Economic Growth: Can the U.S. Consumer Maintain Confidence?

By Aline Wealth Management on October 31, 2019

To suggest that U.S. consumer is the primary driver of global growth may exaggerate the effect of U.S. consumption, but not by much. The U.S. consumer typically accounts for 70 percent of U.S. GDP, and without much help from business investment or government spending in the current environment, the consumer may account for even more than 70 percent of U.S. growth. With the U.S. being the world’s largest economy – and growing faster than the EU, Japan, and the UK – tracing global growth to the U.S. consumer may be an over-simplification, but it’s one with merit.

For the past decade, U.S. consumption has increased along with job growth and wage increases. Now, at 3.7 percent unemployment, job growth is beginning to slow. Slower job growth will lead to slower growth in consumer spending, and, unfortunately, business investment is not poised to pick up the slack if this occurs. At the same time, the U.S. fiscal stimulus has also run its course, and consumer spending outside the U.S. is tepid. Some efforts are being made in Europe, China, and elsewhere to prod slowing economies, but the results are (at least so far) marginal. Without a resolution of trade conflicts or new clarity to geopolitical uncertainties, growth – particularly U.S. economic growth – comes down to the U.S. consumer versus the world.

Let’s Take a Look at Some Data Points:

The International Monetary Fund (IMF) recently lowered its global economic growth forecasts again -projecting a gain of 3% versus their prior estimates of 3.3% back in the spring.  The IMF sees a little better growth in 2020 but this estimate was also revised lower (3.4% from 3.6%) and has begun to describe the current environment as a “synchronized slowdown”.   As stated in the article in Bloomberg: “The revised outlook is already the weakest since the crash 10 years ago, and the risks in the forecast are very much, as economists say, to the downside.”

https://www.bloomberg.com/opinion/articles/2019-10-21/imf-growth-forecasts-world-economy-is-stumbling-toward-disaster

The Organization for Economic Cooperation and Development (OECD) publishes, among other reports and indicators, a Leading Indicator of economic conditions globally and is designed to provide early signals of turning points in business cycles.  As shown in the chart below, the leading international economic indicators for recession have hit levels not seen since the GFC of 2008/09.  Does this mean we are heading towards a recession?  No.  But it does mean that there are concerns out there that warrant our careful attention.

No Help from Business Investment

Economic growth driven by U.S. consumption is frequently complemented by business investment; i.e., businesses respond to a growing economy by investing in capacity, technology, and productivity enhancements to take advantage of greater opportunities to increase sales and improve profits. In the process, this business investment, also known as capital expenditures, adds to the pace of growth.

As is apparent from the above chart, business investment has already slowed, and it seems unlikely to reverse higher. CEOs find few reasons to increase outlay of capital at this point, and there are many arguments to delay such action. The extended length of this recovery may be reason enough for many CEOs to be cautious about making significant investments, as we are potentially nearing the ending stages of this economic cycle. Economic forecasts reinforce this notion: the Federal Open Market Committee projects U.S. growth to slow to 2 percent in 2020 (from 2.2 percent in 2019) and forecast growth of less than 2 percent in 2021 and 2022. Many private economists are even less optimistic.

In addition to concerns that weak U.S. economic growth will delay returns on any significant business investment, CEOs are troubled by other risks. Tariffs, reciprocal actions, and related supply chain disruptions add to uncertainty and encourage inaction regarding business investment decisions. Capital expenditure decisions are further hindered by geopolitical risk, including interruptions to oil supply, protectionist policies driven by populist politics, and increased regulatory actions often aimed at large American companies. It is not surprising that in the third-quarter Business Roundtable Survey, CEO confidence plunged again. Macro-economic research firm Strategas identifies CEO optimism as a leading indicator of capital expenditures, and our impression is that business investment is not poised to contribute much to U.S. growth anytime soon.

As indicated above, confidence among CEOs fell to its lowest in a decade in the 3^rd quarter, according to survey data from the Conference Board, a nonprofit research group (see chart below).  The last time the survey came close to showing these levels of gloom, businesses were still shedding about 800,000 jobs a month because of the recession.  The Duke University/CFO Global Business Outlook stated in the 3^rd quarter that US business optimism dropped to its lowest level in 3 years.  It stated that “a majority of CFOs expect a recession to start before the presidential election”.  Furthermore, the CFO survey has “been conducted for 94 consecutive quarters and spans the globe, making it the world’s longest-running and most comprehensive research on senior finance executives.  Results are for the US unless stated otherwise.”

https://www.cfosurvey.org/press-release/optimism-sinks-to-3-year-low-recession-expected-before-2020-election/

The National Federation of Independent Business (NFIB) publishes an optimism indicator for small businesses – and as these small businesses are the lifeblood of the US economy it is considered an important metric to watch.  As the chart (source: Factset) below illustrates –this optimism index is trending towards the lows back in January.

