A neat summary of the current state of play

Consumers are struggling

Analysis: Signs of household stress are all around

By Rex Nutting, MarketWatch

Last Update: 12:08 PM ET Jul 4, 2007

WASHINGTON (MarketWatch) -- Just when it appeared the U.S. economy would pick up steam after a year-long soft patch, the U.S. consumer is running out of gas. The signs of stress are all around.

Prices are rising, but incomes and wealth aren't. With most households already overburdened with debt, consumers are being squeezed. There's only one thing to do, even though it goes against every fiber of their being: Cut back on expenses.

Realtors are feeling it, retailers are feeling it, and so are automakers and bankers. Consider this news from Tuesday:

• Sales at retail chain stores continued to weaken in the last week of June. The International Council of Shopping Centers index barely grew week-over-week, while the Redbook index fell to a cyclical low, with same-store sales up just 1.2% compared with a year earlier.
• Vehicle sales declined for the sixth straight month in June. In the past six years, sales have been weaker on only two occasions. At the same time, the automakers have stepped up their production, setting up the industry for another round of layoffs and production cutbacks.
• Home sales fell again in May. The National Association of Realtors said the number of contracts signed on previously owned homes fell 3.5% to the lowest level since the recession.
• More consumers fell behind on their debt payments in the first quarter. The percentage of loans that were 30-days past due rose to the highest level since the recession of 2001.

The news in prior weeks hadn't been much better:

• Home prices fell 2.7% in the past year, the biggest decline in 16 years. A 2.7% drop may not seem like much, but considering how hard it is to get homeowners to accept less than they paid for their house, it's startling.
• Homebuilders got even more depressed about their industry. The housing market index fell to a 16-year low.
• Delinquencies on home mortgages are rising, especially for subprime loans. Unfortunately, delinquencies and foreclosures are also rising for borrowers with good credit who took out adjustable-rate loans. That's unheard of when the unemployment rate is under 5%.
• The stock market, after a nice run up from March to May, has been flat over the past seven weeks.
• Consumer prices rose 0.5% in May, the fastest monthly increase in 17 months.
• Real take-home income (that is, adjusted for inflation) has fallen two months in a row, after a big boost in the first quarter that mostly went to the ultra-rich who received mammoth bonuses and stock options. For the rest of us, the picture is a well-known story around kitchen tables: The median hourly wage, adjusted for inflation, has fallen four months in a row through May and was up just 1.1% in the past year.
• The personal savings rate was negative for the 26th consecutive month in May.

From a distance, everything looks fine. The U.S. economy likely grew at a 3% annual rate in the just concluded second quarter, after stumbling to a 0.7% growth rate in the first quarter.

But the improvement isn't as good as it looks, because much of it is merely a turn in the inventory cycle that has little to do with the strength of final demand. Many companies had reduced their bloated inventories too much, and they began to replenish their stocks in the second quarter in anticipation of a pickup in sales.

The Institute for Supply Management index showed more manufacturing firms increased production than at any time in the past three years, and the net percentage reporting more orders was the most in a year.

But if there is no pickup in sales to U.S. consumers, these companies will find themselves overstocked again unless exports can make up the difference.

That's why the best news this week was the drop in the value of the dollar, which hit a 26-year high against British sterling.

Not all is doom, of course. There's been a steady drop in gasoline prices over the past six weeks, which should give consumers as much of a psychological lift as a fiscal one.

And on Friday, the government will report on job growth in June. All the indications point to another healthy increase of about 130,000 in nonfarm payrolls, while the jobless rate is expected to remain at a very low 4.5%.

As long as consumers are working, they'll keep spending.

All these issues have been mentioned here before. However I would like to add a few points.

• As alluded to in the article 1Q07 saw a draw-down of inventories and consequently low growth. The 2Q07 has seen manufacturers gear-up production to re-stock low inventory levels. Firms could well find themselves over-stocked again if the US consumer decides to take a breather. Thus growth slows again in third quarter as inventories are drawn down again. The longer this cycle goes on the more likely the consumer will run out of breath as the housing market continues to take a heavier toll. The question is will the depreciating dollar be enough to offset an ailing consumer?
  
• Lower production and a tapped out consumer lead to lower earnings. Firms that have propped up their earnings with massive buybacks won't be able to do so indefinitely as earnings dwindle. However they will be helped out by international operations.
  
• Whilst it's true that healthy job creation keeps consumers spending remember that around 150,000 jobs need to be created in the US each month just to keep pace with population growth. So a 130,000 increase forecast for Friday is not that positive and in fact anything less will be a concern.