Strong consumer spending is driving economic growth, but how much longer will consumer confidence last?
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From the pages of In Business magazine.
American consumers are in a very good mood, if decreasing monetary anxiety is any indication, and they are propping up an American economy in spite of multiple anchors threatening to weigh it down. While one lament about the “Trump economy” is how much economic growth we’ve been sacrificing by engaging in a trade war with China, consumer spending remains the one strong undercurrent that is preventing a slowing but still growing economy from dipping below sea level.
When preliminary third quarter GDP came in at a mediocre 1.9 percent, the lack of business investment was most often cited as the main culprit, but strong consumer confidence was hailed as the savior, and why not? According to the Money Anxiety Index, which measures actual financial behavior, consumer money anxiety declined 2.6 points in the third quarter of 2019, from 43.6 to 41.0, and it reflects high financial confidence which enabled consumers to increase their Q3 spending by a 2.9 percent annual rate.
A declining Money Anxiety Index means higher financial confidence. Right now, this economic indicator is trending in the right direction, and it’s not the only one. In the closely watched University of Michigan index, consumer sentiment climbed higher than expected in November, to 96.8 from 95.5 the previous month. Economists had expected consumer sentiment to slip, but in this particular survey, consumer sentiment has been at 95 or higher in 30 of the past 35 months.
This level of optimism has not been seen since the economically robust dot-com expansion between January 1998 and December 2000, when the index remained at 100 or above in 34 of 36 months. Ironically, both periods featured impeachment proceedings.
Risks from the ongoing U.S.-China trade war and slow global economic growth still could shock consumers out of their optimism, but that hasn’t yet happened. The holiday shopping season will yield more clues, but to avoid a recession in 2020, consumer spending must remain strong.
Staying above water
Led by both consumer and government spending, the nation’s gross domestic product grew at a revised 2.1 percent in the third quarter, up from 2 percent in Q2 but down from 3.1 percent in Q1. As was the case in quarter number two, consumer spending — a key component of GDP, along with investments, government spending, and net exports — led the way. Of those four factors, consumer spending is the largest contributor to GDP, representing two-thirds of the U.S. economy.
With consumer spending — driven by historically low unemployment — as the main ballast, how much longer can U.S. consumers remain confident enough to keep the economy afloat? “It’s hard to know,” says economist Elliot Eisenberg: “Right now, consumer numbers are really good. Job growth came out and it was terrific [in October and November]. There were upward revisions to August and September. That said, job growth is slowing compared to 2018, and wage growth is slowing, too, so there are some problems, but savings rates are high. All in all, American households are in pretty good shape.”
U.S. manufacturing data is weak based on the declining ISM Purchasing Manager’s Index. The trade war and escalating tariffs continued to hammer manufacturing, as national employment in that sector decreased by 36,000 in October but grew by 54,000 in November. As long as the manufacturing and CapEx (business investment) situations don’t get worse, Eisenberg believes that households can keep on going.
Also telling is that the labor force continues to expand, with 325,000 new entrants in October and more than a million since July. As a result, the labor force participation rate rose to 63.3 percent despite the relentless march of baby boom retirements — an estimated 10,000 per day. Still, the labor market is so tight that there are roughly 1.19 jobs for every unemployed person.
While the economy still is growing, it’s late in a long recovery cycle that dates back 10 years. Gross domestic product has weakened from 3.1 percent growth in the first quarter and some signs point to further weakening in the final quarter of 2019. GDP growth is inhibited by weak population growth and weak labor productivity growth, and in an increasingly service-oriented economy, productivity gains are harder to come by.
Since consumer confidence is considered a leading economic indicator, it usually starts to drop about one year before a decline in the economy, and there is no evidence that consumers have soured on the economy, their personal finances, and the buying climate. “When you start slowing down, things can go wrong, but the consumer is a champion now, a super champion,” Eisenberg says.
Although small business confidence also is historically strong, the biggest disappointment of Q3 was business investment, which saw its steepest decline since the fourth quarter of 2015 and a back-to-back decline of greater that 1 percent for the first time since 2009. With respect to business investment and the economy as a whole, a fair amount of hope is riding on the trade talks between the U.S. and China. Eisenberg has been saying a recession could occur as early as the fourth quarter of 2020, but he acknowledges that a trade agreement between the U.S. and China could further extend the recovery.
As more recent negotiations unfolded, Eisenberg acknowledged the trade talks matter because they would bump up gross domestic product by a couple of tenths of a point, boost the stock market, and help CapEx. As our writing deadline approached, another potentially damaging round of tariffs was scheduled to go into effect on Dec. 15, and they would apply to $160 billion in imported goods from China. “The economy can go on without having a trade deal,” Eisenberg says. “You simply don’t want to see the trade barrier problem get worse.”
A good trade deal with China could provide just enough stimulus to ward off recession. “There is nothing single handedly here that will cause a recession, but with weakening growth, poor manufacturing, and higher tariffs — you get the idea,” Eisenberg says. “You’d get a little snowball effect that could, could, could get us there. But all else being equal, no I don’t see a recession in the near term. Trade matters but I still don’t see a recession until the earliest, the earliest, late in 2020.”
In late October, the Fed cut interest rates another quarter point, but Eisenberg believes the benefits of recent interest rate cuts are waning as home construction’s share of GDP has shrunk from about 5 percent to 3.5 percent.
