Consumer Confidence Falls, but Spending Holds Up 

Adam Phillips, Managing Director, Investments

Consumer confidence fell again in September, reaching its lowest level since 2014. But unlike 2014, when confidence was improving following the Global Financial Crisis, today it is moving in the opposite direction.

The weakness extends beyond the headline number. Consumers’ assessment of current conditions declined, as did expectations for the future. Two factors appear to be weighing particularly heavily on households: inflation and the labor market.

One-year inflation expectations increased to 6.1%, up from 5.8% the previous month. Consumer expectations are not necessarily a reliable forecast of future inflation, but they do provide insight into how households are feeling about the prices they encounter every day.

Those concerns come as inflation has outpaced wage growth for five consecutive months. Wages are still rising, but purchasing power has recently been moving in the other direction.

The labor market is creating another source of uncertainty. Layoffs have not increased significantly, but consumers increasingly report that jobs are becoming harder to find. The percentage saying jobs are hard to get rose another 1.6 percentage points last month, reaching its highest level outside the pandemic since 2016.

A weakening labor market does not necessarily begin with widespread job losses. It can show up first through fewer openings, slower hiring, longer job searches and less confidence among employees that another opportunity will be available if they leave their current position.

The Wealth Effect
Despite these pressures, consumer spending has remained relatively resilient.

One reason may be household wealth. Stocks now represent roughly one-third of total household assets, a record share, following several years of strong market returns.

Recent JPMorgan research also points to the growing connection between investment wealth and spending. Net withdrawals from investment accounts have increased from the equivalent of about 3.5% of consumer spending in 2019 to nearly 7% today.

That raises an interesting consideration for investors.

We typically think about the relationship between the economy and financial markets in one direction. Economic conditions affect corporate earnings, which in turn influence stock prices. But that relationship may increasingly work in reverse as well.

Higher stock prices increase household wealth. Greater household wealth can support spending, and consumer spending represents roughly two-thirds of the U.S. economy.

For the past several years, that dynamic has generally created a positive feedback loop: markets rise, household wealth increases, consumers have greater financial resources available to spend, and that spending supports economic growth and corporate earnings.

But wealth effects can work in both directions. A sustained market decline could increasingly affect not only investment portfolios, but consumer behavior as well.

This does not mean we are forecasting a significant decline in consumer spending or suggesting that markets are about to fall. Instead, it helps explain an unusual feature of today’s economy.

Consumer sentiment is weak. Inflation continues to frustrate households. The labor market has cooled. Yet consumer spending remains surprisingly resilient.

Part of the explanation may be that American households have never had this much wealth tied to financial markets. As that share has grown, the line separating what happens on Wall Street from what happens in the broader economy may be getting thinner.

Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA^®), a CERTIFIED FINANCIAL PLANNER™ (CFP^®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio. 

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Video Transcript: 

Adam Phillips:

This week I want to spend a few minutes talking about the consumer, because we got some pretty interesting data on consumer confidence last week, and I think it highlights a growing tension in the economy.

Consumer confidence fell again in September, dropping to its lowest level since 2014. Now, that comparison is interesting because the last time confidence was at these levels, the direction of travel was very different. Back in 2014, confidence was still on the rise following the Global Financial Crisis. Today, it's deteriorating.

And when you look underneath the headline number, there wasn't much good news. Consumers' assessment of their present situation declined, but expectations for the future fell as well. There seem to be two things weighing particularly heavily on consumers right now.

The first is inflation. One-year inflation expectations increased to 6.1%, up from 5.8% the month before. Obviously, that's not a forecast of where inflation is actually going to be. Consumer inflation expectations tend to be heavily influenced by the prices people see every day. But it tells us something important about how consumers are feeling.

And that lines up with another trend we've been watching: inflation has now been outpacing wage growth for five consecutive months. So even though wages are still going up, purchasing power has been moving in the other direction.

The second issue is the labor market. We aren't seeing a significant increase in layoffs. But increasingly, consumers are telling us that jobs are becoming harder to find. The percentage of consumers saying jobs are hard to get increased another 1.6 percentage points last month. Outside of the pandemic, that's now the highest level since 2016.

And I think that's an important distinction. A weakening labor market doesn't necessarily begin with people losing their jobs. It can begin with fewer job openings, companies hiring less aggressively, people taking longer to find work, and employees becoming less confident that another opportunity is waiting for them if they leave their current job.

All of that can affect consumer behavior well before you see a big increase in unemployment. So put this together and you have a consumer who is increasingly concerned about inflation, less confident in the labor market, and whose wages recently haven't been keeping pace with prices.

And yet there's another side to this story. Consumer spending has remained relatively resilient. Why is that?

There are obviously a number of reasons, but one that I think deserves more attention is household wealth. Stocks now represent a record of roughly one-third of total household assets. And after several years of strong market returns, household wealth has increased substantially.

There was some interesting research recently from JPMorgan looking at the relationship between investment accounts and consumer spending. They found that net withdrawals from investment accounts have increased from the equivalent of about 3.5% of consumer spending in 2019 to almost 7% today. In other words, investment wealth appears to be playing an increasingly important role in supporting consumption. And I think that has an interesting implication for investors.

We normally think about the relationship between the economy and the stock market in one direction. The economy affects corporate earnings, corporate earnings affect stock prices, and therefore what's happening in the economy affects the market.

But increasingly, that relationship may also be working in reverse. Higher stock prices increase household wealth. Higher household wealth can support consumer spending. And consumer spending, of course, represents roughly two-thirds of the U.S. economy.

So as households have accumulated more financial assets, the performance of the stock market may actually matter more to the economy than it did in previous cycles.

For the last several years, that's generally been a positive feedback loop. Markets rise, household wealth rises, consumers feel wealthier and have greater financial resources available to spend, and that spending supports economic growth and corporate earnings.

But it's also worth remembering that wealth effects can work in both directions. If markets experience a sustained decline, the impact may not be limited to investors' brokerage statements. It could increasingly affect consumer behavior as well.

None of this means we're forecasting a major decline in consumer spending or suggesting that markets are about to fall. But I do think it helps explain one of the more unusual features of the economy today.

Consumer sentiment looks weak. Inflation continues to frustrate households. The labor market has clearly cooled. And yet consumer spending has remained surprisingly resilient. Part of the answer may simply be that American households have never had this much wealth tied to financial markets. And as that share has grown, the line separating what's happening on Wall Street from what's happening in the broader economy may be getting a little thinner.

That's something we'll continue watching.

Thanks for listening, and we'll see you next week.

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