‘The kids are alright’ — especially the wealthy ones

The personal savings rate in the U.S. has dropped sharply in recent quarters and was revised lower still in the latest round of revisions to third quarter GDP. Are financially stressed households dipping into savings? Unlikely. Instead, look to spending habits of America’s well-heeled set to explain the shift in savings.

From very low levels at the height of the debt-fueled boom, the personal savings rate of U.S. households soared in the wake of the financial crisis. Since then, the savings rate appeared to have settled in the 5-6 percent range, until recently that is.

{mosads}Data released by the Bureau of Economic Statistics revealed that the rate of savings fell back to pre-crisis levels by the third quarter of this year.

Financial stress? No.

The rate at which we save is a factor of nominal disposable or after-tax income and nominal consumption. If growth in consumption outpaces growth in income, the savings rate falls (and, of course, vice versa). What makes consumers spend beyond their means? Several factors.

Unexpected costs that force a household to dip into savings, job loss, reduced work hours or any other event that results in a measurable dent to income are an easy few that come to mind.

While these financial stresses can certainly lead consumers to draw down savings, unexpected costs are generally idiosyncratic, and data on weekly jobless claims suggest there is no widespread loss of jobs, certainly not the magnitude needed to show up in the aggregate income data. Moreover, average earnings are still growing and growth in aggregate hours worked remains steady.

Debt-fueled demand? No.

What about debt? Nine years into the economic expansion, are U.S. households now emboldened enough to drive consumption via increased debt levels? To be sure, average household debt is climbing, but to-date, it remains shy of the pre-crisis peak.

Moreover, the Federal Reserve’s aggregate debt-service ratio (the proportion of disposable income used to service monthly debt payments) remains near a 37-year low, suggesting that the consumer is in relatively good financial shape.

Lastly, by our estimate, only about 10 percent of outstanding household debt, which includes mortgages, is subject to a variable rate. In other words, as the Federal Open Market Committee continues to hike interest rates, very little pinch is felt by households in terms of increased interest expense.

U.S. households themselves have broadly corroborated what the data suggests. In November, the University of Michigan’s survey of consumers’ perception of their current personal finances revealed that households broadly feel they are better off than one-year ago.

The wealth effect? Yes.

Why, then, is consumption outpacing growth in income? The answer lies in who is doing the spending, as well as why. When attempting to marry micro data on consumer finances to aggregate data on savings and wealth, Maki and Palumbo (2001) found that it is wealthy households in the U.S. that drive savings.

Indeed, financial assets as a share of net worth tends to map closely (inversely) to the ebb and flow of the personal savings rate.

It turns out that the recent decline in the savings rate among U.S. households can largely be attributed to stock market gains.

Not only is financial market income from capital gains and dividends not counted by the Bureau of Economic Analysis in its measure of aggregate personal income, spending driven by those gains is counted in its measure of consumption. In other words, the wealth effect on consumption is also reflected in the drop in savings.

Should you require additional evidence, consider this: The top 20 percent of income earners in the U.S. represent nearly 40 percent of all consumer expenditures.

We estimate that since late 2016, around the same time the S&P 500 began its latest tear and the savings rate dropped, spending on high-end luxury items such as personal aircraft, pleasure boats and other recreational vehicles, theater tickets, foreign travel, portfolio management services and the like, has likewise experience a renewed climb.

When consumer sentiment is high, and households are spending, economists tend to say, “The kids are alright.” I would take that a step further and say that today, the kids are indeed alright, but 20 percent of them are feeling great.

Ellen Zentner is the chief U.S. economist for Morgan Stanley.