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No repeat of 2008 seen with US consumer braced for next downturn

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No repeat of 2008 seen with US consumer braced for next downturn

If the next U.S. downturn looks very different from the Great Recession of 2008/2009, we could have the American consumer to thank.

After entering the financial crisis with record debt levels of 143.6% of net disposable income, U.S. households have been relatively prudent in the intervening years, cutting borrowing to 108.7% as of 2017. While slowing global growth threatens to derail the longest U.S. economic expansion in history, free spending consumers are keeping the specter of recession at bay, pushing up real personal consumption expenditure by 4.7% in the second quarter, the fastest pace in five years.

While Americans' affluence in 2007 was largely bound up in soaring house prices, this time it is more closely linked to equities. That could be a double-edged sword; while their prosperity is less concentrated than 12 years ago, it remains vulnerable to what many see as an overvalued stock market.

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"The key metrics to watch are confidence and financial markets," said Gregory Daco, chief U.S. economist at Oxford Economics. "The reduced leverage and much increased savings are encouraging today, but a sharp deterioration of confidence — because of tariffs for instance — or a pullback in stocks could spell trouble for the U.S. economy in an environment of slower global growth."

Confidence trick

For now, confidence is holding up well. At 135.1 in August, it is just shy of a 19-year high reached in October 2018. Job growth remains robust and unemployment is close to the lowest level since 1969.

The stock market, too, has weathered a turbulent period marked by an escalating trade war between the U.S. and China. The S&P 500 index has rallied 340.4% since the March 9, 2009, low point of the crisis and has rallied almost 19% this year.

However, morale can evaporate quickly. Consumer confidence dropped from 111.9 in July 2007 to 25.3 in February 2009. In 2008, as the financial crisis got under way, growth in consumer spending of 0.6% in the second quarter made way for contractions of 3% and 3.7% in the following two periods.

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Equity market rallies can be equally as susceptible to sudden changes of sentiment. The S&P 500 plunged almost 16% in the three weeks before Christmas 2018 as investors got nervous about excessive tightening by the Federal Reserve.

Consumer is king

That matters more to the U.S. economy than most. Households directly own around 30% of the U.S. stock market, compared with about 12% of shares listed on the London Stock Exchange. A triennial study by the Federal Reserve covering the three years to the end of 2016 found that 51.9% of U.S. households own stocks.

"A downturn which wipes out stock market valuation will reduce the value of assets. But if wealth were stored in other noncyclical assets they [households] may be better off," said Peter Dixon, a senior economist at Commerzbank AG.

The importance of consumers to the U.S. economy is hard to exaggerate. At 68.6% of GDP, the U.S. was the second-most dependent economy on household spending after Colombia in 2018, according to the OECD. That compares with 66.1% for the U.K., 38.7% in China, 52.4% in Germany and 55.5% in Japan.

A key metric to look at when assessing their ability to withstand a downturn, according to Dixon, is the household wealth ratio, which shows net worth as a percentage of disposable personal income.

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This time around households are only slightly wealthier, with a net worth of 684% of income in the first quarter of 2019, compared with a peak of 655.8% in the third quarter of 2007. However, with lower debt levels and a more diversified asset base, U.S. policy makers will be hoping that consumers can absorb the effects of any slowdown or recession.

"What we are trying to show here is whether households have a wealth cushion they can run down in the event that jobs dry up and labor income growth slows," Dixon said.

"What crucified households in 2008-2009 was the collapse in house prices which reduced nonfinancial wealth. Maybe if we don't see the same collapse this time around, they will be better off."

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