The Great Recession in 2008-09 was extremely painful for many Americans. Its pain was felt by both its depth and its duration – the S&P 500 fell by more than 50% from its October 2007 peak over the next 18 months. It then took another 3 years for the S&P to fully recover in 2012 to its pre-recession peak.
While we’re not out of the woods yet, we are within 5% of the pre-recession market peak. One of the reasons for this swift recovery is the amount and speed of stimulus provided by the Federal Reserve and the federal government. But another key reason for the market turnaround is the U.S. consumer is much healthier today than 2008.
- Consumers Drive the Economy – Approximately 70% of the U.S. economy consists of spending by U.S. consumers. So if you’re looking for clues as to the health of the economy or future direction of the stock market, taking the temperature of the U.S. consumer is a good place to start.
- A Lot of Debt – Looking at the chart, compare the average household’s balance sheet today with 2008. In 2008, household debt was approximately equal to the total goods produced (GDP) by the U.S. in a given year. Much of this debt was due to the real estate bubble that saw many consumers buy bigger houses with less equity down (more debt).
- 2008 – More Debt at Higher Interest Rates – Not only was the average consumer more indebted when the Great Recession began, with the Fed funds rate at 5%, consumers were paying much higher interest costs to service that higher debt load. The higher debt and debt servicing costs took a big bite out of consumers' budget, reducing their remaining spending power (which hurts the economy) and put them more at risk of defaulting on their loans if the economy took a slide.
- Today – Lower Debt at Lower Interest Rates – Today, the average household has 25% less debt as a percentage of 2019 GDP. Additionally, the Fed funds rate was 1.50% when this recession began, which means it's costing the average household much less in interest costs to meet their debt obligations than in 2008 – look no further than the difference in mortgage rates then and now. Higher equity in homes with lower debt and lower debt servicing costs means the average household has more money to spend today (to boost the economy) and is also less likely to default on their outstanding debt – a problem that extended the length and severity of the Great Recession.
- A Note on Government Debt – The chart also shows government debt at a 45 year high as a percentage of GDP. While this level of debt isn’t ideal, it’s more manageable than one might think primarily due to the current low level of interest rates. The government can borrow from 1-30 years presently for an average of less than 1% per year. That’s a very low relative cost of servicing its outstanding debt. The last time government debt was this high (as a percentage of GDP) was following the Great Depression and World War II, which was also the last time the yield on the 10 year treasury bond remained below 3% for 2 decades. The moral of the story, high debt isn’t preferable but can be manageable when interest rates are low. If interest rates were to rise significantly, the cost of servicing this debt would grow much larger forcing the government to reduce its spending elsewhere, which could restrict economic growth.
For investors, the health of the U.S. consumer is critical to the economy and corporate earnings – two large drivers of long-term stock market performance. The improved health of the U.S. consumer should help Americans (and the stock market) weather the current economic recession better than the Great Recession.
Disclosure: The opinions voiced in this material are for general information only and should not be construed as personalized investment advice, including the recommendation to engage in a particular investment strategy. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Rates quoted within are subject to change and, as such, may no longer be accurate. Past performances may not be indicative of future results and may have been impacted by events and economic conditions that will not occur or prevail in the future. No investment strategy can guarantee a profit or protect against a loss in periods of declining values. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those undertaken or recommended by Visionary Wealth Advisors, will be profitable or equal any historical performance level(s).