Our first purpose is to identify which components of PCE are growing at a faster or slower rate than the overall aggregates. Our second purpose is to determine whether, and to what extent, growth rates are accelerating or decelerating over various time frames.

Figure 3: Annualized Growth Rates of Major Components of Real PCE

Real PCE growth has been near the historical median for the past 1-month and 3-month periods. However, growth in durable goods – which are more economically sensitive – has been sluggish during this time-frame. Also, recreation services – a discretionary item – have been notably weak for the past 6 months.

Contributions to Change and Acceleration of Real PCE: Components Analysis

In this section our analysis is focused on the component contributions to the MoM Change and MoM Acceleration that are attributable to select major components of PCE.

Figure 4: Contributions to Change and Acceleration Attributable to Major Components

Virtually all of the deceleration in PCE during the month of October can be attributed to the contraction and deceleration in durable goods consumption – particularly motor vehicles and parts. This may have been due to the effects of the auto strikes. The deceleration in PCE would have been considerably worse had it not been for the positive contribution of Gasoline and Other Energy Goods. Services components showed a pretty broad-based deceleration of growth.

Implications for the U.S. Economy

Personal consumption spending in the U.S. is decelerating – but not yet as significantly as the deceleration in real personal income would imply. Moreover, it is important to note that the most economically sensitive components of personal spending seem to be leading the slow-down in PCE.

All of this leaves open the possibility of a stronger deceleration or even contraction in real personal spending, in the next few months. In this regard, it is important to monitor behavioral variables that could impact the marginal propensity to consume. Anything that would lower the marginal propensity to consume and increase the savings rate could have a severe impact on aggregate personal spending.

Until now, personal consumption spending has remained very resilient in the face of numerous headwinds, including anemic real income growth, more restrictive access to credit and higher interest rates. However, these and other fundamental factors are in place which would cause consumption to pull back rather abruptly if there were a significant shock to consumer sentiment, which lowered the marginal propensity to consume.

Implications for Financial Markets

Financial markets participants are unaware of the gap that has developed between Personal Income and Personal Expenditures. This gap has rendered the economy vulnerable to a shock to consumer sentiment that would cause an increase (even just a normalization) of the savings rate and a major decline in personal consumption spending.

What sorts of factors could produce a shock to consumer sentiment and behavior? Top leading contenders would be a wealth shock due to a decline in stock prices, declines in home values, an oil price shock or a significant rise in unemployment and job insecurity.

While we are not predicting any sort of shock to consumer sentiment, we believe that the U.S. economy and markets are more vulnerable than usual to such a shock.

Concluding Thoughts

As part of our investment discipline, the team at Successful Portfolio Strategy will today be evaluating whether the most recent Personal Consumption Expenditures data – in combination with other fundamental and non-fundamental factors – warrants any changes (tactical or strategic) in our portfolio holdings. Together with the Personal Income data, we believe macro vulnerabilities are rising. The increase in macro risk, precisely at a time when the S&P VIX Index (VIX) and other measures of prospective market risk have fallen to very low levels has created an interesting divergence. We believe that this divergence is exploitable.

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