Consumers Power Economy, Businesses Hesitate

Personal disposable incomes rose 0.2% after adjusting for inflation in November. This marks a slight slowdown from the 0.3% pace of October. Farm income was the largest outlier during the first two months of the quarter as subsidies were paid, offsetting the drop in exports and income that were triggered by our trading partners in retaliation to tariffs. The blow to farmers by a drop in exports to China was particularly large, prompting a surge in farm bankruptcies. (E.g. Subsidies came too late to blunt the pain of a trade skirmish with China.)

Personal consumption expenditures rose at a slightly faster 0.3% after adjusting for inflation. That follows an October surge of 0.6%, and confirms that consumers remain a driver of economic gains. Consumers continued to purchase everything from clothing to cars. Spending on services moderated a bit, but held strong during the month. Travel remains robust.

The saving rate dipped to 6% in November, as consumers relied more on saving and their access to credit to fund purchases. Credit card usage, which has remained much lower than in previous cycles, is returning. Increased use by low income households that have seen the bulk of recent wage gains has been particularly important for retail sales. Consumer spending gains are much more broad based than they were earlier in the cycle.

The personal consumption expenditure (PCE) index, a better measure of inflation than the consumer price index (CPI), edged up a modest 0.1% in November. A drop in energy prices was the primary reason for the moderation in inflation. The PCE index slowed to a 1.8% gain from a year ago. The core PCE, the best indicator of where inflation is headed, edged up a tenth to 1.9% on a year-over-year basis. This is near the Federal Reserve’s 2% target and yet another reason why earlier this week the Fed felt comfortable raising rates for a fourth time in 2018.

Businesses were more cautious than consumers in November. Core durable goods orders, which measures business optimism, fell 0.6% during the month. The good news is that the drop follows an upward revision to October’s rate. The bad news is that shipments, which represent actual business spending, also dropped during the month.

One of the largest outliers to the orders data during the month was an increase in defense spending, largely for aircraft orders. Heading into 2019, a government shutdown in late December could disrupt defense gains; much depends on the shutdown’s length.

Bottom Line
Consumers are still driving economic gains, which is why the Fed felt justified in raising rates. Market concerns are more about the outlook for profits. Margins are expected to be squeezed by a broad spectrum of factors, the largest of which is tariffs and the depressing effect trade skirmishes have had on exports and business optimism about the future. All of these issues explain the market volatility we are seeing.

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