Retail chains such as Wal-Mart (NYSE:WMT) have attributed disappointing results for the third quarter to low spending and declining consumer sentiment. The retail giant recently reported a 0.3% decline in U.S. comparable store sales for the three months ending September and released a cautious outlook for the fourth quarter, expecting a 1.4% decline in traffic (read more here). However, data released by the U.S. Department of Commerce indicates that consumer trends are actually improving. Personal consumption expenditures (PCE) for the third quarter were actually up 3% over the same period in the prior year.  Expenditures on durable goods were up 6% while those on motor vehicles and parts were up 7%. Expenditures on items such as clothing and footwear, and food and beverages were also up 2%. Taking into account the real personal expenditures, in terms of chained 2009 dollars, a 2% increase in PCE can be observed over the prior year, with spending on durable goods up 8%. 
Indeed, this trend was reflected in the results reported by card companies like Discover Financial (NYSE:DFS) and American Express (NYSE:AXP). American Express reported an 8% year-on-year increase in average spend per card-member for the third quarter, while Discover reported 3% growth in sales volume. Both companies have similar business operations and earn transaction interchange fees as well as interest on credit card loans from propriety credit cards issued through their banking networks. However, the business models differ substantially. American Express earns 65% of its revenue from transaction fees and 15% from interest income. In contrast, Discover Financial 65% of its income from interest income and 15% from transaction fees.
We expect strong results from both card companies in the fourth quarter as expenditures continue to increase. Both stocks have surged this year, buoyed by strong earnings. American Express is up 50% year-to-date, while Discover has gained close to 40% since the beginning of the year.
- Earnings Review: Operational Discipline Helps American Express Report Higher Margins
- Earnings Preview: American Express’ Fourth Quarter Should Round Off A Tough Year
- Where We Expect American Express’ Revenue Growth To Come From
- How Have Charge-Off Rates For Major U.S. Card Issuers Trended Over Recent Quarters?
- How Much In U.S. Credit Card Purchases Did The Various Payment Companies Process In Q3?
- How Much In U.S. Card Purchase Volumes Did The Country’s Largest Card Issuers Report In Q3 2016?
Salaries Rising While Savings Remain Low
Department of Commerce reports show that personal income in the U.S. was up 4% year-on-year during the third quarter, and grew 1% over the prior quarter. Wages and salaries were up 3%, with a 4% increase in the private industries sector.  The Fed’s monetary policies like the quantitative easing (QE) program and zero interest rate policy have been designed to improve the economy and have had an impact on the unemployment rate, which has improved from 7.9% in January to 7.3% in October.  Low interest rates have also prompted consumers to spend a higher proportion of their earnings. PCE as a percentage of disposable income was 92% in the third quarter, up from 90% in the first quarter of 2011. Personal saving as a percentage of disposable personal income has dropped from 6.2% to 4.7% during the same period.
These statistics indicate that consumer spending will continue to grow through the fourth quarter. However, the results must be read with caution. The labor force participation rate, which measures the persons available for and willing to work and excludes those who are not looking for work, is at a 35 year low of 63%.  This suggests that the decline in the unemployment rate might be due to a rise in the number of potential workers not looking for work. Discover Financial and American Express are generally quite selective with respect to who they offer their cards to. The average American Express household earns about $97,000 per year, whereas the industry average is $71,000.  We believe that the two companies will maintain volume growth through the last three months of 2013 and the next few years.
Discover Maintains Loan Growth Despite Industry Stagnation
The total revolving consumer debt in the U.S. has been constant around $840 billion for the last two years.  However, Discover has maintained a strong growth rate through this period and reported a 4% increase in credit card loans for the third quarter. American Express’ U.S. cardmember loan balance fell by 3% during the same period. Discover’s share of the total outstanding revolving consumer debt has gone up from 5.3% at the end of 2011 to 6% in the last quarter. The company offers lucrative cards with schemes such as 0% introductory APR on purchases for 15 months along with 5% cash back on quarterly rotating categories and 20% cash back bonuses on online shopping. 
Discover’s charge-off rate (percentage of loans that are considered unredeemable) hit a historic low of 2.05% in the third quarter, much lower than the industry average of 3.5%.  We expect a short-term growth rate of around 3% for Discover’s credit card loans, tapering off in the long term.
American Express has also maintained a market share of 6% of the total revolving consumer debt in the U.S. while keeping a low charge-off rate of 1.7%. We believe that it can also show long term growth in U.S. loans.Notes:
- Table 2.1. Personal Income and Its Disposition (A) (Q) [↩] [↩]
- Table 2.8.6. Real Personal Consumption Expenditures by Major Type of Product, Monthly, Chained Dollars (M) [↩]
- U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]
- Labor Force Statistics from the Current Population Survey, United States Department Of Labor, November 21, 2013 [↩]
- Spending by affluent helps Amex to strong quarter, Yahoo News, April 18th, 2012 [↩]
- Consumer Credit Outstanding (Levels) [↩]
- Cash Back or a Low Interest Credit Card, Which is Better? [↩]
- Charge-Off Rate On Credit Card Loans, Top 100 Banks Ranked By Assets, Board of Governors of the Federal Reserve System [↩]