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 one. 

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 recession.

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 quarter.
    • 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 Capacity and Confidence

Consumer spending is a function of two components:  Capacity and confidence. 

Capacity

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.

Employment:

Lowest unemployment rate since 1969

Continuing, albeit moderating employment growth

Continuing, albeit moderating wage growth

Savings Rate

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.

Balance Sheet:

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.

Confidence

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 Watch

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 purchases.

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. 

Trade Headlines

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 Consumer

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”.