5 Reasons to Bet on a Consumer Rebound

Is it time to bet on a consumer rebound? Historically, it's never been wise for investors to underestimate the willingness of Americans to spend.

But so far in this recovery we haven't reached the "spending-like-drunken-sailors" stage.

The good news is that we may soon see the beginnings of a splurge, because although the economic recovery has been limp these past few years, there seems to be an important turning point.

Tepid spending, so far. The last couple of years personal spending has been growing at an annualized rate of less than 2 percent. That might sound reasonable, but it's a shadow of the growth we saw before the financial crisis, where it increased at an annualized rate of 4 to 6 percent.

In short, the economy could be a lot better than it is currently.

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"If the U.S. isn't consuming it usually comes down to confidence and uncertainty," says Frances Hudson, global thematic strategist at Standard Life Investments in Edinburgh, Scotland. "Underlying that lack of confidence is that idea that we are still in special measures."

The Federal Reserve has implemented near-zero interest rates since the financial crisis. Whether it wants to or not, by keeping the cost of borrowing money so low, the Fed is signaling that the economy is too weak to make changes.

Improving consumer confidence. But there's the rub, because although growth in consumer spending has been tepid by the standards set before the financial crisis, measures of consumer confidence have been ticking up.

The Conference Board's Consumer Confidence Index has trended higher over the past few months. In general, higher confidence means more spending.

Warmer housing market. The other thing associated with rising consumer spending is home prices, says Eddy Elfenbein, author of the Crossing Wall Street blog.

That too has been doing well. The S&P CoreLogic Case-Shiller 20-City Composite Home Price index has been steadily rising since March 2012. It measures prices changes for residential real estate across major U.S. cities.

Wealth effect. The reason that rising home prices are often associated with increased consumer spending is because of something known as the "wealth effect."

The idea behind the wealth effect is that as the value of a person's assets increases they feel wealthier and then have a tendency to spend more, even when their income hasn't actually changed.

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Certainly, spending was lifted by the housing boom that eventually led to the financial crisis in 2008-2009.

The problem is that the wealth effect also works in reverse. When assets, such as housing prices, decline in value then spending can contract. It's a negative wealth effect. When you feel poorer you spend less, even if your income hasn't changed.

The fallout from the housing bust may just be part of the spending problem we've seen over the past few years. Subdued housing prices may have left many feeling psychologically strapped.

A turning point. But that drag may now almost be over as a turning point is being reached.

Nationally, home prices are almost back at the level they were before the housing bust in early 2006. The S&P CoreLogic Case-Shiller National Home Price index, which tracks residential real estate prices across the U.S., is within a whisker of the level just before the market crashed.

It means the average price of homes in the U.S. will soon have recovered to prices seen a decade ago, if the upward trend continues. That in turn, should feed into a positive wealth effect and increased spending may ensue, although not everyone is hugely optimistic.

"Will it mean they'll spend?" says Terry Gardner, a portfolio strategist at C.J. Lawrence in New York. "The rate of change will be slow and they will be frugal."

That makes a lot of sense, because the Great Recession was a traumatic event for many people that has made many people more cautious than they ever were previously.

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Still, knowing America the urge to splurge is never too far from the surface.

Simon Constable is a columnist and author. In addition to following the financial markets, he likes to watch his cat play with string. You can follow him on Twitter @simonconstable.