Most of the U.S. households now possess fewer liquid assets than they held at the onset of the pandemic. This suggests a decreasing financial buffer for U.S. consumers. In today’s FA Alpha Daily, we will talk about how the reduction in consumer spending could trigger a chain of events leading to a recession.
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According to a recent study by the Federal Reserve focused on household finances, the lowest 80% of U.S. households by income have less cash than they did before the pandemic.
The top 20% of households still have excess savings but frankly, that doesn’t make a huge difference.
The top 20% typically aren’t characterized by “excessive” consumption.
What we mean is, that group had enough cash and earnings coming in pre-pandemic that the extra savings didn’t change their spending patterns.
So, it makes sense that they’ve still got cash saved up.
But the other 80% are in trouble. These households now possess fewer liquid assets than they held at the onset of the pandemic.
The data suggests a decreasing financial buffer for U.S. consumers. This is concerning.
Consumers have played a vital role in sustaining the economy this year. Plus, their actions have helped prevent a recession that many had predicted.
As households’ discretionary funds completely run out, there’s good reason to think that will cause an economic slowdown.
As households’ disposable income dwindles, they naturally cut back on spending. Consumer spending is a huge chunk of a country’s gross domestic product (“GDP”), and it’s a primary driver of economic growth. So, when consumer spending declines, GDP and economic growth follow suit.
In addition, when consumers have less money to spend on goods and services, businesses experience reduced revenue.
This can lead to a chain reaction. Companies might slow down production due to decreased demand. This slowdown could potentially lead to layoffs or reduced working hours for employees. And worse yet, it could lead to bankruptcies.
Completing the chain reaction, if folks are laid off, their income drops to zero, and their spending power drops even more.
This is yet another reason for banks to become more conservative in their lending practices.
All these factors, stemming from diminished household discretionary funds, can contribute to economic contraction. This contraction, if sustained over time, will lead to a recession.
And it looks like U.S. households could be the first domino. Now that we’re totally out of the pandemic buffer, it won’t take much to start the chain reaction that will send us into a recession.
That’s why we expect a recession to officially start sometime next year. So don’t get caught unawares. Despite stocks doing quite well so far this year, the 2023 rebound doesn’t look like it’s going to last much longer given all these looming headwinds.
That’s why we recommend staying alert and diversified. It’s unlikely that the types of investments that rallied early this year will keep performing well.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
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