During the current turning point, a splintering is taking place between the consuming and business sectors of the economy. Many firms are experiencing a turnaround in their financial fortunes due to downsizings, layoffs and other cost cutting. This has helped them with profitability. The stock markets have been reacting accordingly, with solid index gains. At the same time, many firms’ inventories have been reduced to the point where they need rebuilding.

Productivity and profitability

The gains in business productivity and profitability are being achieved at the expense of job losses. It is this very effect that is causing consumer confidence to remain low. As the chart below shows, consumer confidence in general continues to sit well below normal levels. Confidence will take a while to recover, since the outlook for employment gains is restrained into the first half of next year. Companies will be quite pleased to see their bottom lines improve as a result of achieving the same or greater output levels with a reduced number of workers.

The latest Purchasing Managers Index (PMI) of the Institute of Supply Management (ISM) is at its highest level since April 2006. The latest monthly reading of 55.7% in October corresponds with an economy that is expanding at a rate of +4.5% annually. The output level of the beleaguered manufacturing sector has now been growing, as opposed to contracting, for the past six months. In addition to the “cash for clunkers” program, officially known as CARS, and inventory rebuilding, a pickup in exports to a recovering world outside the U.S. and the price advantage in global markets that comes from the falling greenback have provided assistance. 

Consumer spending within GDP

Despite the foregoing, the consumer did carry his or her share of the load in the third quarter gross domestic product (GDP) figures. Total GDP change, quarter to quarter annualized, was +3.5% in the July to September period. Personal consumption expenditures (PCE) were almost an exact match at +3.4%. Many individuals did take advantage of ‘cash for clunkers’ and the hard-to-believe low interest rates to make a gas-sipping automobile purchase.

Without the CARS program in the coming months, and given the precarious state of confidence that many consumers still have about their employment prospects, the fourth quarter will be challenged to come up with as good a PCE growth number. Weak consumer spending hurts construction through less retail investment and less need for production capacity expansions.