The Consumption Conundrum: How Credit, Savings, Wealth Effects Sustain SpendingView all comments (0)0GDP, released last Tuesday, showed that the economy grew by a larger-than-expected 4.3%. Powering the strong economic growth was personal consumption, which rose by 3.5%. Consumers are spending!. What’s unusual about that statement is that consumer sentiment remains historically weak.Typically, there is a strong correlation between personal consumption and consumer sentiment. As we share below, the University of Michigan and the Conference Board consumer sentiment indexes are at or near 10-year lows. Moreover, they are generally worsening, yet personal consumption continues to grow strongly.Can such a divergence continue? To help answer that, consider the five bullet points below, which explain why personal consumption has been strong.Wealth Effect: U.S. stock markets will post their third 20%+ increase in a row.Non-discretionary Spending: The mix of spending is leaning towards non-discretionary items. For instance, spending on housing, healthcare, insurance, and travel is increasing as a share of total spending. Many of these expenditures are unavoidable, not confidence-driven impulse purchases. For example, healthcare spending accounted for nearly 20% of consumption.Credit: Rising use of credit cards, buy-now-pay-later, and home equity loans boosts spending in the short term.Savings: Real personal income was flat, thus consumers are using savings, which fell to a historically low 4.7% rate, or credit to meet their needs. Neither is sustainable over the longer run.Inflation: Even if the inflation rate is normalizing, the higher prices of goods and services weigh on consumers’ psyche, in turn making sentiment worse. However, its impact on consumption is not as significant.As shown below, the VIX volatility index spiked in April following the announcement of Liberation Day tariffs. At the time, many pundits, ourselves included, thought the year would be a roller coaster of sorts. Instead, the market steadily advanced, rising almost 45% from the April lows. Similarly, volatility simmered down in the summer months. Heading into year-end, the VIX is likely to settle near the year’s lows.Some view this low VIX level as a sign of complacency. Not surprisingly, after three consecutive years of 20%+ gains, investors are not emphasizing the need to hedge. Between the Supreme Court’s ruling on tariffs, numerous geopolitical risks, a new Fed Chair, and mid-term elections, might next year be the roller coaster ride everyone expected this year?Original PostThe Consumption Conundrum: How Credit, Savings, Wealth Effects Sustain SpendingView all comments (0)0