Consumer Is King
They say Wall Street makes money and Main Street makes everything else. While investors should indeed pay attention to big-picture news out of New York and Washington, D.C., they can't afford to lose sight of developments in Peoria, Ill.; Tucson, Ariz.; and Charleston, S.C.
Consumer spending accounts for more than two-thirds of U.S. economic activity, which explains the importance of keeping up with the health and attitude of consumers. When they're confident, they tend to spend more, and consumer spending is a key driver of corporate profits. With that in mind, let's examine the state of the consumer through four lenses:
1) Job growth. Nonfarm payrolls have expanded by an average of 204,000 jobs per month over the last year and 223,000 over the last three years. Along the way, the unemployment rate dipped below 5% for the first time since early 2008. With wages also starting to rise, the labor market is sending out bullish vibrations.
2) Individual investor sentiment. While consumer sentiment doesn't always move in lockstep with investor sentiment, consumers are also investors. The latest American Association of Individual Investors Sentiment Survey found 31.3% of respondents bullish versus 26.8% bearish. Bullishness has hovered below the long-run average of 38.5% for most of the last 18 months, reflecting skittishness about the stock market that a six-month uptrend hasn't calmed.
3) Consumer confidence. A 2011 study in the International Journal of Economics and Finance found that consumer confidence and stock markets enjoy a symbiotic relationship. Consumers tend to interpret market returns as a leading indicator of the economy's direction, while confident consumers tend to invest more. Given this correlation, we're somewhat surprised that the two most commonly cited indexes of consumer confidence haven't risen over the last six months, a period of strong stock returns. However, confidence is higher than it was a couple years ago.
4) Consistent GDP growth. The U.S. economy has delivered six consecutive years of modest growth, never higher than 2.6% or lower than 1.6%. Not in at least six decades has annual GDP growth been confined to a range of less than a single percentage point in six straight years. The Blue Chip Economic Indicators consensus projects growth of 1.5% in gross domestic product this year and 2.2% next year.
Economic data doesn't tell a seamless tale about U.S. consumers — it rarely does. The robust labor market suggests consumers can continue to drive the economy, yet they remain somewhat nervous about whether the good news can keep coming.
At the moment, we're holding about 19% of our recommended lists in a short-term bond fund. But with the Dow Industrials and S&P 500 Index reaching new record highs last week, a bullish move in the Dow Transports above their April 20 closing high of 8,109.19 would spark us to boost our equity exposure.