WASHINGTON – There has been a great divide in the economy in the past few months: Consumers are spending more and reporting having better job prospects and greater confidence about the future; businesses are reporting a pullback in growth and hiring plans and projecting a gloomy tone from the executive suite.
Eventually, business activity will pick up to fulfill that surging demand for consumers or households will pull back as their job prospects and incomes wither; which one happens will determine how the economy looks over the months ahead.
But let’s back up. Why is this divide happening? What can account for such drastically different impressions of what is going on between the living room and the boardroom? There are five answers that seem most plausible, though none is entirely satisfactory on its own.
Corporate executives are deeply attuned to what might happen if Congress and the White House cannot come to agreement on taxes and spending by the end of the year: Dramatic and immediate tax hikes and spending cuts.
The CEO mindset on the cliff has been evident in a spate of third-quarter earnings announcements in the past two weeks; almost uniformly, the executives discuss the looming threat to the economy, usually offering only vague comments that it has been a drag on their confidence and that they don’t know exactly what a resolution would look like. It seems a safe bet that ordinary Americans are spending less time sweating the sequester or panicking over the payroll holiday.
Some companies have responded more concretely to the threat of financial turbulence at the start of the year. General Electric has issued $7 billion in new bonds, essentially getting ahead of the curve by refinancing $5 billion that matures in February and raising more cash on top of that.
We issued it in October so we don’t have to worry about what happens if the fiscal cliff is not resolved, GE’s chief financial officer, Keith Sherin, told the Financial Times. If it’s choppy, we are prepared.
Some of the most gloomy assessments of economic conditions have come from companies that do extensive business overseas. By many accounts, as troubled as the U.S. economy has been in recent months, it looks better than many of its counterparts. The 1.5 percent or so growth that the United States seems to be experiencing is better than the recessionary environment in Europe, and Chinese markets that are growing at something well below the breakneck pace that companies had become accustomed to.
The weakness in Europe was underscored last Wednesday with a new report that Germany’s powerhouse manufacturing sector is contracting. A survey of purchasing managers by Markit Economics showed a surprising drop in an index of business activity, to 45.7 this month from 47.4 in October (numbers below 50 indicate contraction). By contrast, the most recent survey of purchasing managers at American manufacturers (which uses the same scale), came in at 51.5, showing expansion.
In China, the 7.4 percent third-quarter gross domestic product growth rate that the government reported earlier this month would be the envy of any major industrialized nation but was still the lowest in that nation since early 2009, in the depths of the recession.
Executives of larger firms are acutely aware of economic conditions in overseas markets, and these realities are surely affecting their confidence and expectations. American families may only be forced to come to grips with those overseas realities if they lead to job cuts among exporters.
The signs of progress in the housing sector are growing more convincing with every data release: Home construction, prices and sales activity are all generally on an uptrend, if nowhere near back to historically normal levels.
It might be that this is an arena where ordinary Americans have their finger closer to the pulse of what is going on than the executives, and it is making them more confident about their personal financial health and the economy at large.
For families underwater on their mortgages, who owe more than the mortgages are worth, even small gains in what they perceive the value of their home to be – say, a house down the street sells for a little more than expected – can shift their perception of their net worth in a big way.
If the improvement in housing sustains itself and accelerates, it could be a source of strength for the U.S. economy that businesses aren’t yet counting on – a long-awaited surprise from a sector that has dragged on growth for the better part of six years.
The price of gasoline plays an outsize role in Americans’ perceptions of what is happening with the economy. It is a large expense, incurred regularly, and its price has been wildly volatile in recent years.
For businesses, fuel prices are just one more variable and has to be reflected in projections; many companies even use futures markets to hedge against changes in fuel prices. Not many ordinary commuters can do the same.
The price has been moving down a bit in recent weeks, which could account for some of the buoyant sense among consumers. The recent high for national average price for a gallon of unleaded gasoline was $3.871 Sept. 13. The price was down to $3.625 last Tuesday, according to AAA.
But the gas price explanation isn’t entirely satisfying. Analyzing the change in prices against the change in the University of Michigan Consumer Sentiment Index since the 1990s shows that gasoline prices explain only 4 percent of the shift in consumer mood. And the drop in the past month is small enough to help explain only a much smaller improvement in the sentiment index than that reported.
A final, not-entirely-satisfying explanation for the divide is the stock market. The Standard & Poor’s 500-stock index is up more than 10 percent since June 1, a few recent choppy days in the market notwithstanding. The rise occurred despite weak economic prospects, as the world’s central bankers deployed new tools to pump up growth.
Higher stock prices translate into greater wealth in Americans’ retirement accounts and a greater feeling of confidence. The stock market does a slightly better job explaining changes in consumer sentiment than gas prices do.