US economy is resilient but are markets losing confidence?

After staving off recession for longer than many thought possible, the US consumer is finally about to crack, according to Bloomberg’s latest Markets Live Pulse survey. 

More than half of 526 respondents said that personal consumption — the most important driver of economic growth — will shrink in early 2024, which would be the first quarterly decline since the onset of the pandemic. Another 21% said the reversal will happen even sooner, in the last quarter of this year, as high borrowing costs eat into household budgets while Covid-era savings run down. 

The finding is at odds with the optimism that’s permeated US equity markets for most of the summer, as cooling inflation and low unemployment bolstered hopes for a so-called soft landing. Should the economy stop growing — a scenario that’s quite likely if consumer spending contracts — it could mean more downside for stocks, which have already slipped from late-July highs. 

“The likelihood of a soft landing, falling inflation, an end to Fed tightening, a peak in interest rates, a stable dollar, stable oil prices — all those things helped drive the market up,” says Alec Young, chief investment strategist at MAPsignals. “If the market loses confidence in that scenario, then stocks are vulnerable.”

'IT IS NOT SUSTAINABLE'

Right now, the US economy appears to be speeding up rather than stalling. Growth is forecast to accelerate in the third quarter on the back of a recent pickup in household spending, which jumped in July by the most in six months. 

To some analysts, it looks a bit like a last hurrah.

“The big question is: Is this strength in consumption sustainable?” says Anna Wong, Bloomberg Economics’ chief US economist, who expects a recession to start by year-end. “It is not sustainable, because it’s driven by these one-off factors” – notably a summer splurge on blockbuster movies and concert tours.

The enduring strength of the US job market has propped up household spending in the face of the biggest price increases in decades. It’s led some analysts to push out their expectations for a recession — or even scrap them altogether. 

Economists at Goldman Sachs Group Inc. expect the consumer to outperform yet again in 2024 — and keep the economy growing — amid steady job growth and pay hikes that beat inflation. 

'REALLY STRUGGLING'

But there are plenty of headwinds looming.

Researchers at the Federal Reserve Bank of San Francisco say the excess savings that have helped consumers get through the price spike will run out in the current quarter — a sentiment that three-quarters of the MLIV Pulse respondents agreed with.

“There’s increasingly an issue where the lower end of the income and wealth spectrum is really struggling with the accumulated inflation of the last couple years,” while wealthier Americans are still cushioned by savings and asset appreciation, said Thomas Simons, Jefferies’ US economist.

In the aggregate, consumers have been able to bend under the weight of higher prices, he said. “But there will come a point where that’s no longer feasible.”

Delinquency rates on credit cards and auto loans are rising, as households feel the financial squeeze after the Fed raised interest rates by more than 5 percentage points.

And another kind of debt — student loans — is about to come due again for millions of Americans who benefited from the pandemic freeze on repayments.

A majority of investors in the MLIV Pulse survey pointed to the declining availability and soaring cost of credit — mortgage rates are near two-decade highs — as the biggest obstacle for consumers in the coming months.

Some three-quarters of respondents said auto or retail stocks are the most vulnerable to declining excess savings and tighter consumer credit – a concern that’s not entirely priced in by the markets. While General Motors Co. and Ford Motor Co. have essentially missed out on this year’s wider stock rally, Tesla Inc. more than doubled in value.

'JUST TAKING LONGER'

Since the economy’s fate hinges on what US consumers will do next, investors are looking in all kinds of places for the answer.

Asked what they consider a good leading indicator, MLIV Pulse respondents pointed to everything from the most standard measures – like retail sales or credit-card delinquencies — to airline bookings, pet adoptions, and the use of “Buy Now Pay Later” installment plans. 

That’s perhaps because conventional guides have often proved to be unreliable amid the turbulence of the past few years.

“The traditional playbook for the economy and markets is challenging in this post-pandemic environment,” said Keith Lerner, co-chief investment officer at Truist Wealth. “Things are just taking longer to play out.”