Consumers Not Ready To Commit

9/13/2010


By definition, the recession is over, with expansion of gross domestic product in each of the last four quarters. But to a lot of Americans, the downturn doesn’t feel finished.

The tale of today’s economy revolves around two players, each following its own path.

For businesses, the picture is modestly positive. Inventories are building slowly, and orders for manufactured goods rose slightly in July, suggesting optimism is on the rise. However, U.S. businesses remain cautious with their money, as orders for core capital goods fell 8% for the month, the largest decline since the start of 2009.

Corporate profits have been strong in recent quarters, and U.S. businesses appear to be on increasingly solid footing. Unfortunately, the same cannot be said for the consumer.

Spending on capital goods was trending higher before the unexpected decline in July. Generally, hiring follows a rise in investment spending. But the July declines do not bode well for the labor market. Blue Chip Economic Indicators economists expect the unemployment rate to remain above 9% through the end of 2011, reflecting a muted recovery in the labor market.

Weakness in the housing market and stocks’ declines from April highs have consumers worried about their current wealth. Weakness in the labor market has consumers worried about their future earning power. Measures of consumer sentiment, such as surveys and data on spending, suggest that those worries are translating into fiscal conservatism that, while likely to improve household balance sheets, will not stimulate the economy.

Consumer spending accounts for about two-thirds of the U.S. economy, and if individual Americans continue to sit on their wallets, economic growth will have trouble meeting consensus estimates, which call for expansion of about 2.6% in the second half of this year and at least 2.8% in 2011.

The torrid growth in corporate profits this year is not likely to repeat in 2011, while spending on personal consumption is expected to rise. The Blue Chip consensus projects spending growth of 2.5% next year, up from 1.7% this year. While such an increase may not sound like much on the surface, consumption spending topped $9 trillion in the year ended June. When you consider numbers that big, an extra 0.8% can mean a lot for companies dependent on consumer spending and the firms that supply those companies. History suggests 2.5% growth is well within reach. Over the last 50 years, consumption spending has grown at an average annualized rate of 3.4%.

Of course, we’re still a long way from 2011. The consensus projects corporate profits, as measured by the U.S. Bureau of Economic Analysis, will climb 6.9% next year, down from the 8.7% growth expected in January and the 26.5% expected for 2010. Estimates for 2011 are rising, but at a slower pace than 2010 estimates.

Are the estimates for personal consumption and corporate profits reasonable? Yes. Is there risk to those estimates, particularly for personal consumption? Certainly. And recent action by the economists in the Blue Chip consensus suggests they recognize that risk. Expectations for growth of GDP and consumption spending have fallen in recent months, and further declines would not be a surprise.

For hints about the direction of the economy, pay attention to the consumer and stock-market indexes. Businesses have at least partially bought into the idea of a recovery, and if the consumer gets on board and starts to spend, businesses in turn should step up their hiring.

For now, the University of Michigan and Conference Board indexes of consumer confidence remain below long-term norms. Key drivers of consumer confidence include the stock market, the cost of energy and consumer goods, the labor market, and the housing market. Inflation appears to be under control, but the jury on the other three drivers is still out. Developments on all three fronts will affect what the consumer does in the year ahead.


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