Morgan Stanley
  • Wealth Management
  • Feb 19, 2020

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?

Lisa Shalett Chief Investment Officer, Wealth Management

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. 

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

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