The behaviour of the US consumer holds the key over the next 12 months to two years.
History has shown that consumer confidence is a good indicator of the state of the economy.
According to the Conference Board in the US, their consumer confidence survey reflects prevailing business conditions and likely developments for the months ahead based on consumer attitudes and buying intentions and is reflected in their consumer confidence index.
The latter is based on responses to five questions in the survey, which include respondents’ appraisal of current business conditions, current employment conditions and their expectations regarding business, employment and family income conditions six months hence.
Aptly summed up by Wikipedia: “When consumer confidence is high, consumers make more purchases. When confidence is low, consumers tend to save more and spend less.
"A month-to-month trend in consumer confidence reflects the outlook of consumers with respect to their ability to find and retain good jobs according to their perception of the current state of the economy and their personal financial situation.”
Historical trends also indicate that consumer confidence tends to lead company profits in the region of three months.
Company profits rise when consumer confidence rises as consumers make more purchases.
Company profits decline or grow at a slower rate when confidence slows as consumers tend to spend less.
There is also a tendency that the prices of products tend to rise when consumer confidence is strong as the demand for those products starts to exceed the supply and, conversely, prices stabilise or even fall when the demand for the products falls away as consumers spend less as their confidence wanes.
Consumer confidence in the US is currently at the highest level since November 2000 and is fast approaching the highest level reached in May that year.
The current business conditions and current employment conditions are highly supportive of consumer confidence - the US Institute of Supply Management Index, an excellent indicator of economic activity, is at the highest level since January 2011 and rising, while the unemployment rate is the lowest since December 2000.
In addition, the feel-good factor of higher net worth caused by the 33percent increase in house prices on top of inflation over the past six years is a further boost for consumer confidence.
However, US consumers are facing several strong headwinds going forward. They are likely to be disappointed in what transpires over the next few months compared to their current expectations. The cost of goods and services is increasing at a faster rate. Business conditions are likely to cool off as businesses adjust to forthcoming interest rate hikes.
The US economy is effectively in a full employment position and the ability to create more jobs is severely constrained due to the shortage of skills. Furthermore, the cooling-off of the business conditions is likely to result in lay-offs, and family income conditions are unlikely to improve.
The sell-off of stocks and depressed stock prices are also likely to impact negatively on US consumers as their net worth comes under pressure. Consumers’ expectations regarding business, employment and family income conditions are, therefore, likely to deteriorate in coming months.
There are still some positives, though. Despite bottlenecks appearing there is still spare capacity in the US economy. Capacity utilisation is 77.5percent and compares to 80percent in December 2014, after which the US stock market started to lose upward momentum and effectively moved sideways for the 18 months, characterised by heightened anxiety or volatility.
Furthermore, one very important factor is still missing. Despite fluctuations, the trend in the US yield curve as measured by the difference in yield between 10-year and two-year government bonds is still on a downward trend.
The reversal of the trend whereby the yield of the 10-year bond rose faster than that of the two-year bond heralded the end of the upswing in the US economy in July 2000 and also the upswing in 2007. The reversals were also the precursors of major bear markets in stocks in those years.
So, yes, the bull market in US stocks and other world equity markets may have some legs left and the current correction is healthy and much needed, but the bull market is certainly threatened.
It is especially true when a technical indicator such as stochastics, which is based on the movement in stock market price trends, points to a possible increase in spare capacity and therefore slower economic activity.
Are we going to see a repetition of the 2014 slowdown where the US stock market starts to lose upward momentum - as it currently does - and effectively moved sideways for the 18 months, characterised by heightened anxiety or volatility?
Ryk de Klerk was co-founder of PlexCrown Fund Ratings and is currently a consultant for PlexCrown Fund Ratings.
The views expressed here are not necessarily those of Independent Media.
- BUSINESS REPORT