Consumers are optimistic, and businesses aren’t: Five reasons for the divide

October 24, 2012

There has been a great divide in the economy in the past few months: Consumers are spending more and reporting better job prospects and greater confidence about the future; businesses are reporting a pullback in growth and hiring plans, and projecting a gloomy tone from the executive suite.

Eventually, business activity will pick up to fulfill that surging demand for consumers, or households will pull back as their job prospects and incomes wither. One or the other will determine how the economy looks over the months ahead.

The divide was highlighted in Wednesday’s statement from the Federal Reserve’s policy committee, which concluded a two-day meeting. “Household spending has advanced a bit more quickly,” the committee said in describing the economy in recent weeks, while “growth in business fixed investment has slowed.”

But let’s back up. Why is this divide happening? What can account for such drastically different impressions of what is going on between the living room and the boardroom? There are five answers that seem most plausible, though none is entirely satisfactory on its own.

Staring over the cliff

Corporate executives are deeply attuned to what might happen if Congress and the White House cannot agree on taxes and spending by the end of the year: dramatic and immediate tax increases and spending cuts.

The CEO mindset on the fiscal cliff has been evident in a spate of third-quarter earnings announcements in the past two weeks. Almost uniformly, company executives discuss the looming threat to the economy, usually offering only vague comments that it has been a drag on their confidence and that they don’t know exactly what a resolution would look like. It seems a safe bet that ordinary people are spending less time sweating the sequester or panicking over the payroll holiday.

Some companies have responded more concretely to the threat of financial turbulence. General Electric has issued $7 billion in bonds, essentially getting ahead of the curve by refinancing $5 billion that matures in February and raising more cash on top of that.

“We issued it in October so we don’t have to worry about what happens if the fiscal cliff is not resolved,” GE’s chief financial officer, Keith Sherin, told the Financial Times. “If it’s choppy, we are prepared.”

Looking overseas

Some of the gloomiest assessments of economic conditions have come from companies that do extensive business overseas. By many accounts, as troubled as the U.S. economy has been in recent months, it looks better than many of its counterparts. The 1.5 percent or so growth the United States seems to be experiencing is better than the recessionary environment in Europe. And Chinese markets are growing well below the breakneck pace companies had become accustomed to.

The weakness in Europe was underscored Wednesday with a report that Germany’s powerhouse manufacturing sector is contracting. A survey of purchasing managers by Markit Economics showed a surprising drop in an index of business activity, to 45.7 this month (numbers below 50 indicate contraction). By contrast, the most recent survey of purchasing managers at U.S. manufacturers, which uses the same scale, came in at 51.5, showing expansion.

In China, the 7.4 percent third-quarter gross domestic product growth rate the government reported last week would be the envy of any major industrialized nation. But it was still the lowest there since early 2009, in the depths of the recession.

Executives of larger companies are acutely aware of economic conditions in overseas markets, and those realities are surely affecting their confidence and expectations. U.S. families might be forced to come to grips with those overseas realities if they lead to job cuts among exporters.

Housing is humming

The signs of progress in the housing sector are growing more convincing with every data release. Home construction, prices and sales activity are all generally up, if nowhere near back to historically normal levels.

This might be an arena where ordinary people have their finger closer to the pulse than executives, and it is making them more confident about their personal financial health and the economy at large.

For people who owe more than their mortgages are worth, even small gains in what they perceive is the value of their home — say, a house down the street sells for a little more than expected — can shift their perception of their net worth in a big way.

If the housing improvement sustains itself and accelerates, it could be a source of strength for the U.S. economy that businesses aren’t yet counting on.

It’s a gas, gas, gas

The price of gasoline plays an outsize role in Americans’ perceptions of what is happening with the economy. It is a large expense, incurred regularly, and its price has been wildly volatile in recent years.

For businesses, fuel prices are just one more variable and have to be reflected in projections. Many companies even use futures markets to hedge against changes in fuel prices. Not many ordinary commuters can do the same.

The price has been dropping a bit in recent weeks, which could account for some of the buoyant sense among consumers. The national average for a gallon of unleaded gasoline reached a recent high of $3.871 on Sept. 13. The price was down to $3.625 Tuesday, according to AAA.

But this explanation isn’t entirely satisfying. Analyzing the change in prices against the change in the University of Michigan Consumer Sentiment Index since the 1990s shows that gasoline prices explain only 4 percent of the shift in overall consumer mood. And the drop in the past month is slight enough to help explain only a much smaller improvement in the sentiment index than that reported.

Stock market rising

A final, not-entirely-satisfying explanation for the divide is the stock market. The Standard & Poor’s 500-stock index is up more than 10 percent since June 1, a few recent choppy days in the market notwithstanding. The rise occurred despite weak economic prospects, as the world’s central bankers deployed new tools to pump up growth.

Higher stock prices translate into greater wealth in retirement accounts and more confidence. The stock market does a slightly better job explaining changes in consumer sentiment than gas prices do, accounting for 11 percent of the change since 1990.

Still, one might expect businesses to respond even more enthusiastically to the rise. After all, when investors pay more for shares of a company, it translates into a lower cost of capital for the firm, which should then mean more attractive investment opportunities.

Even on a psychological level, corporate executives tend to have more wealth concentrated in stocks than the average person, including stock options in their own companies. So one could imagine their sensitivity to an improvement in the markets to be greater than most.

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