Analysis and outlook for the global economy
- An influx of positive U.S. economic data continues to support economic growth and consumer sentiment, but consumer spending has lagged.
- Several U.S. leading economic indicators are showing a strong upward trend, with some reaching new cycle highs.
What it may mean for investors
- We believe that the U.S. economy has ample opportunities for continued growth, supporting our recent economic-growth forecast increase for 2017. We will continue to monitor the trend of several leading indicators as well as how consumer behavior develops over the next few quarters.
Last week, we received an influx of positive economic reports which continue to support our upbeat view on the U.S. economy. Much of the data reinforced our recent 2017 forecast update for U.S. gross domestic product (GDP) growth, to 2.3 percent from 2.1 percent.
Over the past quarter, we have continuously heard from many media outlets how “animal spirits” are high, and how the market is expecting consumer sentiment to sustain growth throughout this stage of the economic cycle.1 In this Global Macro Strategy Report, we explore trends in The Conference Board’s U.S. Leading Economic Index (LEI), which reached its highest level in more than a decade last month. We also discuss the relationship between consumer confidence and consumer spending—and how these two indicators might benefit the U.S. economy.
Table 1. Components of the Leading Economic Index
Sources: The Conference Board, Bloomberg; 2/28/2017.
Tracking the Components of the Leading Economic Index
The Conference Board’s U.S. Leading Economic Index is comprised of 10 individual indicators which are “leading” in nature. These indicators include economic variables that tend to signal directional changes in the overall economy. Therefore, they may be able to give us a sense of the future state of the economy. The correlation among these indicators is strong. This helps explain why so many of these indicators are at cycle highs—and, in some cases, at all-time highs. Thus, it is not surprising that most leading indicators currently display similar trends (Table 1).
We have mentioned in previous reports that we believe the U.S. economy is currently in the latter stages of the economic cycle. This view is corroborated by most LEI indicators, particularly three of them: the S&P 500 Index, consumer and business confidence, and new orders from the manufacturing sector. However, the current business cycle differs from latter stages of previous cycles due to a potential boost from infrastructure spending, fiscal policies, and tax reductions. We anticipate that these policy changes could lead to further economic expansion, and could extend the current economic cycle. However, we would feel more confident about the strength and momentum of the economy if it were to be further supported by consumer spending and additional positive data reports over the next few quarters.
Consumers: Do as You Say, Not as You Do
Over the past few months, we have observed how consumer sentiment gauges from the University of Michigan and The Conference Board continue to rise, particularly regarding the near-term outlook. Although we view this as a positive sign, we would like to see further support from other consumer behavior metrics, including consumer spending and retail sales.
Chart 1. Increase in Confidence Presents Opportunity for Spending
Source: FactSet, data as of 3/20/17.
- Consumer spending: Personal spending rose by 4.7 percent in January from the previous year, yet after adjusting for inflation, it increased by only 2.8 percent. At this stage of the recovery, we would expect a larger increase in consumer spending as was typically the case in previous recoveries. This time around, we suspect there might be a delayed reaction and consumer spending may move higher over the coming months. However, should inflation continue to rise, it could serve as a headwind for consumer spending.
- Retail sales: Compared to the upwardly-revised January numbers, the February retail sales data was relatively weak despite the fact that retail sales had risen by 5.7 percent over sales in February 2016. Our expectation is that we may see an upward revision for February that may help restore confidence in consumer demand during the first quarter of the year.
We believe that the U.S. economy has ample opportunities for continued growth. In fact, we recently increased our GDP-growth forecast for 2017. Easy monetary policies from the Federal Reserve in 2015 and much of 2016 helped fuel a surge in economic data, which, in turn, has prompted several leading indicators to reach new cycle highs. Yet, tightening monetary conditions and gradually rising inflation could serve as potential headwinds to domestic economic growth. We are monitoring the trend of several leading indicators and, more importantly, how consumer behavior develops over the next few quarters, particularly in relation to consumer spending. Should consumers increase their spending as we expect, it we feel it would benefit our tactical positioning favoring the Industrials and Consumer Discretionary cyclical equity sectors.
1 Economist John Maynard Keynes coined the term “animal spirits” to refer to emotional mindsets, and more specifically, to those that describe the human emotion that drives consumer confidence.