Deteriorating confidence over the last several months has soured the economic landscape. About four months ago, the Conference Board’s Consumer Confidence Index reached an 18-year high. Since then, the gauge has dropped about 18 points, its biggest three-month decline since 2011. Sentiment’s swift decline has caused some to wonder if a drop in confidence could be self-fulfilling, as lower confidence could weigh on consumer spending, and consequently, on output. Historical data show that the U.S. economy has entered a recession an average of 19 months after a peak in consumer confidence, and a drop in sentiment has been a warning sign for past economic cycles [Figure 1].
While confidence shifts can be meaningful obstacles to economic activity, we think the severity of the current decline is due, in part, to temporary factors such as the government shutdown, and the fundamentals are still in place for sentiment to stabilize.
Over the past several months, U.S. consumer sentiment has had to weather increasing trade risk, a 35-day government shutdown, unnerving headlines on geopolitical issues, a slowdown in global growth, and a near bear market in the S&P 500 Index. Many of these headwinds have understandably chilled confidence, and their collective impact can be daunting.
However, we think many of these headwinds will subside in the near term, if they haven’t already. Trade tensions have had a widespread effect on corporate sentiment and economic activity, but we expect meaningful progress toward a U.S.-China trade resolution soon. Government shutdowns, especially when prolonged, have historically dampened consumer sentiment. For example, consumer confidence fell an average of 9.3 points in the final month of the 1995 and 2013 shutdowns, which were both at least 17 days. However, confidence (and economic activity) typically has rebounded after shutdowns, and we expect the same outcome here.
A downturn in major asset prices can also lead to consumers having a decreased sense of financial well-being, which can restrain spending and further reduce asset prices. The S&P 500 posted one of its worst slides of the current bull market in November and December 2018, but we believe stocks have bottomed, and may even make new highs in 2019. The S&P 500 has rebounded 14% since the late December lows, so we could see sentiment turn solely from stocks rallying.
We believe solid fundamentals are especially important during a mature business cycle, a point we’ve emphasized frequently in today’s volatile environment. The bulk of U.S. economic data we’ve seen lately remains sound. The labor market continues to show strength. Manufacturing gauges rebounded last month. Inflation has largely normalized, and it remains manageable. Most important, we still see reasonable potential for a resurgence in capital investment, which could drive higher productivity and help extend the cycle.
Corporate earnings have also signaled the possibility of a longer runway for economic growth. Profit growth for S&P 500 companies recently peaked at 23% in the third quarter of 2018, the quarter before consumer confidence’s latest high. Since 1980, the U.S. economy has entered a recession an average of 28 months after the last earnings peak in the economic cycle [Figure 2].