In the 90’s the catchphrase was, “It’s the economy stupid.” Today wise investors will adopt the catchphrase, “It’s the consumer stupid”. Why?
The U.S. economy is currently a single engine economy driven
by consumer spending. And much like
flying, it is generally better to be supported by two engines instead of
Because of this, the number one economic variable I am
watching today is consumer confidence.
Why confidence? Because consumer
confidence will drive future consumer spending, currently the sole private
engine of economic growth determining whether we avoid or fall into a
Outside of government spending, consumers were the sole
engine of economic growth in the third quarter.
Absent government spending, third quarter GDP growth was a meager 1.55%. That is why all eyes are on the consumer
today: As the consumer goes, so too will
go U.S. economic growth.
- Business investment, which includes investment
in structures, equipment, intellectual property and investment in inventory, again
detracted from economic growth contracting in the third quarter.
- Trade also reduced economic growth in the third
- Conversely, the heroic consumer continued
spending contributing mightily to third quarter GDP growth.
What does the future hold for consumer spending and a result
the U.S. economy? It’s all about
consumer spending capacity and confidence.
Consumer spending is a function of two components: Capacity and confidence.
The consumer’s capacity to spend looks healthy as employment
growth is adequate, consumers are saving more today than in the past, and both
consumer debt levels and debt payments are currently manageable.
Lowest unemployment rate since 1969
Continuing, albeit moderating
Continuing, albeit moderating wage
The personal savings rate was at
8.1% as of August. This is well above
the 4.6% average during the prior economic expansion indicating consumers have the
capacity to spend more by saving less.
Consumer debt as a percentage of
GDP was 76% as of the end of 2018, much more favorable than the 99% level
reached during the peak of the last economic cycle.
Household debt service payments
(the interest consumers pay on their loans) as a percentage of disposable
personal income are more than 13% below the long-term average thanks to today’s
low interest rates.
While financial capacity is a necessity for consumer
spending, it alone won’t cause consumers to spend. Consumers must also be confident. Consumer confidence is what converts financial
capacity into actual spending. How is
the consumer feeling today? Looking at
the levels, consumers are feeling good.
Looking at the trend, cracks are forming.
There are two primary measures of consumer sentiment, one
produced by The Conference Board and one produced by the University of
Michigan, both are surveys of how consumers are feeling. The most important questions in
understanding the likelihood of consumers’ willingness to convert their
financial capacity into future spending are those relating to consumer expectations.
The most recent survey of consumer confidence from The
Conference Board showed consumer confidence remained elevated, but less so as consumer
confidence declined in October.
Consumer confidence has declined three straight months and is now down
more than 7% from its July high. Importantly,
consumer expectations declined at a greater pace having fallen more than 15%
from its July high. I am watching this closely to see both if a. consumer
expectations decline and b. if the rate of decline increases.
The most recent survey of consumer sentiment from the
University of Michigan showed consumer sentiment continuing its rebound. After peaking in May, sentiment fell by more
than 10% through August but has since improved in September and October. Expectations have also rebounded after
falling nearly 15% in August from its May high.
Like the survey of consumer confidence by The Conference
Board, I am watching this closely to see both if a. consumer expectations
decline and b. if the rate of decline increases.
Consumers Put on
To understand the likely path of consumer sentiment, watch
the headlines. Consumers are highly sensitive to headlines. Having limited time to dig into the details,
consumers often take cues from headlines.
Today, as financial market, job market, and trade war headlines go, so
too will consumer confidence, spending, and the economy.
Financial Market Headlines
There is a concept in economics called the Wealth
Effect. The wealth effect is the concept
that changes in household wealth impact consumer spending. The idea is that when consumers are feeling
wealthier, whether it be through rising 401k’s or home values, they are
inclined to spend more. Conversely,
declining stock market values or home prices can make consumers cautious
leading to restrained spending. With
home values relatively stable, if you want to know whether consumers will keep
spending – watch equity market volatility because that will impact consumer
sentiment and their willingness to convert their spending capacity into
Employment Market Headlines
Even if equity markets continue climbing higher, if
headlines surrounding the employment market turn negative or even just less
sanguine, consumer sentiment will also take a hit. If headlines become less optimistic including
highlighting slowing job growth, or especially if they indicate rising
unemployment rates, consumer confidence will take a meaningful hit, a hit which
will be translated into reduced spending.
Concerned consumers are not carefree consumers.
Anytime “war” is in a headline that is not good for consumer
confidence. We’ve now had talk of trade
war in the headlines for well over a year. Tariffs have been cited as a concern
among consumers in the University of Michigan’s sentiment surveys. While it is possible that the equivalent of a
trade truce may be entered into with China, it will leave the most important
issues unresolved creating the potential for ongoing flare ups in the trade
conflict. Additionally, the U.S. is
engaged in a trade war with Europe. And
that’s just today. We may be in another
trade conflict tomorrow.
All Eyes On the
While there are hundreds economic variables to track, with
consumer spending currently the sole non-government engine of economic
expansion, the mood of the consumer is the number one variable to look to for
insights into whether the U.S. will enter into or avoid a recession. As the mindset of consumers goes, so too will
the economy. In the 90’s the catchphrase
was, “It’s the economy stupid.” Today
wise investors will adopt the catchphrase, “It’s the consumer stupid”.