As investors stepped away from their computers during the holidays, they may have failed to notice an absolutely stunning headline. In the days before Christmas, the Federal Reserve announced that a typical U.S. household spent 10.6% of its after-tax income on debt payments in the third quarter. This measure, known as the debt service ratio (DSR), includes mortgages, credit card bills and other legal debt obligations. You have to go far back to find the last time the DSR was so low — to 1983, in fact.

Falling Debt Service Ratio

Add in non-debt measures, such as rent and car payments, and the figures get adjusted to 15.7%, which also stands at a nearly 30-year low. A pair of factors get the credit: reduced borrowing as many families have held off spending during the past few years to shore up finances. And low interest rates that have enabled many homeowners to refinance mortgages at historically-low borrowing costs.#-ad_banner-#

Lesson learned
The steady reduction in debt comes as no surprise. Americans had become so profligate in the middle of the past decade that their debt-service ratio soared to a stunning 19%. But even with stronger finances, consumers remain reluctant to spend. Many still own homes now worth much less than five years ago. And the value of homes, along with investment portfolios, are the two key assets that provide consumers with a sense of well-being.

Surely, many consumers have taken note of their rising retirement fund balances as the S&P 500 notched another double-digit gain in 2012. And now, home prices have begun to rise in many markets as well. Indeed, a further recovery in the housing market in 2013, with many mortgages moving from “underwater” to “above water,” is likely to be the key psychological catalyst that triggers more robust consumer confidence–and spending. 

For those households that have held off on non-essential purchases, 2013 may be the year when they finally start taking more extravagant vacations, upgrade their wardrobes or even shop for a new home. With personal balance sheets in better shape, consumers could afford to take up debt service levels to 17% and still remain below the 20-year average. That 130 basis point expansion in debt service levels equates to roughly 8% higher consumer borrowing. And that 8% growth in borrowing could really give the U.S. economy a welcome jolt.

It’s hard to overstate the power of U.S. consumer spending, which accounts for two-thirds of the U.S. economy. For that matter, a number of our trading partners also count on the United States (which still accounts for 25% of global gross domestic product (GDP)) for robust export opportunities. In a virtuous cycle, rising demand from U.S. consumers could trigger a fresh wave of capital investments among our trading partners, many of which utilize U.S.-made machinery to make all those consumer goods. 

For investors, the coming years should prove to be quite fertile as many consumer-facing businesses build a head of steam. But selectivity will be crucial. For example, many retail stocks have already anticipated such a rebound. 

For example, the SPDR S&P Retail Index ETF (NYSE: XRT), which owns a wide range of consumer-facing businesses, is already more than 50% higher than it was in 2006 when it was first launched. That means digging deeper into retailers to find industry laggards that have been brutalized by the Great Recession, but would surely benefit from further gains in retail spending. Retail comeback stories I’m watching include:

• JC Penney (NYSE: JCP)
• Casual Male (Nasdaq: DXLG)
• CitiTrends (Nasdaq: CTRN)

If history is any guide, then homebuilder stocks may have more robust upside than retailers, simply because sector share prices remain far below their peaks of the past decade. However, few expect (or want) a return to the housing boom of the past decade, with all of the excesses it wrought, so it may be awhile before share prices return to prior peaks. As is the case with retail, many homebuilding stocks have sharply rebounded in recent years, so selectivity is crucial.

Roughly a month ago, I noted four housing-related stocks that appeared to cover robust growth and reasonable valuations.

14 million and counting
The U.S. auto industry is surely roaring back to life as consumers start spending again. The industry likely sold more than 14 million units in North America in 2012, and analysts think that figure could top 15 million in 2013 (which would still be below the 17 million annual sales rates seen in the past decade).

Yet automakers are closely watching the U.S. housing recovery as rising new construction activity tends to trigger a wave of pickup truck purchases. These option-laden trucks carry profit margins far above the margins generated by smaller cars like the Ford Focus of Chevy Malibu. In effect, the auto industry may sell a few more vehicles in 2013, but the improving sales mix could give a huge lift to margins. 

Add in the fact that the European operations of Ford (NYSE: F), GM (NYSE: GM) and their many parts suppliers are starting to shrink in line with tepid demand (Ford, for example, is closing three European plants during the next 18 months), and the profit drag from that region should soon abate. Shares of Ford and GM have started to move up off of their lows, but remain sharply undervalued in the context of mid-decade earnings.

Risks to Consider: As Washington addresses the budget mess, taxes could rise and government spending could fall, creating a drag on the economy. That may provide a modest headwind for consumer spending in 2013.

Action to Take –> This is a great time to start researching all kinds of consumer-facing businesses. Many of them have been operating in a lean fashion for the past few years, awaiting signs of life in terms of consumer spending. That day may be at hand, and consumer discretionary stocks may prove to be the most fertile investment sector of 2013. On a broader level, many countries and industries across the globe are likely to benefit from a resurgent U.S. consumer. Indeed, this force may be strong enough to finally break the global economy out of its current malaise.

P.S. — It’s finally here… our Top 10 Stocks for 2013. Since we first began publishing this annual report in 2003, our picks have beaten the market seven out of the past nine years… including average annual gains of up to 38.7% in a single year. Go here to learn more.