The outlook for profits depends on the strength of the underlying economy. Photo: AP
The outlook for profits depends on the strength of the underlying economy. Photo: AP

OPINION: US consumers have gone cold, but will global markets follow?

By Ryk de Klerk Time of article published Aug 23, 2018

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JOHANNESBURG - Despite a red-hot economy, consumers in the US have gone cold. The University of Michigan’s consumer sentiment index in August fell by 2.7 percent to the lowest level in 11 months. The number was significantly lower than economists’ expectations of a 0.6 percent increase in sentiment from July to August.

But what is the significance of the number? You may ask.

I follow the Conference Board’s Consumer Confidence Index instead of that of the University of Michigan.

Using the drop in the latter’s index as guidance for what the Conference Board’s Consumer Confidence Index will be for August, it indicates that consumer confidence has fallen close to the lowest levels since the end of last year.

Now, we all know that the levels of stock markets and, therefore, the valuations of these markets depend on the outlook for profits a year or two down the line.

The outlook for profits depends on the strength of the underlying economy, which is dependent on the ability of consumers to spend and their spending habits.

It is no wonder that the valuation of the US stock market as measured by Robert Shiller’s Cyclically Adjusted Price Earnings Ratio of the S&P Composite Index is virtually a mirror image of the Conference Board’s Consumer Confidence Index adjusted for inflation.

The Nobel laureate uses smoothed real earnings over a 10-year period to eliminate the fluctuations in net income caused by variations in profit margins.

Over the past 16 months, the inflation- adjusted Consumer Confidence Index has moved sideways in a relatively narrow band, and the cyclically adjusted price earnings (Cape) ratio of the S&P Composite Index caught up with the confidence index in September last year when it recorded a level of 30.6 as the S&P Composite index appreciated by nearly 7 percent.

Since September last year the Consumer Sentiment Index went sideways, while the S&P Composite Index appreciated by another 12 percent, taking the Cape ratio of the S&P Composite Index to 32.5, meaning that the stock market had run ahead of the underlying economy.

A similar pattern emerged in the US housing sector, where home prices in real terms (adjusted for inflation) and measured by the Shiller US Real Home Price Index track the inflation-adjusted consumer confidence index. However, it does appear that home prices in real terms are marginally overpriced.

US stocks were and still are the main beneficiaries of President Donald Trump’s protectionist agenda.

He has kept to his campaign pledges to prevent American jobs from being lost due to unfair global trade.

He is threatening China with tariff increases on virtually all Chinese exports to the US, and in March he imposed tariff increases on imported steel and aluminium. Furthermore, he is threatening any country or economic region with sanctions if they carry on buying petroleum products from Iran after early November.

While he has backed off from increased tariffs on steel imports from the EU countries and is probably trying to get better trade terms with virtually all countries, he forced the world to the brink of a trade war.

The world’s second-largest economy, China, is feeling the heat of Trump’s agenda, while other emerging economies came under severe pressure.

Even developed economies such as Australia are not unscathed, as growth in the manufacturing sector sagged to a near two-year low, while, according to JP Morgan, the rate of global manufacturing expansion in August hit its lowest reading over the past year.

The similarities of Trump’s protectionism agenda and what happened in the late 1920s are very interesting.

In 1928, Herbert Hoover promised to help beleaguered farmers by increasing tariffs of imported agricultural products, and won the presidential race in that year. Apart from increasing tariffs on primarily agricultural goods, the version of the act passed by the House of Representatives in May 1929 included industrial goods, which was met by retaliation threats by the US’s trading partners.

Just like now, the global economy was faltering and, according to records, by September that year, the threats of retaliatory actions were ignored.

September 1929 also marked the top of the US market, and October/November marked the stock market crash of 1929, followed by the Great Depression.

The similarities between what happened in 1929 and what is currently under way under Trump do not end there, though.

When Hoover was elected as president, the Cape of the S&P Composite Index stood at 25, while it was 27 when Trump was elected.

When the US stock market peaked in September 1929, the Cape of the US market was 32.6, compared to 32.3 currently.

The October to November 1929 crash took the Cape ratio down to 21.2 as the US bourse tumbled more than 34 percent.

The Smoot-Hawley Tariff Act that raised import duties to protect American businesses and farmers was only signed into law in June 1930.

The ramifications of an all-out trade war on the global economy and financial markets therefore appear long before the actual event.

US’s strong hand

Although US equity markets may continue to be boosted by the US’s strong hand on tariffs and sanctions, as it is likely to enhance company profits and underpin household income, it is clear that uncertainty in regard to the road ahead is already taking its toll on the American consumers.

It has become evident that the raised tariffs on US imports from China are not having the effect that had Trump hoped for.

According to Fung Business Intelligence (, the price index for US imports from China fell to a five-month low in July, mainly as a result of the depreciation of the Chinese yuan against the greenback. Most importantly, they think that after the US tariffs on Chinese imports kicked in in the first week of July, it was likely that Chinese suppliers would lower the prices of their exports to keep prices down and remain competitive in the US market. Furthermore, the strong dollar is a headache for US policymakers as it encourages imports, and not only is the prospect of higher employment levels waning, but US consumers are getting worried about keeping their jobs.

Ryk de Klerk is an independent analyst. Contact: [email protected]

The views expressed here are not necessarily those of Independent Media.

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