Morgan Stanley
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The Surprising Strength of the U.S. Consumer

With interest rates low, housing markets rebounding and gas prices falling, robust U.S. consumer spending is helping drive stock market gains. Will it last?

Last year, as U.S. manufacturing was weakening amid a global slowdown due in part to trade tensions, I was concerned about what would happen if the strength of the U.S. consumer was not sufficient to keep the economy afloat.

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I’m not worried about that anymore. A host of economic factors are contributing to a healthy U.S. consumer now, and that’s unlikely to abate near-term. The “black swan” (a surprising and unforecastable event) that has contributed to that strength is the human tragedy of the ongoing coronavirus outbreak. It has led to more than 1,800 deaths as well as a slowdown in growth in Asia. 

This black swan event is having ripple effects through markets and global supply chains, particularly in the U.S. The effects in the U.S. include:

  • Lower energy prices: The cost of gasoline, heating oil and natural gas has fallen as fears of a global growth slowdown have led to lower energy demand. Those lower fuel prices mean more money in consumers’ pockets that they can spend on other things.
 
  • Declining mortgage rates: As investors have sought the stability of U.S. Treasuries, bond prices have risen and interest rates have fallen (bond prices move inversely to rates). That means lower mortgage rates, making home buying more affordable. That should add fuel to a housing market that was already recovering nicely. Plus, lower interest rates create the opportunity for many Americans to refinance, also leaving them with more cash in their pockets each month.

  • Financial market gains: Lower interest rates can contribute to gains in stock prices, which are often valued based on their potential for excess return above a Treasury bond. That has helped support stock valuations, which are historically high based on price-earnings multiples. This, in turn, contributes to growth in household net worth, positive consumer confidence and more spending.

Here’s the problem

Our economists believe the virus will ultimately cause global growth to be delayed, not derailed. That means the positive dynamics contributing to U.S. consumer spending may last a while longer, but not forever.

Meantime, I’m concerned financial markets are increasingly fragile. The S&P 500 is very expensive on a price-earnings basis. Also, inflation is quite muted now, but a rebound in global growth could lead to an uptick in inflation and interest rates that markets (and the Federal Reserve) don’t seem prepared for.

I suggest investors keep their eye on inflation and watch for it to start to perk up. Also, consider including energy, commodity and real estate assets in your portfolio. These investments could hold up if inflationary headwinds develop.