Buying Time

Consumers and central banks need help from businesses and governments to sustain the economy.

Last week, we learned that the U.S. maintained GDP growth at 1.9% annualized during the third quarter of 2019, beating most economists’ forecasts. It also carried on creating tens of thousands of new jobs in October.

The U.S. has been more resilient than most against the global manufacturing downturn. That owes something to the tax cuts that flowed through its economy during 2018. But it also helps to have the world’s most powerful central bank now cutting rates, and that the country’s GDP comes mostly from services and consumption.

Monetary policy and consumer spending are sustaining U.S. growth. They are just about keeping Europe and Japan in the black, too. The most important thing the world’s shoppers are buying is time—time until business leaders and government find the nerve to invest.

How long can consumers carry the economy alone?

Valedictory

Last week, Brad Tank noted growing resistance against negative policy rates and other elements of aggressive monetary policy. Over the following days, the European Central Bank and the Federal Reserve both indicated that monetary policy might have reached its limits in this cycle.

At a valedictory ceremony in Frankfurt, departing ECB president Mario Draghi made yet another plea for euro zone governments to pull their weight. His successor, Christine Lagarde, has already warned about limits to negative rates.

The Fed cut rates on Wednesday, but Chairman Jerome Powell’s comments about sitting on the sidelines unless a “material reassessment” was necessary were enough to remove a December rate cut from futures markets.

Inflation is below target, manufacturing is in a downturn and there is still uncertainty around a U.S.-China trade accord, but the Fed wants to step back. It appears that central banks are also counting on the consumer to get us through these challenges.

Balance Sheets

On balance, that still looks like a reasonable bet.

Friday’s nonfarm payrolls and wage data showed the jobs market beating expectations. The numbers underlying last week’s headline U.S. GDP data perfectly sum up the current environment: Capital expenditure was down 3% to its lowest level in four years, but this was outweighed by a 2.9% rise in personal consumption, which was comfortably ahead of forecasts. And this is not an unsustainable credit binge: U.S. household debt has been rising, but higher asset prices mean that homeowners’ balance sheets are still in good shape.

That capex data is not an outlier, however. Friday saw the Institute for Supply Management’s (ISM) U.S. Manufacturing Index signal ongoing contraction in business sentiment. The Conference Board’s CEO Confidence Index fell to its lowest level since the depths of the financial crisis in September. Recent Purchasing Managers’ Indices (PMI) show continued manufacturing stagnation in much of Europe, where credit growth has also contracted.

Business may remain pessimistic until it sees support from government. A deal between the U.S. and China would help. But hints of a fiscal stimulus out of northern European countries are still insubstantial, and concerted fiscal intervention is unlikely from the U.S. during an election year.

Out Shopping in the U.S.

Nevertheless, when unemployment is so low, wages are growing at 3% above inflation and consumers are out shopping, it is difficult for the U.S. economy not to grow at a rate close to 2%. That provides meaningful support for the rest of the world.

Again, we do think that’s a reasonable bet—but a bet is not a strategy. Consumers are spending now, but sentiment indicators out of both the U.S. and Europe suggest they may have started to worry about the future, not least because many work in or provide services for the manufacturing sector, and many more are uneasy about political uncertainty as the U.S. election campaign kicks off.

The S&P 500 Index hit another record high last week. It’s a buyers’ market in more ways than one. But we’d like to see more than just the consumer supporting the economy before we assume there’s more upside than downside risk in equities.