Before ICSC's RECon, a Consumer Health Check

The mood at next week’s ICSC RECon will be decidedly more positive than a year ago.^† And judging by the most current data, market participants can afford a degree of cautious optimism. Retail transaction activity and pricing metrics are continuing to rise off their lows, albeit unevenly across the national geography. Similarly, property fundamentals are more stable and, for the best quality assets, are showing tangible signs of improvement. Along selected flagship urban corridors – most notably Fifth Avenue below Central Park – recent sales and lease signings have in some cases set post-crisis benchmarks that rival the heady days of 2006 and 2007. Even more significant for the sustainability of current trends, consumer confidence and spending are picking up, in spite of headwinds ranging from worrisome inflationary pressures to the prodding pace of the employment and income recovery.

In Spite Of Things

While government is now a net drag on the economy, the consumer has emerged as a key driver of the still-lackluster return to growth. This is a welcome development since the last year’s shift from public to private and consumer-driven growth was never assured. Concerns about a double-dip in 2010 were largely anchored in concerns about whether we would successfully transition from a recovery fueled by public outlays to a self-reinforcing recovery driven by businesses and households. The latest GDP reports show a surprisingly smooth passage, albeit one lacking in momentum.

For many economists, a clear inflexion in the housing market and markedly stronger employment trends had both been viewed as preconditions of a consumer rebound. In the case of the housing market, the negative “wealth effects” (formally, the wealth elasticity of demand) that accompanied declining home prices have proven an exceptional drag in recent years. In the case of employment trends – and rising wages and salaries, more specifically – the direct income effect of an improving labor market would allow for credit-constrained consumers to spend more while still deleveraging. How is it, then, that consumers are coming on strong in spite of stagnant housing markets and a historically weak recovery in jobs?

The (Not So) Great Deleveraging

As it turns out, very modest improvements in household income and confidence – coinciding with flat housing trends – have proven sufficient to propel spending growth. Home prices are not rising, so there is no positive wealth effect from this asset class. But house prices are generally not in free-fall, either. As a result of our bouncing along the bottom, the housing downturn’s drag on consumer activity has largely petered out.

As part of this equation, a renewed willingness to resort to borrowing amid easing credit availability has also been critical. In its May survey of loan officers, the Federal Reserve reports that the share of banks easing consumer-lending standards was at its highest level since 1994. Even as residential mortgage debt extends its now four-year decline, other forms of consumer credit outstanding are now rising, principally for auto loans and student loans. The hypothesized shift in how Americans think about household debt is difficult to pinpoint in the data. In fact, the historic and much-discussed deleveraging of the consumer balance sheet has been greatly exaggerated – at least outside of the housing sector – both in absolute terms and in term of financial obligations.^‡ In the medium-term, the American consumer’s consistency bodes well for the retail outlook.

† I will be sure to tweet as much from Las Vegas if I am wrong about this.

‡  The homeowner financial obligations ratio has certainly declined, falling from a peak of 17.6 in Q3'07 to 15.1 in Q4'10. The decline is far from historic, however. Its current level is on par with the FOR during the 2001 recession. The simpler debt service ratio is down, as well. Both of these metrics are helped by very low interest rates. Expect them to deteriorate as rates rise.