If one only looked at the rise of the stock market over the past 10 months and did not pick up a newspaper or turn on a television set, one might think the world was a perfect place to be.
There was seemingly nothing that could put a serious dent in the S&P 500 - not downtrends in employment, income, output and spending, not the ongoing fiscal train wreck in Europe, and not even the thought that the U.S. government could end up defaulting on its bills.
But it's time for investors to acknowledge what is becoming increasingly evident - this U.S. recovery is not going as hoped. Most indicators have already turned lower, making it clear that Washington's round of stimulus last fall only bought the economy three to four months of decent growth.
If you want to know where the U.S. economy is headed, I think it is absolutely imperative to keep a firm eye on trends in personal income and saving. Consumer spending accounts for the lion's share of U.S. GDP, and no strong recovery is possible without shoppers opening their wallets.
Sadly, the prognosis in this regard is not good. When you account for all the influences dragging on U.S. consumer spending, it is clear that we are in for a period of very soft growth.
Among the recent negative influences on consumer spending was the runup in energy prices this year. Higher prices for gasoline and heating fuel cut about one percentage point from baseline growth.
Meanwhile, employment growth has slowed to around 1.5 per cent annually, far below last year's peak of more than 3 per cent.
There is also the little matter of the personal savings rate. From the time the recession ended through to the end of last year, it fell from 6.7 per cent to 5.4 per cent. It went on to decline further - to 4.9 per cent as of March-April.
This shift to lower savings is not at all unusual, given that the household sector felt wealthier, thanks to a rising stock market. But the last notch down in savings probably also reflected a decision by many households to respond to rising gasoline prices by running down their savings rate and trying not to alter their spending habits too much over the near-term.
A reluctance to cut back on spending makes sense if you expect higher gas prices to be transitory. However, it's probably myopic to expect cheaper prices at the pump any time soon. Energy prices have shifted upward on a semi-permanent basis - oil is up 25 per cent from a year ago and up 30 per cent from two years ago. Over time, as consumers recognize this new reality and factor it into their budgets, discretionary spending is going to slow.
Moreover, we can no longer count on households feeling wealthier as a result of stock market gains. The market now seems stuck in a trading range. Three-quarters of the expansion in household net worth in the past year was due to the runup in share prices, and insofar as that is over there is little impetus for spending support from a declining savings rate.
In addition, U.S. house prices are still going down rather than up. This continuing mild erosion in home prices is also going to take its toll on consumer psychology.
To add to the consumer's woes, more than a million unemployed Americans have lost their benefits so far this year. By the end of the year, this alone could exert a drag of around half a percentage point on baseline consumer spending growth - and the baseline is now running at just over a 2-per-cent annual rate.
It is clear that growth in consumer spending is close to stalling. The implications for the U.S. recovery are not good.
David Rosenberg