Some economists have a sense of humor.
One seems to be Herb Stein. President Richard Nixon’s economic adviser is also the father of funnyman Ben Stein.
Many remember him for Stein’s Law, which states: “If something cannot go on forever, it will stop.”
This seems silly yet profound at the same time.
At first glance, we may wonder if it even needs to be said.
Economists often extrapolate current conditions into the future.
Stein’s Law is a caution against that.
It reminds economists to consider additional data to understand if a trend is supportable.
Stein’s Law certainly applies to consumer spending.
Stein’s Law and the Economy
Economists often expect trends to remain steady.
But if spending rises as income falls, the trend in spending is unlikely to continue.
That’s where we are now. The chart below shows spending as the red line.
The blue line is income growth.
Changes in consumer spending have outpaced changes in income since May 2021.
Spending Pace Grows While Income Slows
At first, the gap between income and spending made sense.
The Consumer Spending Gap Can’t Last
The pandemic shutdowns had restrained consumer spending.
Incomes had increased thanks to government stimulus spending.
Because so many places shut down during the pandemic, savings increased.
As the economy reopened, spending soared while income growth returned to normal.
The surge in spending coincided with decreases in savings and increases in credit card debt.
While savings are still high, the balance distributions are not even.
Wealthy households benefited more from the bounce-back economy and still have savings.
Many consumers have tapped out their savings and are now living paycheck to paycheck.
Bottom line: Stein’s Law tells us this cannot continue.
Spending will need to return to the income level, and that adjustment is likely to come sooner rather than later.
The decline in consumer spending will coincide with the recession, which draws closer every day.
Michael Carr is the editor of True Options Masters, One Trade, Precision Profits and Market Leaders. He teaches technical analysis and quantitative technical analysis at the New York Institute of Finance. Follow him on Twitter @MichaelCarrGuru.