Economic Growth: The U.S. Consumer vs. The World

By LCK Wealth Management on October 14, 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, 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.

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 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 forecasts 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.

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. Investors are hopeful for additional rate-cuts, but the Fed has so far suggested a different path. While there may be one more cut in 2019, there is no indication that the recent two rate-cuts are the beginning of a long-term policy shift; rather, the Fed has described recent reductions as an “insurance move.” Confirming this idea, the September FOMC Dot-Plot projections reveal that no Fed member foresees more than one more rate-cut over any time horizon, which implies that the Fed is not planning to spur growth through a program of gradually lower rates.

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: Reliable but Challenged

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.

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. For instance, while wage growth has increased, core CPI (inflation) is up 2.4 percent year-over-year and is trending higher; this is the fastest annualized growth rate since 2008, and tariffs that are just now hitting consumer products could exacerbate the situation. If tariffs are applied to auto imports, inflation measures will adjust higher, and economic projections will adjust lower. At that point, concerns about stagflation – the anti-intuitive combination of slow growth (stagnation) and rising prices (inflation) – will unfold, as rising inflation erodes consumer purchasing power, especially in the context of a slowing economy.

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. 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.

Portfolio Considerations

1. Investors who are concerned about potential risks to consumption, including slower jobs growth, potentially higher inflation, and extended credit-card debt can consider an overweight to non-durables (consumer staples) companies that produce products consumers regard as necessities in any environment.
2. If inflation can undermine economic growth and investments that are dependent on growth, an allocation to inflation-protected securities may be prudent to help hedge against rising inflation and the impact it could have on other investments.

3. Gold may be an interesting strategy to address both the potential for rising inflation as well as the downside risks to economic growth. Any expansion of global tensions related to oil, rare earth elements, or trade wars would also be an environment in which gold would outperform.

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