Meanwhile, small businesses have some reason for optimism. According to the National Federation of Independent Business, small firms are eager to hire, but the continuing worker shortage still frustrates them. In November, job creation held steady as the NFIB reported an average addition of 0.29 workers per firm, and while that’s well below the brisk pace set in February 2019, when small businesses reported adding 0.52 workers per firm, it’s up from the 0.12 workers per firm reported in October. William Dunkelberg, the NFIB’s chief economist, says finding qualified workers remains the most-cited business problem, and it serves as a drag on economic growth.
Sixty percent of business owners report hiring or trying to hire in October, but 88 percent of those reported few or no qualified applicants for their open positions. They are attempting to fill positions by increasing compensation, as 30 percent reported raising compensation in October and 22 percent plan to do so in the coming months. “So, they are paying more, which is the way the market should work,” says Bill Smith, president of NFIB-Wisconsin. “If there is less of something, you should have to pay more.”
According to Smith, another emerging issue is the increasing level of uncertainty, and that won’t begin to subside until the trade war comes to an end. “One of the problems with uncertainty is that it’s the enemy of economic progress,” Smith states. “That uncertainty is woven into several different components. One is the tariff issue. A lot of the smaller manufacturers, and probably large manufacturers, but a lot of that part of our economy doesn’t see an end game. The battles continue. The tariff war continues, and it’s an important piece of the uncertainty that’s starting to show up in our economy now.”
The trade war’s impact on Wisconsin agriculture has been well documented, as Wisconsin leads the nation in farm foreclosures. The agricultural economy in Wisconsin is a $105 billion industry, and with the loss of two farms per day on average, that also has a tremendous impact on the state’s small-business economy. “Many of those farms drive the local economy, and as they go out of business and we have fewer of them, it has a negative impact on our Main Street small businesses throughout the state,” Smith notes. “We lose literally thousands of small businesses in hundreds of towns across the state that depend on those small dairy farmers for their economy to be sustained and to hopefully grow.”
Asked whether NFIB members are angry with President Trump for waging the trade war, or whether they understand the importance of fashioning a better deal and are willing to be patient, Smith says it’s a mixed bag. “I think there is some of both,” he states, before adding that NFIB research shows the majority of small business owners (54 percent) believe the tax cuts Trump signed into law had a very positive impact on the general economy and on their own business, and 65 percent said the tax cuts had a positive impact on their personal tax liability.
According to the NFIB, 26 percent of the small business owners who reported tax savings increased spending on employee compensation. “We need to get that renewed,” Smith states. “Those are temporary tax cuts. So, the push now is to make sure those cuts become permanent. That would eliminate another very uncertain component of making decisions on Main Street.”
Based on third quarter corporate earnings, which were down for the third consecutive quarter but not by as much as forecast, recessionary fears had eased by year’s end. Most publicly traded companies beat expectations in Q3, and projected earnings are expected to accelerate in 2020. While some believe expectations are too high, much of the renewed optimism was predicated on a potential end to the trade war between the United States and China.
State of the state
Job growth has clearly slowed in the past year, led by a decline in manufacturing activity. Manufacturing is 11 percent of American GDP, but it’s even more important in Wisconsin, as one in every five jobs in the state reside in that sector. In October, Wisconsin’s unemployment rate ticked up for the fifth consecutive month and now stands at 3.3 percent, compared to April’s rate of 2.8 percent.
Quarterly data released in November shows that state job growth slowed considerably in the first half of 2019. In what some economists consider a sign of labor constraints — simply not enough workers available — Wisconsin finished June with 2,945,000 nonfarm jobs, up 9,340 from June 2018, but that was well below the year-over-year increase recorded the previous June. On average, the state gained 11,000 jobs per month during the first six months of 2019, compared to 28,000 per month in the first half of 2018.
Kurt Bauer, the president and CEO of Wisconsin Manufacturers & Commerce, sensed a slowdown in Wisconsin’s manufacturing workforce, as preliminary monthly data signaled a modest drop. However, a different survey based on a larger sample size indicates that Wisconsin’s manufacturing sector added more than 8,800 jobs by mid-year. Bauer, who sees a lot of “Now Hiring” signs at manufacturing plants, says there is concern among Wisconsin manfucacturers, but it’sbased on more than the effects of the trade war with China.
First, there is the difficulty of replacing retiring baby boomers, which exacerbates factors such as low population growth. In addition, he cites Congressional inaction (until December) on the new trade agreement between the U.S., Mexico, and Canada — 47 percent of Wisconsin exports go to either Canada or Mexico — and what he calls the chilling effect of Gov. Tony Evers’ failed attempts to eliminate the manufacturing part of the state’s manufacturing and agricultural production tax credit. He also cited Evers’ desire to repeal the state’s right-to-work law. From a manufacturing perspective, business operators believe both the production tax credit and the RTW law have made Wisconsin more competitive.
Interestingly, Bauer isn’t as concerned about the lack of a trade deal as he was six months ago because the once-disrupted supply chain is finding other pathways, including nations like Vietnam and Thailand. Interviewed in November, Bauer finds it hard to believe the Chinese government, no matter how much the trade war weakens its economy, will cut a deal before the November 2020 election. “Now, it’s possible because their economy is suffering a little bit and part of that has to be because of the trade tensions between the United States and China, the two largest economies in the world,” Bauer says. “To be honest with you, I’m less concerned about that than I was six months ago or a year ago, and the reason is that trade between nations is very similar to damning water. The water will find another path, and that’s what we’re seeing. Trade is finding other ways in other countries. The supply chain has adjusted, and businesses have adapted remarkably well. They have moved production to other locations.”