View: A strong US consumer won't prevent a recession

By Gary Shilling

With the unemployment rate at a 50-year low, the hope is that the U.S. consumer will more than offset an otherwise faltering economy. Don’t bet on it.

Clearly, the broad economy is not only weak, but weakening. The yield curve has inverted, with 10-year Treasury note yields falling below two-year yields. Every time that’s happened in the post-war era, a recession has followed if it hadn’t already commenced. No exceptions.


The Federal Reserve Bank of St. Louis reports that the lower real interest rates are at the time of inversion, the longer the recession and the higher the unemployment rate climbs. The real 10-year yield is minus 0.13%, even lower than the 2.2% that preceded the 2007-2009 Great Recession.

The manufacturing purchasing managers’ index fell further below the critical 50 level in September to 47.8, indicating contraction. Manufacturing employment constitutes just 8.5% of gross domestic product, but add in transportation, warehousing and retailing, the total rises to 30%. Manufacturing jobs in September fell by 2,000, compared with an average monthly gain of 10,000 the past year. The PMI index for services fell to its lowest reading in three years last month.

Indexes compiled by the Federal Reserve Banks of New York and Cleveland that show the probability of a recession are already at levels consistent with a downturn, and the Business Roundtable CEO Economic Outlook survey plunged from 118.6 in the first quarter of 2018 to 79.2 in the third quarter. Industrial production has dropped in the last two reported months. Capital spending is falling due to trade war uncertainties and excess capacity.

A year ago, Wall Street analysts expected S&P 500 Index operating profits to rise 10% this year. But now they look for just a 1.9% gain, and foresee profits falling 4.1% in the third quarter from a year ago, according to FactSet data. Junk bonds are being dumped, pushing the yield spread on company debt rated CCC to 10.7 percentage points from 6.7 percentage points early last year, foretelling earnings weakness. Investors are shunning Uber Technologies Inc., WeWork and other so-called unicorns that have no earnings horns.

Real consumer spending is 70% of GDP and it declined in seven of 13 post-war recessions, though it rose in the other six. Still, even a slowing of growth in household outlays, combined with weakness in capital spending, housing and foreign trade, will push the economy into decline. Job growth is slowing with an average of 154,000 new monthly payroll jobs in the last six months, compared with 204,000 in the previous half-year period. Average hourly earnings growth slowed from 3.2% in the year ending in August to 2.9% in September.

Consumer confidence and expectations can have significant effects on future spending, and both the University of Michigan and Conference Board surveys have fallen in recent months. A year ago, I was a lonely voice calling for a recession to start in 2019. Now, others are joining, and instilling caution in consumers that can be self-fulfilling.

A New York Fed survey shows a precipitous drop in consumer expectations of inflation, and the central bank rightly fears that households will hold off buying in anticipation of lower prices. The University of Michigan survey finds continuing declines in households’ evaluation of buying conditions for vehicles and houses. The survey also found that, as of July, 59% of respondents expect interest rates to fall over the next 12 months, up from 22% in October 2018. Low and anticipated lower rates encourage people to delay spending and increase savings to meet retirement and other goals.

Ongoing polarization of income and assets also means more money for the wealthy, who account for almost all household saving, and less for low-income spenders. The overall household savings rate has climbed from 1.9% in 2005 to more than 8% in August, according to the Bureau of Economic Analysis, and will no doubt continue to rise. Some 28% of Americans have no financial reserves and only 18% can cover six months or more of expenses, according to Bankrate’s Financial Security poll.

Increases in auto, credit card and student loans are pressuring consumers to restrain spending. Total household debt leaped from 65% of after-tax income in the early 1980s to 133% in 2007. Mortgage repayments and write-offs have reduced it, but only to 99%. It will probably return to its long-run norm, especially as the baby boomer generation is forced to save if it doesn’t want to keep working long after retirement age.

Look for weakness in employment and consumer spending in the coming months. That will seal the case for a recession.