Additionally, from the NFIB we see the chart below which indicates a reduced appetite for optimism going forward. Small businesses spend their resources to grow but they will only do so when they are optimistic about conditions in the future.  They need (as do markets) clarity and confidence –they retrench on any signals of uncertainty.

In addition to the above concerns and data points we are also witnessing a decline in US home sales, housing starts, core CAPEX shipments/orders, production, and retail sales—and this is all supposed to be happening, if one takes its cues from the stock market’s recent ascent to near all-time highs, in an economic expansion?  Something has to give as this doesn’t make sense. It seems that the economy and the stock market in the US are beating to different drums—and without alignment, there is certain to be uncertainties and surprises.

Economic Policies are Spent

Considering possibilities beyond business investment, economic policies can also promote economic growth. Unfortunately, aside from one more rate-cut by the Federal Reserve (the Fed), there is nothing under consideration in Washington to spark U.S. activity. The benefits of reduced regulation and lower taxes have already been realized. And while infrastructure spending could create jobs and increase GDP growth, focus on impeachment, tariffs, technology regulation, and E-cigarettes will likely preoccupy Washington’s time instead. Infrastructure spending or any other government spending is not a relevant agenda item for Congress this year or in 2020.

On a brighter note, monetary policy has been helpful lately in supporting asset prices, especially in real estate. Home sales and mortgage refinancing both recently improved, as 30-year mortgages rates dropped below 4 percent and 15-year mortgage rates dipped below 3.5 percent. According to the Mortgage Bankers Association, the 1-percent drop in mortgage rates over the past 12 months has allowed mortgage purchase applications to grow by about 9 percent and mortgage refinancing to grow by over 100 percent year-over-year.

The Global Economy Offers Little Support

In our view, there is little hope for meaningful help from other major economies: Germany is already in recession; Brexit difficulties add economic hurdles for both the UK and the EU; China is struggling to manage bank liquidity, avoid falling real estate values, and maintain adequate pork supplies, and Japan continues to live through a seemingly never-ending slowdown. Accordingly, U.S. exports to these countries are unlikely to boost U.S. GDP in the coming year.

The U.S. Consumer: Can it Continue to Provide Confidence and Growth?

With the above in mind, hope for economic growth seems to rest solely with the U.S. consumer. Spending should be supported by higher wages and rising employment, although the pace of jobs growth is slowing. The August jobs-growth report of 130,000 is lower than the six-month average of 150,000 and well below the 230,000 figure from a year ago. At the same time, lower interest rates and a related decline in mortgage rates can allow for greater consumption, as increased home sales often translate into additional spending on durable goods to fill those homes. Lower mortgage rates also enable refinancing that, in turn, increases discretionary cashflow and supports additional spending. Thus, the U.S. consumer, with some help from lower mortgage rates, can be the driving force behind U.S. economic growth.

While we still see increasing confidence among consumers (first chart below) we are beginning to see a reduction in that confidence as the 2^nd chart shows a negative view of future conditions.

That worries us—for coupled with the recent reduction in hourly earnings (chart below) the US consumer may be rolling over as it pertains to its ability to maintain growth for the world.

This sort of reminds me of the Atlas statue in Rockefeller Center in NYC – substitute the US Consumer for Atlas – and you have one being—a deity for sure –with the world on his shoulders.  Can the US Consumer continue to stand and walk tall?  Or is the weight of being the only growth engine on the globe too much for even the mighty US Consumer?

Consumer Caveats

Without support from business investment, fiscal policy, or rising growth elsewhere in the world, subtle differences in consumer balance sheets will have a magnified impact on U.S. GDP growth.

Even without rising inflation, consumers may face other hurdles. Household leverage seems contained, but consumer credit as a percent of GDP has risen to 19 percent; this compares to 15.5 percent in 2000 and 17.5 percent in the months prior to the 2008 financial crisis, according to the St. Louis Fed. Such a high level of consumer credit suggests that consumers may not want to extend credit purchases further. When combined with a relatively low savings rate, consumer appetite for increased spending may be limited, especially if consumers wish to reduce credit-card debt or replenish savings.

Putting it All Together

GDP growth of 2.0 percent for 2020 may be overly optimistic. With most of that growth dependent on the U.S. consumer, forward-looking investors should recognize that there are downside risks to U.S. consumption and the U.S. economic-growth story. Those risks include the impact of rising inflation on consumer spending, the potential end of Fed rate cuts, the absence of fiscal initiatives, and a lack of compelling reasons for businesses to increase investment. The resolution of trade issues with China would avoid some potential inflation pressure and help relieve global trade concerns, but this is unlikely to initiate a flood of additional economic activity and business investment. Other economic and political uncertainties will continue to cloud activity in the U.S. and other developed countries, and help for the U.S. consumer may remain elusive for 2020.

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