Living on Borrowed Dime

With the price of almost everything rising across the globe over the last 12 months you’d expect consumer spending to slow abruptly at some point. Surprisingly, this hasn’t really happened yet. It’s strange because clearly, the price of key expenses has increased dramatically, from rents and mortgages through to fuel, power, and food. While at the same time, incomes haven’t increased at the same pace. So how is it that spending is being maintained? How is it sustainable?

The answer is simple. It’s not. What we are seeing is a lag effect and consumers failing to adjust their spending to their new reality. You can see it at both the macro and micro level. Consumers are not as resilient as they appear. While they are spending as they have become accustomed to; they are now living beyond their means. To maintain their lifestyle, they are drawing down on their savings and drawing up on their credit cards and mortgages.

They all know they are going backwards and can’t keep it up, so at what point do their spending habits change? After two years of covid restrictions, this year has been about rewards and spending money on holidays and dining out because everyone feels like they deserve some fun. But as financial reality bites and the new year looms I’d expect Christmas to be the last hurrah for the consumer to spend up big. My guess is these changes come in two phases.

Phase one is after the Christmas and New Year break. It may seem simplistic, but consumers and their spending patterns are not a sophisticated collective, they are everyday people trying their best to navigate the pressures of work and raising their family. Sometimes you don’t need to be an expert in finance to see the signs ahead for the economy. Often the drivers come down to basic human emotions, fear, greed, pleasure, and pain. I think this will be how it plays out at the consumer level.

Families are aware of higher costs, they are starting to feel the pinch but not adjusting yet, but the pressure is building. Over Christmas, they will be catching up with family and friends. Topics for discussion will be increased cost of living, fuel prices, food prices, power bills and mortgage interest rates. People previously trying to maintain their lifestyle to ‘keep up with the Joneses’ while slowly sinking will take comfort as they discover that everyone they know is in the same boat. 

Psychologically, being the first to be frugal when things are getting tight makes it look like you aren’t able to keep up with everyone else. But over Christmas, people in their social groups will become comfortable that they are not the only ones, that in fact it’s everyone. People will become more comfortable about cutting back collectively. It’s easier to tighten your belt when everyone else is too.

Just after these family gatherings and social catchup over Christmas comes the one day of the year when people really think about their lives and goals, that’s January 1. New year’s resolutions and a commitment to balance the family budget or at least live within their means will become a key focus. Those that don’t adjust will sink, but either way consumer spending slows.

What does that all mean in practical terms? Consumers spending less directly hits businesses. Sales will fall across the board, though at different rates for different industries of course. Some businesses are better insulated against a slowdown in consumer spending than others. Some businesses are not reliant on households, while other businesses have pricing power.

But you’ve got to keep in mind that the profit equation for businesses has two sides, revenue from consumers buying their goods and services is one part. The other reality is that businesses are getting hit hard with inflation and rising costs too. Power, fuel, and higher interest rates are all hitting the bottom line hard. So, in 2023 businesses will be hit with falling sales as consumers start to dial back spending and higher costs, a double whammy for profit. This leads to phase two of the fall in consumer spending.

Businesses will have no option but to cut costs, ultimately leading to job losses and it will flow on through to a higher unemployment rate which will be a game changer for the economy and the consumer. Rising unemployment will have a dramatic impact on consumer spending not only as people lose jobs and have less money to spend but because it will shake the confidence of consumers even further. They will fear that they may be next to lose their job. That fear around job security will have a very damaging impact on the economy and further consequences for businesses, government and property that will play out over the course of 2023.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.