By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast
The past pandemic recession saw a dramatic drop in consumer sentiment (as measured by the University of Michigan Survey of Consumers) from February to April of 2020. There was a steeper decline in the Great Recession, but that drop was more protracted than the swift two-month cliff last year, taking almost two years for consumer sentiment to go from peak to trough. Last year’s two-month plummet was the fastest since the 1950s. Following last year’s nosedive, consumer sentiment then started to rebound. From April 2020 to April 2021, consumer sentiment seesawed back and forth, but the overall trend was upward. Since April of this year, consumer sentiment has been on the decline, and the last report saw a recognizable drop from the previous month. According to the report, there were only six other surveys in the last half century that recorded drops that were more significant than last month’s decline.
Another measure of the consumer is the Conference Board’s Consumer Confidence Index. Unlike the University of Michigan Consumer Sentiment survey of only 500 households, the Conference Board surveys 5,000 households. With the Consumer Confidence Index, we are now getting signals somewhat counter to the Michigan Consumer Sentiment Survey. Since January of this year, Consumer Confidence has been on an upward trend and the Index is almost back to the level that existed at the start of last year’s recession.
The question is which do we believe? Does the consumer mood reflect the signals we are getting from the Michigan survey, or are consumers feeling more optimistic, as reflected in the Conference Board numbers? In my view, we have several factors contributing to dampening consumer sentiment in the Michigan survey. First, higher gasoline prices do not put consumers in an ebullient mood. Add the higher prices and availability of some grocery items, and that does not make it better. Second, the Delta variant is not helping. Just when the country was preparing for the end of the pandemic, the Delta variant comes roaring back, putting some plans on hold, and bringing back memories of last year. Third, is linked to consumer behavior and spending related to government stimulus. Do consumers behave differently when spending dollars gained that are separate from earnings through their own labor? My outlook at the beginning of the pandemic last year was that we would see a V shape recovery, but at some point, growth would return to moderating levels, or “gradual growth.” The shift we are seeing in consumer sentiment is linked to that. As households get through the government stimulus phase, and resume spending based on W-2 earnings, more cautious spending patterns will take shape. Consumer optimism will also separate from any boosts that may have been attributed to government stimulus. The last report on retail sales saw a drop, and this was not unexpected.
The important question is whether we are going to see a slowdown in hiring and the overall economy because of shifting consumer sentiment? We will continue to see strong payroll numbers, both nationally and locally, and there are several reasons why. One is the status of inventories which are at very low levels. The ISM (Institute of Supply Management) Index on Customer Inventories is at the lowest level in the history of the series. The macro inventory to sales ratio has shown some incremental gains from the trough but remains low. The current inventory to sales level is comparable to 2012, a big year for Louisville area manufacturing. Another reason for continued growth in payrolls this year is linked to numbers that we should expect to see in labor force growth. For different reasons, labor force growth has been stuck, although we are seeing some signs of progress in Louisville Metro. As labor force growth increases the rest of the year and into next, this will also support overall payroll growth. Gains in productivity due to innovations and technology investments will moderate payroll growth in some sectors, but the overall trend will be positive. Last week saw another decline in new claims for unemployment, now at the lowest level in the pandemic phase of the economy.
Despite some of the conflicting signals on consumer attitudes, the household is still in good shape. Household net worth levels are the highest ever. The increase over the past year and a half is the largest we’ve ever observed, at least going back to the 1940s. Savings rates have come down but are still elevated compared to the past 20 years. Make no mistake, there are certainly risks to the current recovery. The latest Delta variant could place a dent on spending, and government stimulus will likely not come to the rescue. The variant could also serve as a headwind to labor force growth, thus reducing payroll gains. Consumer spending will moderate, but that should not come as a surprise. A moderation will not derail the recovery, and we should not mistake the anticipated slower growth, with an economy in deep trouble. It is just getting closer to normal.
Data sources: FactSet, University of Michigan Survey of Consumers August 2021, Census Advance Monthly Sales for Retail and Food Services, July 2021.